Operating a Compensation Committee Like a Well-Oiled Machine

Allocating partner income used to be a science. Now it is a fine art. Not too long ago, the majority of firms allocated income with some combination of a formula (eat what you kill), ownership percentage, and seniority. Few compensation systems recognized subjective factors such as developing staff; firm management; teamwork; achieving formal, written goals; and performance appraisals.

The change over the last 20 years has been dramatic. Systems for allocating income based on both objective (production) and subjective factors have shifted sharply to subjective systems, mostly compensation committees and, to a lesser extent, a one-person committee consisting of the managing partner. Here’s the evidence (all data from the Rosenberg Survey):

Why firms use compensation committees

• It’s the best of all systems for achieving a balance between traditional production (finder, minder, grinder) and subjective or intangible factors. One reason for this is that highly credible comp committee members are free to use their best judgment in recognizing performance factors instead of being bound by rigid rules and formulas.
• Comp committees, if operated properly, align the firm’s strategic plan and vision with how partners are compensated. If the partners don’t execute the strategic plan, who will?
• Formulas have well-documented flaws. Perhaps the most prominent is that formulas promote “me” vs. “we.”
• There isn’t anything better. Not by a longshot.

Here’s the wrong way to operate a compensation committee

1. The CC operates as a temporary jury, in session after year-end meeting for just a few hours or a couple of days at most. Not enough time to plan their approach and carefully study performance data.
2. The CC “shoots from the hip.” They look at data that is regularly available to all partners; no special efforts are made to collect the data needed to fairly assess performance. They sit around a table, talk a bit and agree on the income allocation. Cut and dried.

How to Operate a Compensation Committee is for firms that have come to understand that compensation formulas don’t work because they fail to recognize critically important performance intangibles. They have heard that larger, more progressive firms use compensation committees to allocate partner income, but they don’t understand how to operate such a committee. Don’t let an outdated comp formula hold your firm back. Order your copy today!

Topics include: Characteristics of a good system • Structuring partner compensation • The vital link of compensation to strategic planning and to partner goal setting • The critical role of effective communication in the success of comp committees and pitfalls to avoid • Guidelines for the make-up of the committee and how partners become committee members • Performance criteria for partners • Open vs. closed compensation systems and other key considerations shaping the landscape

Characteristics of a good compensation committee

1. The compensation of 99% of the world’s executives is based on the subjective judgment of management, not some sort of formula or non-performance-based factors such as ownership, pay equal or seniority. CPA firms should operate the same way.
2. Those serving on the CC are highly credible partners whom the other partners trust implicitly to make fair, unbiased decisions.
3. The CC makes a sincere effort to collect all pertinent information, not just the regular stuff, which forms the basis for making compensation decisions.
4. The CC’s work is not defined by a few hours or a couple of days. Instead, it’s performed over a period of months.
5. Compensation changes aren’t simply handed to each partner on a slip of paper. They are explained and are thus much more acceptable than those cloaked in mystery. Also, like any performance appraisal system, communication with each partner is designed to improve their performance.

Tips for operating a compensation committee based on our experience in the trenches

Walk before you run. This is especially important for firms operating their first or second year with a CC. Avoid taking on too much. Less is more. Perhaps goal-setting and partner evaluations are too much to do right away, especially if the firm has never done them.

Don’t let the full partner group defang the CC by creating excessive, rigid guidelines for the CC to follow. Firms opt for the CC because they believe this body is capable of making sound judgments on their own with minimal interference from the full partner group.

Don’t disempower the executive committee (EC) by selecting a group totally different from members to sit on the CC. If the EC are doing their job properly, they often have in-depth and privileged information on each partner’s performance. This is invaluable to a CC; a totally different “jury” will not have these critically important insights.

Begin by laying the ground rules. Months before the CC deliberates, the ground rules for operating the CC should be agreed on. A timeline for the committee’s activities should be created.

The CC should avoid “wimping out” on administering tough love. It has been well documented that CPA firm partners, who are generally nice, caring, honest people, are conflict averse. They don’t like allocating income in a way that will disappoint one or more partners, even though their initial judgments are justified.

Goal setting. Goals must be written properly (if they are to be part of the process). The goals should be (a) measurable, (b) “stretch” goals (not accomplished by partners doing what they regularly perform every year) and (c) written in a way that the degree of difficulty (just like judging a two Olympic divers competing in the same event) is relatively even from partner to partner. In some cases, it may not make sense for the degree of difficulty to be similar. If this occurs, it should be made clear to partners that their potential achievement will be lower (or higher) than peers as a result.

Closed vs. open. Though partners may cling to their “right” to know what each earns, they must understand that this is counterproductive to operating an effective CC. If the CC members know that each partner has access to everyone’s income, they have a strong tendency to smooth out the changes from year to year to minimize conflicts. Partners have an irresistible urge to assess their compensation by comparing themselves to fellow partners instead of the proper way, which is by comparing actual performance against what was expected.

Don’t be afraid to ask for help. The assistance of a consultant experienced in the operation of comp committees can be extremely helpful to many firms, especially in the first couple of years. I know this seems self-serving, but it comes from our experience of seeing many firms fail to operate the CC properly because they stubbornly chose to go it alone.