8 aspects that might fall to your compensation committee.
cpa firms have a habit of making frequent changes – some major and some minor – to their system and methodology of allocating partner income, just as a baseball team tweaks its roster of players during a long, grueling season.
more: principals who aren’t cpas | non-equity partners: why have them? | why you might want an executive committee | buyout when a partner dies | why and how new partners buy in
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because of this, firms are advised to keep the wording on partner compensation in their partner agreements as general as possible. this avoids the need to change the agreement every time the income allocation system is modified.
alternative language
- the system used to allocate the firm’s partner income shall be decided by the partners. (quite simple!)
- the system used to allocate the firm’s partner income shall be decided by the compensation committee, executive committee or managing partner.
compensation committee
if your firm uses a compensation committee (cc) to allocate partner income, you may wish to include a specific section for this in your partner agreement.
decisions that need to be made
- will the managing partner be an automatic member of the cc and serve as its chair? i strongly recommend this.
- will the executive committee also serve as the cc? or will partners who are not ec members be placed on the cc in some manner? we recently conducted a survey of this and found:
- in 57 percent of the firms, ec and cc were the same people.
- in 43 percent of the firms, ecs had some but not all of their members serve on both committees.
i am a strong advocate of the ec and the cc being the same group. if the ec is doing its job properly, it is an active, committed group that, together with the mp, is intimately familiar with the performance of each partner and thus in a great position to evaluate their performance.
to some partner groups, making the ec and the cc one and the same is worrisome because the partners fear that too much power will be bestowed upon one small group. so they prefer other ways to staff the cc. here are three, in order of how common they are:
- the cc is composed of a certain number of ec members and a certain number of elected partners. usually there are more ec members than non-ec members.
- the cc is composed of the entire ec plus a certain number of at-large partners elected by the other partners.
- the elected cc has no ec members on it except the mp. this is by far the least common alternative.
- how many members should be on the cc? it’s similar to the ec. a committee of three, including the mp, serves a firm well until it approaches 10 to 15 partners or so. if the firm has a second large office, it may make sense for the mp of that office to serve on the cc, either as an official member or as an ex-officio member.
- what authority will the cc have? specifically, will it have the freedom to decide any or all of following, or will it be bound by guidelines given to it by the mp, the ec or the full partner group?
- the methodology and systems used to allocate income. this includes determining
- the extent to which the system will be performance-based vs. based on non-performance factors such as ownership percentage or pay-equal
- the extent to which the committee will rely on a production formula, allocate income on a subjective basis or use other approaches. if a formula, will income be allocated totally based on the formula or will the cc have the freedom to adjust it as it deems necessary?
- tiers of income, such as interest on capital, base, draw and bonus
- the dollar amount included in each tier
- how much of the income earned by the firm will be paid to the partners. firms often hold back some of the partner income to invest in the firm.
- when the income is to be distributed
- whether the cc’s duties will extend to the compensation of non-equity partners and other personnel
- whether the cc’s decisions will be final or will require approval of the full partner group. most firms avoid subjecting the cc’s decisions to the full partner group because this can be demeaning and discouraging to the cc, especially if its decisions are challenged or even changed.
- whether the system is open (with all partners knowing what the others earn) or closed (with only the cc knowing each partner’s earnings).