Discerning the Value of the Compensation Committee

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Time-consuming and littered with potential landmines, the process of setting partner compensation is never easy. But a compensation committee may be one way to smooth the yearly event, if done correctly.

Compensation committees are popular. Once firms get to a certain size, comp committees are used far more often than other systems, such as basing compensation on a formula or on the sole discretion of the MP. Only 12% of firms under $5 million in net revenue use compensation committees, according to IPA data from 2020. At the $10 million to $15 million level, however, that percentage jumps to 60%, ultimately climbing to 78% for firms between $50 million and $75 million.

There’s a reason why comp committees are used so often. They work, but there’s no getting around the personality issues and the time they take. The task is so draining that Ed Moss, MP of IPA 400 firm Moss Krusick & Associates (MKA) meets with partners on goals every year but sets compensation only every two years.

Meanwhile, Alan Litwin, then-MP of Providence, R.I.-based IPA 100 firm KLR said, “I guess compensation is always challenging because it’s a sensitive topic. Some people will walk in, and no matter what you say the response is ‘thank you,’ and others walk in and say ‘Why isn’t it more?’”

While it’s impossible to make everyone happy, consultant Carl George said that in the end, his goal was fairness and honest, clear communication with the partners on the decisions made. George, a former COO and CEO of Milwaukee-based Clifton Gunderson (now CLA), has served on comp committees for nearly 30 years, and he believes they offer numerous advantages over formulas.

Formulas show the numbers, but that’s not the whole story. Building a big book of business, or “playing to the formula,” may not be in the best long-term interest of the firm, he said. “If you are only formula-based, there’s a good chance that all partners will not be in alignment with the vision.” Also, the MP can’t possibly know all aspects of a partner’s work. Hearing perspectives from other comp committee members provides a fuller picture and a fairer process.

Typically, George said, the MP is a permanent member of the comp committee with two or three other members, who change every few years or so. Members are chosen in various ways. Some MPs appoint the other members; sometimes they are elected by the partner group; sometimes the comp committee and the executive committee are one and the same.

MOSTLY METRICS, BUT ROOM FOR SUBJECTIVITY AT MKA: At Winter Park, Fla.-based MKA, the unofficial committee for the firm’s 10 partners is made up of Moss and a tax partner with input from the controller. (“I don’t want to make any decisions by myself.”) The open compensation system was closed about four years ago when the firm had five partners. Moss notes that open comp caused so much friction – even though partners comparing themselves were “night and day” – that the need for change was obvious.

Compensation is primarily determined by billable hours worked, book of business generated and book of business managed, Moss said. Partners are expected to do some administrative work, but not much. While he doesn’t call the firm’s approach to compensation a formula, per se, it’s pretty clear-cut. Only 5% is based on subjective factors, such as marketing the firm, following firm policies and training.

Metrics help because ownership is so skewed, said Moss, who owns about 70% of the firm (too much, in his view). Another partner owns 15% and others are at 2% to 5%. He said that while the first $225,000 of profit is allocated based on ownership, profits above that go into the bonus pool, which he distributes evenly among the five executive committee members who own the majority of the firm. “I can have that meeting and no matter what I do, someone’s going to leave the room unhappy. So I’m like, ‘I can’t win, we’re just going to split it,’ ” he said, laughing.

The main idea, however, is to motivate the partner group to drive overall firm success. Since some partners own such a small percentage, they act more like employees than a firm founder would, but if the firm does well, they’ll benefit financially. “The bonus pool has been fairly successful at getting everyone on an even playing field to want to increase revenues, and when something goes wrong, we all feel the pinch a little bit.” Another peer pressure motivator, he hopes, is partner access to every other partner’s self-evaluation and goals for the year.

The system has room for improvement, particularly when it comes to accountability for the intangibles, Moss said. Positive behavior is rewarded, but there are no negative consequences if expectations aren’t met. Eight years ago, he discussed lowering comp if receivables and WIP are greater than the firm average, for example, but he got so much pushback that he dropped it.

Moss believes firm partners trust in the compensation committee’s decisions – after lengthy conversations, reviews of the metrics and a discussion on how to make more money, “When I show them the metrics they understand it, but the initial reaction is, ‘I’m not making enough.’ ”

IN-DEPTH DISCUSSIONS AT KLR: At KLR, the three-person committee is appointed by Litwin. The committee is guided by a combination of performance metrics and subjective assessments. The comp system is closed – Litwin sees no upside to an open system – so partners know the size of the bonus pool but not how it’s distributed.

The centerpiece of the process is one-on-one conversations. Before the committee meets, Litwin holds two- to three-hour discussions with each of the 36 partners between Nov. 1 and Dec. 15 to compare the previous year’s goals with performance. While it’s time-consuming, Litwin believes long conversations are unavoidable. Partners look forward to talking about their self-assessments, and the end-of-year timeframe makes it easier to put last year in the past and look ahead, he said. It’s exhausting. “By the time I get to mid-December I’m toast, I’m done.”

Litwin said he recognized early on that the partners have different skills and cannot be judged the same way, so formulas don’t work, even though it would make setting compensation a lot easier. “To me, that doesn’t capture all the intangibles that we expect of our partners.”

Partners propose their own goals for the coming year, customized to emphasize their strengths, and Litwin ensures they line up with firmwide strategy and goals. They can’t just be about making money. The goals are important, he said, but the interpretation of the goals and communication around them is even more important.

In the end, Litwin believes the key to successful comp committees is trust in the process, which is why it’s so important to be straightforward, honest and unwavering. The committee does not vote and works everything out by consensus. “It’s so rare for someone to come back and say, ‘No, that’s not fair.”


Carl George saID compensation committees can go wrong when…

It’s unclear exactly how the process works and how decisions were made. Like a step-by-step outline of an audit process, the comp committee should develop a detailed process and protocols and publish them. Transparency builds trust.

Partners don’t trust their peers to make fair decisions. Comp committee members may come into the role with built-in biases, either positive or negative. It takes a strong MP to ensure those biases don’t color the evaluation results. Sometimes the most likeable, friendly partners are not the best performers.

Firm vision and partner goals aren’t aligned. Partners must be held accountable to move the firm as a whole forward by following the strategic plan. Priorities get muddy when the overall strategy isn’t followed.

George’s thoughts on how to improve comp committees…

Insist on honesty and fairness. Evaluations must be forthright and transparent, even if it’s difficult. “It’s hard for a lot of people to do,” he said. “It’s a lot easier to skirt around the issue because, you know, it’s a confrontation.” If you don’t set good goals and have meaningful evaluations, don’t expect the results you could otherwise achieve.

Understand everyone will have one bad year. Committees can consider the circumstances and look at the performance trends over three years, George advises. On the other hand, one good year does not a career make either.

Consider closing the comp system when the firm gets to about eight or 10 partners. When partners know what their peers are making, it’s natural to second-guess decision-making, even without knowing all the information. Monday morning quarterbacking fosters ill will.

Save time where you can. It’s understood that partner comp is time-consuming, but the committee can save itself some time by putting limits on the number of questions and length of responses in the self-evaluation form. George said he’s read self-evaluations of 20 or 30 pages. Looking back, he would have cut those by half.

Consider an even number of members.  George served on Clifton Gunderson’s comp committee when the firm grew from roughly $20 million to $250 million. He always insisted on four members – two from management and two from the practice side. That way, any 2-to-2 disagreements had to be worked out among them. nIPA

This article originally appeared in the July 2021 edition of INSIDE Public Accounting. To subscribe to INSIDE Public Accounting Monthly click here.


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