Except for periodic economic downturns, most firms evolve through many growth stages over time. Firm size changes often trigger modifications of their management practices. The system for allocating partner income is a prime example.
Here are several best practices for partner compensation that usually change as firms migrate from smaller to larger:
Establish a link between a firm’s partner compensation system and achieving strategic plan goals. For starters, most smaller firms don’t have a strategic plan. Their “strategy” is simply to bring in business, service clients, hire staff to work for them and make money. It’s the classic “working in your firm instead of on your firm” syndrome. But invariably, firms hit the wall at some stage (commonly at $6-7 million in annual fees) and find that a strategic plan is needed to leap over the hurdle.
The next lesson these firms learn is that you can’t achieve your vision unless the partners make it happen. But if the partners spend all of their time on client matters, they won’t have time to implement strategic planning goals. That’s when the partner compensation system gets everyone’s attention. The firm sees that strategic planning goals won’t be accomplished until the partners’ priorities are changed. A link must be established between partner compensation and strategic planning in order for the firm to start growing again. You manage what is measured.
Recognize intangible performance measures. The following are routinely compensated by larger firms that are virtually ignored by smaller firms. A few of them are (1) mentoring staff, (2) managing the firm, (3) living and breathing the firm’s core values, (4) developing specialties and niches and (5) functioning as a team to service clients rather than as Lone Ranger.
The compensation committee and the Board become one and the same. As firms grow, they find that their “eat what you kill” systems no longer work and adopt the compensation committee format. Though the partners may be committed to the comp committee concept, this is a big leap in faith nonetheless. It’s common for the partner group to provide for a comp committee that is different from the Executive Committee because the partners are comforted by the independence of the people allocating income from those who manage the firm. The partners are convinced that this will prevent management from usurping power or being vindictive when allocating income.
One could describe these early comp committees as “juries”; the committee members are called to duty and have a finite task to do – allocate income with an independent mind. They work on that task for a short period of time, conclude their work and disband.
The larger a firm gets, the more it relies on the management and leadership of key management personnel such as the managing partner, the Board and department heads. As time goes on, management personnel spend more and more time coaching and mentoring other partners. At some point, an “aha moment” occurs: For top management personnel to be effective in leading other partners, they need to influence how partners are paid, not a “jury” which has little knowledge of what’s been going on between management and the partners they are coaching.
Open vs. closed system. 80-90% of firms with under 8 partners have open systems (all partners know what every partner earns). But at firms with 13 or more partners, its roughly 50-50, open vs. closed (only the comp committee members know what each partner earns). What explains this divergence?
Again, it’s an evolutionary phenomenon. Smaller firms hold dear their feelings of democracy. Partners in smaller firms have grown up with the firm and therefore, have always had access to all confidential data, including partner comp details. Taking this “right” away initially seems incomprehensible. But as the firm grows larger and begins to be managed like a real business, it is neither feasible nor fair for partner comp to be open. Partners in smaller firms essentially compete with each other for their slice of the partner income pie. But as firms grow larger, partners come to understand that they should be compensated based on how they perform vs. expectations, not how they perform vs. other partners. A closed system gives the firm’s management the freedom to link a partner’s compensation to his/her performance without worrying about having to explain why Partner A is paid X and Partner B is paid Y.
For a chart that lays out Partner comp best practices as firm move from Small to Large, click on the highlighted link.