Good topic, great list.  It'll be interesting to see how you group and categorize them.

One thought, taken from Alfie Kohn's thinking: how to make sure a compensation system doesn't drive the employee to focus on the extrinsic rewards--i.e. the compensation itself--to the exclusion of the intrinstic rewards, e.g. work well done, contribution to society, team player, etc.  Maybe you can one-line that thought as "the system remains a means to an end, not an end in itself."

I hope you do write this book.

You may be intending #2 to include this idea, but I would like to see a system that helps integrate individual interests with corporate goals. The compensation scheme alone can't do that, of course, but it can aid the doing of it - especially if you view it as broader than mere financial compensation, incorporating development opportunities (underwriting specialized or advanced ed, etc.).

Specific discussion of the complex motivations behind some compensation elements - such as equity awards supposedly aligning the interests of managers and owners, but sometimes actually further distorting them as managers game the numbers to cash out or avoid losses - would be very helpful, too.

It would be great to see a thoughtful approach such as you outline applied to a treatment of the subject. It seems to me it would have to be book length, though.

The criteria are quantifiable.  Often I see criteria that are hard to interpret. Or too open to mis-interpretation by the reviewer.  For example,  Individual is a team player, to your point #12. For clarity sake, it should be cited as "Individual participated in and contributed to X number of company initiatives in the past year."  
It clearly defines the expectations of the individual.

And every criteria can be reworked to be quantifiable.

~ heidi

This is an interesting list.  A central question that I would like to see addressed more definitively is whether incentives of any type truly motivate behavior, in either the short or long term.  Or whether, as people like Alfie Kohn believe, that incentives are a corporate myth based on flawed behavioral research conducted in the late thirties by B.F. Skinner (operant conditioning).  Kohn cites nearly three decades of research that concludes incentives are a form of control that worsens productivity; that long-term behavior change cannot be created with external motivators; that incentives may influence short term actions but as soon as they are removed, the action stop, etc.  Other researchers argue that incentives are simply an excuse to create competitive pay levels while creating the appearance of variable pay.

It is an interesting topic.  I have enjoyed your other work, most recntly "Strategy and the Fat Smoker" and I am sure you will do this topic justice as well.

I have to stop back in here to endorse Joel's suggestion that this effort begin by questioning the very assumptions upon which such much work is expended - such an exploration will thoroughly and effectively inform the presentation of the rest of the work.

In Managing The Professional Services Firm you touched on this topic and I frequently review that section when compensation time comes.  It is a wonderful topic.

The one thing that I can see that's missing, but weaved into your current list is "The risks of a cash flow mismatch are mitigated"  Too often I see people miss the very important distintion between booking, invoicing and collection.  The first two are nice, but I can only write checks off the last.

Hm. There are elements of 'what have you done for me lately' in there - in fact, that seems to be a central theme.

Fair comment, Stephen. Do you have any modifications or suggestions? 

Three things occur to me about this project.  First, a good  compensation system requires a large dose of good management to support it.  And second, one's performance and payment thereon is intrinsically intertwined with a lot of other people's performance and that strikes me as having a lot of interesting ramifications on the design of the system.  Third, simple is better.  

Looking forward to seeing the finished product. 

The biggest lesson I learned about compensation, and especially conditional compensation such as bonuses or share options, from 12 years running a software firm is that it should not be DE-motivating.

A typical problem is that a company might offer staff a bonus if a certain project is completed on time. However, they are likely to know or inuit earlier than anyone else if a project is slipping. At that point the 'early completion bonus' which they were counting on turns into a 'late completion penalty'.

On another point, is it right that CEOs should earn hundreds of times what regular employees get?  When thinking about compensation policy in the widest sense, do questions of fairness and social cohesion come into it?  (Mind you I remember hearing a story about the union bosses of a big English company urging the boss NOT to sell the company Rolls Royce because they thought it would trigger anxiety in the workforce that the company was going down the tubes!)

I don't really have any suggestions. I am inclined to follow Joel Head in wondering whether compensation systems motivate behaviour. I would suspect that, at best, a good compensation system is a necessary, but not sufficient, condition.

I accept immediately all the comments about a good comp or profit distribution scheme being necessary but not sufficient, but that doesn't take off the table the question of what the hallmarks of a "good" compensation system are. There is still a need to make choices among many design elements.

An extra dimension is introduced is one thinks not of "compensation" systems, but of "profit distribution" systems, such as those needed in partenrships where the partners divide the profits. How much should partners take out as (individual) current year bonuses? How much of current profit should be used to fund growth in retained earnings and hence the share value? (On the theory that remuneration through increasing share value promotes a focus on firmwide success.)

