From the February 2014 issue of Investment Advisor • Subscribe!

January 27, 2014

Compensation Golden Rule: Money Can’t Buy Happiness

‘For the love of money is the root of all evil.’—1 Timothy 6:10

One of the biggest mistakes that managers make is using money as a substitute for active management. This practice stems from the mistaken belief that a big enough carrot will motivate people to work harder, faster and smarter.

True, compensation helps keep people engaged in their roles—as do job security, status, respect and positive work conditions. These factors all contribute to the health of a business, but they are not motivators. As a firm leader, you must hire motivated people and create an environment where they can excel. The challenge, of course, is to identify motivated people in the first place. If your employees lack the aptitude, drive or interest to do the job you expect of them, no amount of money is going to sustain their focus or compel them to do excellent work over a long period of time.

Using money as the carrot to goad performance is not a sustainable strategy, particularly with disillusioned employees. Throwing money at unhappy people will not make them happy. It just ameliorates their pain while they suffer work that bores them or an environment that frustrates them.

Different people are motivated by different incentives, including management recognition, flexible work arrangements, career advancement and stretch assignments. Leaders must discover whether their employees are satisfied in their work by having deliberate conversations with them.

While financial incentives have been shown to produce short-term behavior, considerable evidence proves that a singular focus on money often creates unintended consequences. Take, for example, hedge funds that have been fined for buying inside information, bankers who sold home mortgages to people who could not afford them and executives who focused on bonuses rather than building enduring businesses (think Enron, WorldCom and scores of other underperforming companies).

What sort of firm culture do you want to create? Do you have clear guardrails and a process for keeping people aligned with your goals and your values so that you do not suffer from such unintended consequences?

While money may not be the root of all evil, the blind pursuit of big rewards can drive organizations in a direction that ultimately consumes them. Along the way, money can create a culture that values revenue generation over all else including safety, respect and alignment with the strategic objectives of the business.

To sharpen this point even finer, scores of professions prove that the size of the paycheck doesn’t matter, except to the extent that low or unequal pay may become a distraction. What drives the behavior of teachers, soldiers, clergy and social workers? The top performers among them are motivated to save or change lives with considerable personal sacrifice, and are driven to excel in their role regardless of pay. The same is true for firemen, police officers and missionaries.

I was just visiting Japan, where tips are frowned upon (or even viewed as an insult), yet the service from doormen, waitresses and railroad employees was extraordinary. They performed their jobs in a superior and respectful way, encouraged through training, performance evaluations and culture to excel.

Please don’t misunderstand: The financial advice profession rewards its players well and should continue to do so. The intellectual capital, risk, expertise and wisdom required justify the value of people in this business. When financial rewards become the sole driver of behavior, however, other values get distorted. Further, the concept of pay for performance may be out of sync with why some chose this profession in the first place.

This was not always true, of course. In the past, the retail financial business was more about product sales than advisory solutions, and there was a need to tie commissions, trips and bonuses to volume of business rather than quality of advice. As the industry moved toward a profession, revenue generation fell aside as the sole criteria for measuring success.

Compensation theory suggests that the more your job focuses on sales, the higher the percentage of compensation should be variable and short-term focused. The more your job centers on management or service, the higher the percentage of compensation should be fixed, with a lower percentage variable. In most mature advisory practices, 85% to 90% of revenue comes from existing clients, not new sales—yet many compensation models still use a pay-for-sales formula. The reward system must evolve with the business model, not to ignore business development, but rather to see it as one component in the overall economics of an advisory practice.

Firms that have avoided the money trap do three things right.

  • Develop a compensation strategy that is aligned with their business vision.

  • Document a compensation philosophy that clearly states what behavior is valued.

  • Implement a performance evaluation process that provides psychic rewards as well as clear communication on what behavior is expected.

Unfortunately, many in this business follow the herd by creating plans that look identical to those of other firms. A word of caution: Unless your strategy, vision and desired culture mirror these other firms, your reward structure may be misaligned with the business you want to create.

Let’s look at an example of a firm that aligns its compensation plan with its vision. This firm wishes to grow the business with high-net-worth clients who have generated their wealth on their own (as opposed to inheritance, lottery winnings or litigation settlements). The firm expects all senior advisors to be accountable for business development as well as to manage a set number of relationships. In addition, the firm employs a team-based approach to serving all their clients in order to leverage different skill sets and to have each individual focused on their highest and best use. In addition, the firm strives to become a dominant wealth manager in their region and needs to make employee recruitment and development a cornerstone of their growth strategy.

With that in mind, this firm defined key components of their compensation philosophy. Compensation must:

  1. Be externally competitive and internally equitable.

  1. Be aligned with their overall business strategy and the culture they are trying to create.

  1. Reward team performance as well as individual performance.

  1. Value client retention as well as client acquisition.

  1. Reward continuing education and professional development.

  1. Value leadership, management and succession planning.

  1. Value a culture of safety that includes compliance, consulting with each other and managing reputational risk.

Developing this framework for compensation will help the firm reinforce the right behavior without veering off their path. When a challenge arises because a rainmaker or a potential recruit requests compensation tied solely to their revenue production, the firm can reference this model. The compensation plan also assists in evaluating the cultural fit of new hires and in discussions with existing associates. Applying this discipline ensures proper job matching, cultural fit and a team of people who share your vision for the business.

Pay for play can work in certain organizations, but when the compensation model becomes unfair or values the wrong behaviors, dysfunction takes root. Financial rewards are only one of the key levers that drive culture and performance. Engagement of all associates, management actions around what is tolerated and not tolerated and open communication and feedback almost always produce a better outcome.

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