Shifting sands: the changing landscape of leadership remuneration

Across all sectors there is much theory, discussion and debate about executive remuneration, with Remuneration Committee (Remco) chairs battling their way through the competing demands of different stakeholders, including investors, partners, staff, consultants and, increasingly, the media. In professional services, partly as a result of changing legislation and changing expectations, C-suite executives are increasingly being brought into the equity of a firm, and this is thought by some to be the beginning of a broader trend in the attitudes towards remuneration.

The remuneration of the professional service chief executive (CEO) or managing partner, is the focus of this article. For the article to be comprehensive, it must include the role of the CEO (what are they in role to do) and the competing interests from different stakeholders without which it would be impossible to judge performance. The article refers throughout to 'CEO' and includes those whose role is designated CEO, managing partner or other similar nomenclature.

Professional service firms continue to have a variety of ways in which remuneration for their partners and senior executives is set. Where firms have non-lawyers fulfilling senior management posts (leaving partners free to win, retain and service clients) a key issue is whether or not to treat them as though they are partners when setting remuneration scales and bonuses.

Professional service firms have steadily developed their remuneration models over time from two original models - equality through equal sharing and lockstep where remuneration rises steadily in prescribed steps over a prescribed period. There are firms who still embrace these simple methods. Modified lock step, market related salaries, and profit units are some of the hybrids which have emerged in recent years, with or without a clear linkage to effective performance and development review systems. All hybrids usually have a complex set of rules governing their operation.

With a recent report commenting on the poor impact of 'eat what you kill' remuneration systems, it is clear that remuneration policy and systems can materially impact on the success of a professional service business. The need for higher levels of performance, sometimes to stave off financial disaster, or the need for an all-embracing culture of 'all for one and one for all' can have a significant impact on the chosen remuneration model. At the end of the day, remuneration is the single most important factor which enables a partner, whether fulfilling a senior management post or not, to measure how well they are valued against their peer group. As a consequence the remuneration system and the relativity of reward of one person to another becomes critical in managing the mood, commitment, motivation, and commonality of purpose of partners.

Remuneration systems, especially in firms undergoing transformational change, will need to be based on clearly identified, measurable performance objectives if the desired change is to have any chance of being bedded into firm culture; after all, what gets measured gets done. Firms which have mature, stable cultures may not see the need to have such a 'modern' approach.

Whichever remuneration system is chosen, three ingredients are essential - fairness, consistency and transparency. Great care needs to be taken in setting the remuneration of the CEO to make sure that the gap, which is all too common, between the client-facing partners and the management team is properly reflective of contribution to the overall wellbeing of the business.

To put this in a modern context we must first bust some old assumptions and state some modern truths, as shown in Table 1. These truths come from the latest thinking from Remco chairs, and although few partnerships have a Remco, they do have equivalent groups, and look to public companies as a source of best practice.

CEO pay is an emotional issue as CEOs will compare themselves to their peers in terms of pay and performance, typically through rose-tinted lenses. A recently appointed managing partner of a large European law firm said: 'I walked into the room, as the new managing partner, and the compensation they offered me was less than I used to earn. So I left the room and told them to think again or find someone else.' Simon Slater, CEO of Thomas Snell & Passmore said: ' I agree CEO remuneration should reflect outputs and be linked to strategy; I agree CEO remuneration should be spread over a term, be it three or four years, with one-year milestones; and I agree CEOs should engage with the firm's clients generally and its key clients specifically'. Jeremy Boadle, chief financial officer at Smith & Williamson said: ''The CEO's remuneration should very clearly be partly based on performance of the firm; his role is definitively there to improve performance so his reward should be based on results.'

CEO performance

Historically professional services have not recognised the value of, or invested enough in, management and leadership. However this is not endemic across the entire sector, as management consultancies tend to invest 7-8 per cent of revenue into personnel development, compared with 4-5 per cent for Accountancy and 2-3 per cent for Law firms. Table 2 highlights some views on the traditional view of the fundamental purpose of management.

Current practice

• Now the majority of CEOs do no, or a very limited amount, of client work.

• The role of CEO is often the last role they hold in the firm. This has a significant impact on whether younger partners put themselves forward, as they may find it difficult to return to client work after their term. It will also tend to mean that their next role will either be another CEO role or they will go plural, seeking non-executive director roles.