Firms who design or redesign their system have a lot of separate elements to think about.

David

OK, then, with all of that said...

You need to distinguish between:

- what a good compensation system is - that is, how it's structured, what it measures, etc.

- what it does, that is, what business goals it;s intended to accomplish

- and how it's perceived, both by employees but also by customers (think of the signs at the computer store saying "our staff are NOT paid by commission")

Your list conflates all three. 

My first thought, when I read one of your previous comments, was of WestJet. This company's advertising makes a lot of the fact that the company is owned by its employees.

This seems to be a pretty good system - give staff a stake in the company. And it certainly seems to work for WestJet!

But if the system is being set up by owners in order to increase the profits produced by employees, in order to increase dividends for shareholders (who are NOT the employees) then the calculation changes.

I think that the type of RELATION the company has with its staff changes the nature of the sort of compensation system that is going to work. I can think of many examples fom my own life:

- one company I worked for ended up hiring my mother and all my brothers, so I was motivated to help it succeed

- another company was a restaurant started by a friend, so I tried to help him get started by providing reliable hlp

- another company a frind and I co-founded, so we were trying to make it in business

- another company was some big American multinational that took all its profits home (and tried to turn us into little Americans, eech)

- another was a student-run newspaper

and so on. You get the idea. Each of these create very different conditions for compensation.

The range of variability will be different in the larger companies that are probably your target audience. But I'll bet that the needs for compensation are very different in AOL than in Google.

Good stuff, Stephen. that's why this is going to be a tough topic to write about, particularly if one is trying to find "evidence" that some systems are "better" than others. As you point out, there are lots of moving parts here. 

Does anyone know of either (a) some good books and articles on I should read or (b) any data-based studies. I'm familiar with Alfie Kohn, but are there any good books out there currently offering substantive advice on designing comp or profit distribution systems (especially in a professional environment?)

Reading Mr. Downes comments makes me think that a good compensation system would be flexible enough to adapt to the individual's & business's needs as things change.  His 4 examples each have a different motivation for achievment and compensation in return.  And in each situation there is probably different levels of effort and reward that are available from both parties.  In the employment situations I have been in my motivations have come from differing directions and they varied as time went on.  But having said that, I was never consulted about any of those factors nor what I was willing to offer in exchange for my compensation.   Accordingly, one of the features that might be most useful is a sort contractual offer and acceptance/quid pro quo/I will do this for that kind of thing that expires and renews at set intervals.  I don't know if that is practicable, but if something were worked out along those lines how many of the items on David's list would potentially addressed? 

Terrific List!

Basically a "no-suprises-in-the-end" system. Both for Managers and the folks under them.

A system that shows and gives a realistic forecast of what precisely you'd get if you are performing the way you are performing right now, and how would it be if you performed in a different way.

That way:-
1. Employees would get to choose what they want to do, and hence be able to see where they'd get to at the end of the year.
2. Managers know how to design and improvise "ways" to get the best out of their employees.

The evidence based management community c/o Jeffrey Pfeffer is getting some sort of handle on what works; it would be good to use that knowledge in developing such a list.  Starter for ten would be

link

or http://tinyurl.com/ynk76q

You need to be able to cost in the effect of any bonus schemes onto a project when you are pricing a project. So your system has to be sufficiently transparent and simple so that it can have a predictable effect on the profitability of any project.

It is interesting to note that not all compensation schemes are put into place to incentivize staff. It is also possible to use compensation to reduce staffing costs. For example, if you pay a consultant with a small basic salary but a significant bonus based on a proportion of the billings he or she makes, you are also reducing your operational costs for when the consultant is 'on the bench'.

Further research and evidence-based measures will be brilliant. I agree there is a need to know what works rather than guess and feel.

Only a rather more down-to-earth angle: In myexperience, some of these systems (particularly those that include share options, phantom shares, Embedded Value-based bonuses, notional loans accumulating with interest, dividend financing, Texan Auctions and a host of other complex and not necessarily useful characteristics) are poorly understood by the designers. 

1. The true cost is not fully understood, resulting in unhappiness and sometimes broken promises when the time comes to show the money.
2. Components of schemes are copied from other organisations. The original intent and fine-tuning of these schemes is lost when it is applied to the current organisation. This can also cause the final costs to be very different from expectations.

