How to Move From Pay-Equal to Performance-Based Comp

QUESTION FROM A READER:  Our 10-partner CPA firm has had a modified pay-equal compensation system for a long time.  We finally seem ready to move to a performance-based system, but there is a lot of anxiety over how to do it.  What’s the best way to pull this off?

SOLUTION.  Read on for a dozen recommended steps when moving from pay-equal to performance-based partner compensation.

Educate partners on the downsides of non-performance-based systems.  Even though the partners may say they favor a performance-based system, they are still anxious about it, mainly because they wonder how their income will be affected.  Partners need to be educated on the harm that a pay-equal system does to firms.  This way, there is no going back.  Some of the downsides are failure to reward top performers, encouraging and rewarding complacency, stagnation of the firm and lack of partner accountability.

Performance = production metrics PLUS intangibles.  The partners must understand and buy into this concept.  The production metrics in this formula are Finding (bringing in business), Minding (size of client base managed) and Grinding (billable hours).  But there are several other intangible performance traits that make firms successful such as firm management, helping staff learn and grow, teamwork and many more.  The partners need to understand and accept this concept.  Also, each partner should understand that they should have different goals and expectations.  Partners should not be, and are not, clones of one another.

Avoid comp formulas.  For accountants, formulas seem intuitive, logical, fair and prevent arguments.  But nothing can be farther from the truth.  Formulas cause partners to game the system by hoarding clients and billable hours, failing to recognize performance intangibles, and encouraging “I” vs., “We” thinking.  There are many other flaws. Don’t negate the courage shown by your partner group in committing to performance-based compensation by adopting a formula as your first choice.  Resist this temptation!

CPA Partner Compensation:  The Art and the Science explains ►partner comp 101 ►all 12 systems used by firms, ►how to design your firm’s system ►open vs. closed systems  ►the role of “book of business” ►differences between large and small firms’ systems ► the MP’s compensation ► trends and controversies  ►best practices

Get partner buy-in to the comp system selected.  Most humans, especially those as intelligent and self-confident as CPA firm partners, are more likely to commit to a change if they feel involved in the review process instead of having the change stuffed down their throats.  So, make sure the group has a thorough and spirited discussion of the major performance-based alternatives such as compensation committee, formulas, MP-decides and paper & pencil.

Give strong consideration to the compensation committee approach.  My mother used to say “if everyone started jumping off a tall building, would you?”  In other words, before making a decision, give careful thought to what’s best for you instead of blindly doing what everyone else does.  Having said that, at the risk of mildly contradicting my dear mother, you need to know that 82% of all multi-partner accounting firms with 13 or more partners use a compensation committee to allocate income.  There are good reasons for this. Make sure the partners know this statistic. Firms use the CC method because it enables the firm to recognize both production and intangibles. The firm puts the compensation process in the hands of a small number of very wise, credible people.  The CC approach is great for aligning the firm’s strategic plan and vision with how the partners are evaluated and compensated.  And, the CC approach is not a formula.

Get partner consensus on the most important performance traits.  Candidates are finding, minding, grinding, managing the firm, delivering great client service, mentoring and development of staff, teamwork, work ethic, and client retention among others.

Assure that the CC won’t operate as a smoke-filled back room.  CCs are doomed without good communication between the committee and the partners.  Partners need to know what’s expected of them at the beginning of the year and how their comp was decided at the end of the year.  Assure your partners that the CC is committed to good communications with the partners, throughout the year, on how their comp will be determined.

Transferring clients.   In virtually every situation where I have helped firms move away from a non-performance-based system, there are cases where some partners really manage the full relationship with clients and have done so for many years, but the client still resides on the client run of the originating partner.  This practice has a very practical basis:  Partners want as much credit for clients as they can get in order to benefit compensation-wise.  Usually, once a firm changes to performance-based, the partners often agree that clients should be transferred around but are anxious that this will reduce their compensation.  The CC must assure that transferring clients will not negatively affect their compensation.

Buyout considerations.  Many buyouts for departing partners are based on their compensation.  So, naturally, when a comp system is changed, the firm must consider the impact on buyouts.  The impact of the change could have a dramatic effect on the buyout if the compensation of the partners is way out of line.  Many firms address this by “freezing” the partners’ buyout under the first system so that they don’t lose retirement pay.  Going forward, the impact of relative partner compensation is fully implemented.

Resist separating the comp committee from the executive committee.  I see this a lot.  A firm has finally, courageously, made the leap from pay-equal to comp committee.  But they’re anxious to see how it will work.  One way to make the change feel safer is to make the CC and the EC separate, ala the separation of powers in the U.S. constitution.  In their eyes, this prevents the CC from making a “power grab.”  This is a big mistake.  If the EC is doing its job, it is an active and critical arm of the firm’s top-level management, working in concert with the MP.  Part of the EC’s job is their continual observation and assessment of how everything in the firm is working, from marketing to training to recruiting to quality control to profitability and yes, the performance of the partners.  For the EC do this job year-round and then suddenly, cede control over compensation at year-end to an ad-hoc panel makes no sense.  It is the EC along with the MP that is most familiar with the partners’ performance.  Why deprive the income allocation process of this knowledge by creating a temporary comp committee whose members know relatively little about the details of each partner’s performance?

Seek support.  Making the leap from pay-equal to comp committee is a big change.  The partners, including the newly formed comp committee, may understand the concept behind the new system.  But there is a natural feeling by the CC of being overwhelmed.  The biggest question we hear is: “After the CC thoroughly studies the performance of each partner, how do we actually put an income number next to each partner’s name?”  This is where the help of an experienced CPA industry consultant can help.  Ask one of these people to attend the CC meetings for the first year or two to provide counsel and advice.  This will help immensely.