• The senior partner represents the partnership and the CEO runs the business. Some firms have a senior partner and COO mix.

• The CEO's compensation structure tends to be aligned with the compensation structure for other partners. This is often a combination of points and bonus, with the latter being subject to different criteria.

• The body that sets partner compensation also sets the CEO compensation, although the method of assessments for this lead role is sketchy across the sector.

The problem with current practice is that it is based on inputs and not outputs and the question of performance goes unanswered. Those firms that do define the role more clearly, actually only tend to designate the responsibilities or the skills required and therefore tend to focus on the achievements of the individual rather than the achievements of the firm. This means the majority of committees that set CEO pay do, at best, an average job.

Common mistakes include:

1.The unfocused CEO

Allowing a CEO to split their time between management and their old practice. This is particularly common in firms under financial pressure or with a strong focus on business development. Firms with revenues in excess of £20m should all have a full time business leader, whether they are called CEO, MP or COO is less important. CEOs can demand to continue to handle client accounts so as to protect their position if their new role fails; this is likely to lead to a less than positive attitude to delivery.

2.Valuing management through time

Although this article pushes the focus away from inputs, some firms may pay nothing for the CEO's time or outputs and as a result get nothing in return: 'You pay peanuts, you get monkeys'. Other firms allow the CEO to bill management time, effectively treating the firm as a client, but again this measures activity not results and can lead to rewarding poor performance. Once again, the need is to value the management impact and effective contribution to business objectives and not the inputs.

3. Flat price

This is where a CEO gets a fixed income, typically above their last earnings, regardless of inputs or outputs. When you look at business motivators money usually ranks in terms of importance somewhere between 5 and 10. This means a CEO should be motivated by the role and opportunity itself and you should not require to pay them additional bonuses or commissions. However, the reality is that even the best intentioned and most talented people can get distracted or occasionally lazy, therefore it is useful for the firm to have the performance whip as most people over the period of their term, typically, five years, will require a sharpened challenge at some point.

The client time dilemma

One London managing partner in a top UK accountancy firm commented: 'One particular area struck me, which is the debate about CEOs/managing partners retaining client relationships. The pendulum seems to swing on this topic from time-to-time. In my London managing partner role, I did not have responsibility for delivering client projects, but met clients on a broader basis fairly often; that is the model I believe your paper is supporting. Nevertheless, we as a firm are now more supportive of partners in senior management positions retaining the relationship/project lead role for a proportion of their time. I guess you can call it either way.' Steve Cooke, the senior partner at Slaughter & May said: 'I'll be aiming to do a significant amount of client work, as this is what I enjoy doing most and I want to keep up those relationships. You can't maintain those relationships without the client work.' The way the role evolves is shown in Figure 1.

The remuneration and measurement process

Ultimately, some of the information for Remco evaluation is objective, based on statistical and anecdotal evidence. Were goals achieved, targets met, projects completed on time and the like? Were there unanticipated successes or failures? How did the CEO deal with any crisis? A large part of the evaluation can be subjective.

The committee considers all these factors, as shown in Figure 2, in arriving at a number that reflects how well the CEO performed his or her management job (as opposed to how the partner performed as a practicing lawyer). In the final analysis, the most powerful elements of this process are goal setting, self-evaluation, accountability and two-way communication.

A chief executive of a UK Chartered Institute said: 'A Remco was introduced and very poorly managed and has simply failed. I think an effective Remco is predicated on governance structure which works. The Remco is really an intermediary between the chief executive and management senior team and the 'owners' of the organisation. My instinct is that the issue is binary - do the owners want the chief executive to continue and if so then Remco's job is to find a price that works.'

Conclusion

The role that CEOs might play, the scope of their authority and the firm's expectations will all vary with the qualities, skills and character of the individual elected to fill the job and with the culture of the firm.

The balance between external and internal focus, as shown in Figure 1, whether or not the individual continues to serve clients, his or her role in rainmaking and so forth really depend on the person and the firm's expectations.

The main thing is to make sure that the person and the firm are in agreement as to those expectations - and that the expectations are woven into the process for evaluating performance and setting compensation.

John Jeffcock is chief executive of Winmark (www.winmarkglobal.com)