In terms of more general compensation systems, the costs of time, money and employee goodwill in implementing a lengthy, inflexible appraisal form should not be underestimated. I've known professional firms where most staff devote a full week to the process. The extent of grumbling and "I don't care anymore so I'll put down anything" is as expected, with the resultant massive reduction in credibility of the entire procedure.

On the theme of "necessary not sufficient" I think it is clear that the implementation and practical issues will not make a great compensation system. However, poor implementation, and insufficient thought given to the practical side can surely ruin an otherwise impressive proposal.

From factors you've mentioned I'd point two as the most important:

1. Fairness (partially covered by point 6)

2. Comprehensibility (8 and 9)

When many people think compensation system isn't fair it sucks. When many people don't understand compensation system it sucks. Judging only on those two points most compensation system suck. Of course fairness and comprehensibility alone don't guarantee a success, as the system can drive people to the wrong direction, but these two are must-haves.

Thing you missed on the list - compensation system is made not only for regular employees but also for managers who review performance of their team members. When they feel system isn't fair or have to trick the system to get results they feel in their guts - system sucks. I’ve worked with the system which left me after each iteration completely frustrated as I couldn’t reward my team enough.

And one last thing. If people who make performance reviews are poor at that, the whole system sucks. They can destroy even a perfect system (if there was any).

Since the trackback system of this blog doesn't seem to be working, I thought I'd mention my blog post (http://blog.gdinwiddie.com/2008/01/27/agile-compensation/) triggered by this list. You may find it interesting that one of the complaints about the list, here, is that it mostly seems concerned with individual performance rather than team performance. I doubt that's the intent, but I do have to agree that bullet #2 looks a little lonely up there.

There is a difference between short-term and long-term compensation.

Short-term compensation is all about how we reward people for their work this quarter or year.

Long-term compensation is focused on what the pay structures exist for different types of employees (& owners, given that many professional services firms are partnerships).

Long-term compensation is generally tied to the perceived market value of that person or role and all the firms I have worked for have made extensive use of salary surveys. Generally, the questions here are: 1. How much would it cost us to replace this person at current market rates & 2. How much would it cost us to keep this person happy? As the staff member becomes harder to replace, you shift from 1. to 2. Long-term compensation shapes behaviour through the promotion process - so I don't think you can talk about money with about talking about career paths & promotions processes. 

Whereas short-term compensation is more about behaviour change (theoretically at least). The lesson I took from Evidence-Based Management was: performance pay works well when you understand performance and can monitor individually. And from what I've seen, most professional services firms are really bad at that.

A final point: an associate may get a bonus of tens of thousands of dollars but if they make partner they increase their income by hundreds of thousands. If the behaviours incented by the bonus scheme conflict with the behaviours required to become partner, which would you do?

How about executive compensation?  Ideas for capping executive compensation based on the rank-and-file employee compensation have been discussed for a while. Discussions on these topics will be helpful.

I know I am late to the party on this, but I think I have something to add.

My views are that compensation system in a Professional Knowledge Firm should have the following elements:

1. A base salary in line with the experience and perceived value of the person.
2. A quarterly or trimester variable amount based on the acquistion and/or demostratation of increased knowledge. For example, the passing of a certification test.
3. A quarter or trimester amount based on the achievement of profitability of the entire firm.
4. A descretionary bonus of varing amounts for work performed above and beyond. (We at VeraSage would call this a TIP clause, if it were paid by a customer.)

I hope this helps some of you.

Please enter your comment  COMPENSATION IS THE MOST DIFFICULT AND CHALLENGING CONSULTING ENGAGEMENT HERE AT TOWNSON & ALEXANDER BECAUSE OF THE TOP MANAGEMENT'S EGO AND CORPORATE POLITICS THAT SMOTHER THE BUSINESS ISSUES.  POINT # 5 OF THE CRITERIA FOR A GOOD COMPENSATION SYSTEM MAY BE ILL ADVISED IN THAT IT IS FOSTERING "AMATEUR NIGHT AT THE MOVIES" BECAUSE COMP PLANS ARE SO MISUNDERSTOOD AND COMPLEX, REQUIRING OUTSIDE CONSULTING EXPERTS WHO HAVE "BEEN THERE".

HERE ARE THE BASICS:

- PAY THE LEAST (MORE ON THIS "BASIC" LATER)

- GET THE MOST (RESULTS BASED ON HARD AND SMART WORK)

- MAKE IT LAST.

