From the November 2006 issue of Investment Advisor • Subscribe!

Just Rewards

Consider employee compensation an investment, not a cost

The cartoon strip Dilbert by Scott Adams terrifically captures the essence of business life, and the motivation/demotivation dichotomy is often satirized. In a recent cartoon, Dilbert's colleagues were invited to a training session from Dogbert's School of Management. The lesson was teaching employees how to do the impossible. Dogbert gave each

participant a large rock which he instructed them to "throw in the air and demand that it stay there without falling, offer some non-monetary compensation to incent it, and if the rock refuses, try yelling at it."

Many advisors probably recognize the parallels to management practices in their own firms. How great it would be if we could hire talented people at the lowest possible cost, and not share any rewards with them. By contrast, how annoying it is when they don't sustain a focus on what we want of them, and become disloyal, disinterested, and impervious to our exhortations to work.

The fact is that as employers we create many of these problems ourselves. By viewing our employees as a cost to be minimized, we set up an adversarial relationship that also minimizes motivation, loyalty, and job satisfaction. In contrast, consider how different it would be if we treated employees as investments whose potential can help us grow our practices.

Thinking of compensation as an investment rather than a cost is an even bigger challenge today with the acute shortage of talent. According to the 2006 Moss Adams Financial Performance Study of Advisory Firms, salaries and benefits in many practices are causing both direct and overhead costs to rise faster than revenues. As a result, both gross profit margins and operating profit margins are getting squeezed. There are many sources of this constriction besides rising employement costs, including declining productivity and pricing that has not kept up with the service offering. More often than not, however, we find this pattern of eroding profitability emerges when the compensation plan is misaligned with the behavior that owners seek from employees.

The problem arises from the fact that advisory firms design their compensation plans based on what are perceived as "best practices," or simply borrow one from another firm. As business owners, we like to rely on what others have done and outside data because it seems objective and defensible--two key elements in getting employees to accept what we offer. However, at Moss Adams we often caution against relying solely on market benchmarks and plans developed by your peers because your values may not be the same as another firm's.

Benchmarks are generated to help frame a compensation strategy, not to define it. On the surface, many advisory firms look the same, but there are also many variables, including the market a firm targets, the nature of the advice it provides, the client experience it creates, and the owners' vision for the future.

Goals, Roles, Behaviors

When designing a compensation program, it's important to know what you want to accomplish as a business; what each individual's role should be in fulfilling those goals; and what individual behavior you seek to reinforce. With these objectives clear, you can begin to craft a compensation philosophy that is much like an investment policy statement: It outlines parameters and defines expectations in a sensible framework for managing a complex part of your practice.

Compensation has six basic components. Each plays a role in reinforcing behavior and demonstrating your values:

  1. Base
  2. Short-term incentive
  3. Long-term incentive
  4. Benefits & perquisites
  5. Retirement plans
  6. Equity

Most advisory firms use some combination of base pay, short-term incentives, retirement, and benefit plans. As practices become larger and more complex, they often will look to long-term incentive plans such as phantom stock, employee stock ownership plans, deferred compensation plans, or opportunities to purchase equity.

The balance between firm revenue, profitability, and individual performance varies by position. Well-designed plans align compensation with individual job expectations and responsibilities.

A good way to design an incentive plan for staff at all levels is to put yourself in their shoes and fill in this sentence: "If I do more of X, I can make more money." Your challenge--and theirs--is to fill in the blank correctly. It's not easy to complete this sentence for every position, but there is an approach you can take to get closer to the measure: Define excellence for each position, and use base compensation to reward expected performance along with incentives to recognize individuals who exceed base expectations.

We too often see the temptation to pay people a low base and then give them a bonus based on how well the firm does. The problem is that the more distant a person's connection to the result, the less of an impact the reward has. A high proportion of variable compensation may be incongruous with many jobs, putting too much emphasis on a payment they can't directly influence. This is especially true in smaller practices with one rainmaker whose success in gathering clients and making sales will dictate the rewards for others.

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What's the Market Bearing?

We also see compensation plans that are created by advisors with good intentions but produce an unintended result. Not all employees are motivated by money; not all staff are excited by long-term incentives when their primary concern is paying the mortgage or buying groceries. Plans that don't consider what motivates each employee will have little impact on behavior, or worse, encourage behavior that is detrimental to the firm.

In creating a sound compensation plan, it's important to understand what the market is paying for different positions. In last year's Moss Adams compensation and staffing study (available at FPAnet.org), we attempted to clarify the key positions within a typical advisory firm. Then we could bracket the pay for each role and provide a framework for structuring base pay and bonus programs. However, it's important not to pick just the median or the upper or lower range of any pay scale. When determining the base, evaluate each employee based on their experience, responsibility, education and contribution, within the range of compensation for their job.

Base pay should also be considered in conjunction with each employee's incentive plan. Incentives may be expressed as a percentage of the base or a percentage of an objective for the coming year, as long as they require achieving intended goals so that you can evaluate your return on investment. Remember that once an incentive plan has been implemented, it's not likely to retain its original form forever. Circumstances in the business change, new behaviors need to be encouraged, new goals need to be reached, and incentive plans need to be adapted to fit these new realities. To keep your plan current, monitor how well it addresses these issues:

  • Provides competitive compensation.
  • Ensures compensation levels are affordable and internally equitable.
  • Rewards employees for performance, behavior, and contributions to the firm.
  • Reinforces teamwork and firm cohesiveness by sharing in the financial success.
  • Ties an individual's compensation to the expectations of his/her position.
  • Aligns an individual's compensation with the goals of the firm.
  • Promotes the values of the firm, including:

Intellectual curiosity;

Respect for others;

Consistent delivery of the client service experience.

While compensation plays an important role in driving performance of individuals and the business, it's also important to recognize that money is not an adequate substitute for active management. Individuals seek both financial and psychic rewards, and what you say and do with employees can have as important an impact on individual performance as the money.

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