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With so much on their minds, why would or should an overhaul of the organization's compensation systems become a high priority? Would a transition to a pay-for-performance compensation system really be worth the effort - especially when so much debate about pay-for-performance systems has transpired over the past several years?

In our 2006 Owner Compensation Survey, 140 (36 percent of the 388 respondents) indicated that if they were to select a new compensation system, they would choose a pay-for-performance plan. Another 71 (18 percent of the 388 respondents) indicated they would select a formula method (one in which the firm uses algebraic formulae to determine income allocation). These statistics suggest to us that the move toward pay-for-performance is a move away from traditional entitlement or subjective systems.

WHAT IS PAY-FOR-PERFORMANCE?

Pay-for-performance is frequently referred to as merit pay or incentive pay. Regardless of what people may name it, pay-for-performance is paying or compensating an individual beyond their base pay or salary for accomplishing specific, agreed-upon measures of performance, rather than only for time worked, seniority and/or ownership.

In a structured pay-for-performance program or system, employees and owners are clear about and understand the relationship between performance and the incentive. This understanding is documented in a written agreement before the fact and is often called a win-win agreement (a term first coined by Dr. Stephen R. Covey in his bestseller, The 7 Habits of Highly Effective People). A win-win agreement is an informal contract between the firm and the individual that outlines expectations of the individual in order for them to earn a portion or all of the incentive pay for which they are (or could be) eligible.

More specifically, win-win agreements outline desired outcomes, guidelines about how the individual will accomplish these desired outcomes, resources that may be needed to support them in their accomplishment of these goals, how accountability will happen (often through tracking), and what the consequences (payout) will be.

What most people - both employees and firm leadership - appreciate about documenting agreed-upon expectations is the lack of surprises at the end of the year. In most cases, pay-for-performance systems (unless there are design flaws) minimize favoritism as well. And yes, evaluation of subjective factors is possible, but generally small.

IS IT ALL TIED TO PERFORMANCE?

From our consulting experiences, we are finding that many accounting firms tie a percentage of total compensation to some type of performance. We've seen ranges from10 percent to 50 percent. In other industries, we've seen as much as 100 percent of compensation earned as incentive pay. In any case, true pay-for-performance is variable compensation that must be re-earned each year and typically is not reflected as a salary increase that permanently increases base salary.

THE PROCESS

Let's assume a firm has developed and communicated its mission, vision and values, as well as a strategy to help realize the vision, and thus achieve its mission. A pay-for-performance system goes hand in hand with (i.e., links to and supports) the strategic plan and is designed so that the behaviors needed to accomplish the strategy are promoted.

You must note, however, that it is difficult, if not impossible, to implement a pay-for-performance plan without a strategic plan that includes key goals for the year and how you will measure accomplishment of those goals.For example, Firm A is a midsized firm in a secondary market in the Midwest. One of its strategies for the current year is to develop new services. To accomplish this strategy in part, the tax department determines that it will develop an estate-planning practice with a team of competent professionals.

Firm goal: Develop new services over the next 12 months.

Tax department goal: Develop a viable estate-planning group in 12 months.

Tax partner goals: Client development/management, develop 24 prospects, cross-sell to existing clients or sell to prospects.

Leadership: Development of viable estate planning practice by Dec. 31; help estate-planning team members achieve their goals.

When developing a pay-for-performance system, as indicated earlier, the firm must determine the results it intends to measure and what actions are necessary to achieve those results. In the case above, firm leaders must meet with members of the tax department who will be involved in the estate-planning initiative. For the initiative to be successful, what must the department head accomplish? What must other partners do? What must tax managers and tax staff members do? The answers to these questions serve as the foundation for a win-win agreement with each team member and for a win-win agreement between the firm and the tax department.

Most people recognize the above steps as a basic goal-setting process. Certainly, when creating a pay-for-performance system, you follow these steps, but pay-for-performance brings an added dimension. Each person in the firm knows up front what they must do to be successful and how these actions impact the success of the team. In other words, they understand how their behavior is measured and rewarded, as well as how the team is rewarded by accomplishing its goals. Bottom line - an effective pay-for-performance system measures both independent and interdependent accomplishment.

In addition, an effective pay-for-performance system rewards both character and competence. Think about character as living the firm's core values, and competence as knowledge, skills and abilities in a variety of both hard-skill and soft-skill categories (e.g., client service, business development, technical skills, leadership, etc.). Simply put, an individual may have great skills and produce excellent results (e.g., high billings), but will not receive maximum pay for performance if they abuse team members, thus impacting employee satisfaction and even retention.

On the flip side, an individual who is nice and whom everyone loves working with, but lacks skill and doesn't have a track record of results, will not receive maximum pay for performance either.

Soft skills that are often measured and evaluated include:

Does the individual partner work well with others?

Does the individual exhibit an attitude of teamwork and/or develop the team?

Is the individual looked upon as a role model?

Is the individual dedicated to lifelong learning and development?

After determining broad categories of competencies, specific behaviors can be determined for each role or position in the firm. In the next article we will discuss the pitfalls and benefits of a pay-for-performance system.

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