HERE ARE 4 GUIDELINES FOR COMPENSATION PLANS THAT MAKE THE 3 "BASICS" WORK:

1. NO TAKE AWAYS (OTHER THAN BIG SALES TERRITORIES THAT ARE NOT BEING COVERED)

2. COMP PLANS MUST PAY FOR THEMSELVES (A MAX OF 20% OF THE INCREMENTAL PROFIT GAINED GOES TO THE EMPLOYEE WITH 80% GOING TO THE CORPORATION)

3. THEY MUST MAXIMZE THE GROSS DOLLAR PROFIT POOL.

4. THEY MUST DO ALL OF THE ABOVE MONTHLY, QUARTERLY, AND ANNUALLY.

AND YOU CAN NOT DO THAT BY "PAYING THE LEAST" - THE COMP PLANS SHOULD AND MUST TRIGGER WILD CELEBRATION AND ENTHUSIASM IN THE WORK FORCE - NOT ALWAYS THE CASE...

OTHER FACTORS THAT MUST BE PART OF THE COMPENSATION PLAN ARE MINIMUM NUMBERS TO ACHIEVE RE CSI; REPEAT BUSINESS (THE EASIEST OF ALL BUSINESS SOURCES AND YET MOSTLY IGNORED RE COMP PLANS); REFERRAL BUSINESS (AGAIN IGNORED); AND BUSINESS ACTIVITIES SUCH AS APPOINTMENTS WITH NEW DECISION MAKERS AND PRESENTATIONS TO SAME.

THE ONLY THING PREVENTING SUCH COMMON SENSE COMPENSATION PLAN STRUCTURES ARE THE EGOS OF TOP MANAGEMENT AND THEIR SUPPORTING CORPORATE CULTURE ("WE DON'T DO THAT AROUND HERE...").

AND IN SUMMARY, THE ONLY WAY SUCH PLANS WILL EVER BE CREATED, APPROVED, AND IMPLEMENTED IS THAT TOP MANAGEMENT MUST AND SHOULD BE PAID THE SAME WAY - FOR INCREMENTAL AND ONGOING POSITIVE RESULTS VERSUS "BUSINESES AS USUAL".

Ok, ok, we hear you. ;)

Seriously, Harry, thanks for participating in the dialogue, but you need to know that posting in all caps is considered to be shouting.

Late to this game, but like a zoo who has embraced the most advanced, humane and enlightened policies in dealing with animals if the zoo keeper(s) is not in synch with them and has the judgement to apply them as intended you just have another zoo or in simplier terms still sometimes it is the mechanic and not the tools. So may be the focus for achieving the "best compensation system" needs to be shifted!

As Brad Hildebrandt once said: to discuss compensation systems is always good for consultants, but there is no such thing as the best one....

Actually, I have seen quite a few since working with law firms for 10 years, and each partnership has its own way of defining a fair and equitable system, whatever the point of departure is. My impression is that this is the most important point: that it is considered fair and equitable by most of the partners. So there is a social contract around any system, and if this contract is questioned due to economic turbulances, then the system discussion will beginn.

A worldwide study among law firms which we have conducted in 2006 shows that basically, each system has its advantages and disadvantage. In the end, it comes down to two things: whether internal cooperation is enhanced in an equal share system (lockstep being quite close to that), with the downside of some partners considered less performing, or whether individual pay is considered appropriate in merit based systems (all other systems than equal share or lockstep), with the downside of having complaining about the lack of teamspirit).  

By the way, those systems which try to measure everything  finished last on all criteria.

This is really tricky issue. In our firm we have tested several and none have been good. We have tested a fixed percentage of the consultant's invoicing an extra percentage for successful sales. That one is good when the times are bad i.e. minimizing the company risks; downside is that then the firm is not a FIRM anymore but more like a bunch of hunters (or how was it David?). Nowadays we have a fixed monthly salary for juniors, fixed salary a bonus if company quarterly operating profit is more than 20% for senior consultants and partners as well. Partners get they extra through dividend at the end of the year. At the moment this compensation model is not too bad, but obviously it is not so flexible if we get a kinf of a downturn. I know that the downturn won´t come if the firm is a true professional service firm delivering first class services as David has said, but while trying to create one like that we have to have something different. David, I might be pathetic, but aren't you also looking for something similar what Gary Hamel is talking about, compensating people according to their skills, passion or something; value they create for the company. Gary's idea (if I have understood it correctly) emerges from the fact that while technology, "brain power" etc. has remarkably developed during the last hundred years, the management practises are more or less still on the same level as they were in the beginning of industrialization. Are consultants and their firms actually the first "breed" to truly encounter the need for more farreaching management methods and related compensation models?

By the way, what Chris said about complex compensation systems and measuring everything - could not agree more - I´ve been there.