Making pay-for-performance pay
Laying the groundwork for a successful incentive pay system
What business leader today isn’t being asked to exceed customer expectations in a climate of
fear and economic downturn, to be forward-thinking and innovative, and to execute on the orga-
nization’s vision and strategy but to do so with decreased resources?
BY AUGUST AQUILA AND CORAL RICE
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.
which they are (or could be) eligible.
More specifically, win-win agreements out-
line desired outcomes, guidelines about how
the individual will accomplish these desired
outcomes, resources that may be needed to
support them in their accomplishment of
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.
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
August Aquila is a well-known consultant
to the accounting profession, and can be
reached at firstname.lastname@example.org.
Coral Rice is a senior consultant, and can
be reached at email@example.com.
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
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 lead-
ers must meet with members of the tax
department who will be involved in the es-
tate-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 ques-
tions 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.