By Alan Radding
The year 2000 is shaping up to be one of compensation shift within the consulting industry. Although some are moving faster than others, most firms are feeling pressure to consider major changes to their nonpartner compensation programs. Their goal: Share more of the wealth being generated, through consulting for equity, venture capital funds, and other investments in the New Economy.
"This is a big issue that went from being peripheral to being important. Firms have quietly been taking stock in companies for years, but now there is pressure to share it with the bottom and middle of the organization," says Alan Johnson, president of Johnson Associates, a New York–based compensation consulting firm that frequently works with consultancies. "By providing consultants with a share in firm investments, the message is that you can stay here and share in the excitement [of the New Economy] without the risk."
So far, however, much of the new compensation structures are a work in progress, and likely beneficiaries have seen no change to their compensation packages to date.
"We know we can't go on much longer like that," says George Stalk, a BCG senior vice president. He envisions a compensation package with less emphasis on base salary and more risk-based compensation with a higher upside. In the meantime, the firm's partners have agreed to share with all employees a portion of their gains from investments in the New Economy or consulting-for-equity agreements, after they recover their initial investment and their cost of capital. "It's substantial, and it's a windfall that everyone is entitled to if they were at BCG when the venture was started and when the venture stopped or the liquidity event occurred," Stalk says.
Getting over the hurdles
Even with programs like these immediately visible on the horizon, getting there was not easy. In fact, legal and regulatory hurdles, including insider trading rules, have dictated how far some firms can go. As a result, don't expect to be invited to iniinvest directly in your firm's venture capital fund any time soon.
According to Andrew N. Friedman, a partner in the securities practice group at the law firm Cohen, Milstein, Hausfeld & Toll in Washington, to comply with certain SEC regulations, firms may have to limit investors with nonregistered interest in these funds to individuals with at least $200,000 in net income ($300,000 in joint income if they are married) or a net worth of at least $1 million. As you can imagine, "that keeps a large number of people out" of these funds, says Stalk.
Booz-Allen & Hamilton is working on a new compensation approach and hopes to roll something out this year. But the process of doing so has not been easy. "Any firm that wants to offer staff equity participation in its investments faces horrendously complex legal issues," says Harry Quarls, the firm's managing director of corporate finance. "I've had flanks of lawyers dealing with the SEC for six to nine months to get it done."
In some cases, however, firms have designed their programs to benefit from existing laws. BCG, for example, has structured its plan to make sure it produces a capital gain rather than ordinary income, in order to minimize taxes for recipients.
The risk question
Even if consultants can't invest directly in venture capital funds, there is still plenty of risk to go around. Firms are grappling with the risk inherent in many of these new compensation approaches, as well as the increasing appetite for risk among consultants. "We're trying to respond to [the greater appetite for risk], and that is why we are re-evaluating the compensation system," says Jim Down, chairman of Mercer Management Consulting. However, risk-based pay for lower-level consultants will be something completely new for the firm. "There's a lot of risk as you become more senior in the firm, and that's by design. But historically, we've insulated nonpartners from the risk."
Risk is also a key issue for Viant, whose compensation package for consultants relies heavily on stock options. To provide some balance in case its stock performs poorly, the firm has recently increased the cash component of its compensation package. This way, "if the stock was to tank, people wouldn't be in dire straits, because they could live on the cash component," says Diane Hall, the firm's chief people officer. In addition, the firm does not rule out repricing options if it were necessary to retain talent. "If something drastic happened, we would evaluate whether we should and could do an options repricing for our employee base," Hall says.
Overall, firms are trying to find the right level of risk for both themselves and their consultants. "People always believe that pay-at-risk programs are going to be successful," says Quarls. But if a program tied to some form of equity participation or other fluctuating formula does not pay out, firms are concerned that they could end up losing some of their people.
No entitlements
Even as firms roll out compensation programs based on overall firm financial performance, they are being careful to keep these programs from being viewed as entitlements. As a result, consultants can expect actual payouts from these new compensation programs to be based at least in part on their own individual performance.
PricewaterhouseCoopers' consultant share unit plan has been in place for two years, operating like a phantom stock program. In other words, the total awards pool is based on overall firm performance, and each consultant is awarded a certain number of units from the pool each year based on his individual performance. Overall, consultants have an opportunity to earn up to 40% of their salaries through the program.
To measure consultant performance and determine rewards under the plan, the firm uses a balanced scorecard to evaluate consultant performance. Not surprisingly, contributions to clients weigh most heavily as measured by actual performance on engagements, with business development, innovation and creativity, and helping to develop others in the firm, among other measures, also considered. Then, to provide a retention incentive once an award has been made, the firm pays out the awards in three equal payments over two years. For example, if a consultant receives a $30,000 award, she will get $10,000 in cash immediately, another $10,000 a year later, and the final $10,000 the following year. The firm also pays appreciation based on the partnership share value on the awarded amounts that have not yet been paid out.
Because the plan has been in place for some time, PwC expects to use its basic structure to share the rewards from its equity investments and consulting-for-equity arrangements with clients, according to Bob Russell, a partner with the firm. He expects the change to take hold some time next year, once the firm's proposed reorganization is complete.
Opportunities for all?
As firms work to avoid making these programs entitlements, they are also grappling with how to make sure they are equitable. This is particularly true for firms that want to limit sharing the gains from equity investments to those consultants who actually worked with the company involved. "You have to be careful that you don't end up with somebody saying, 'I didn't have the opportunity to make the same amount of money as somebody else, because they were staffed on a different case than I was,'" says Down. "We don't want to end up with some people feeling like they're first-class or second-class citizens."
Even this current crop of compensation changes is not likely to appeal to everyone. "If a guy wants to go out and make $50 million, there's no way he's going to make it in the consulting industry," says Quarls. "The question is, How far should [firms go] to accommodate a handful of people who are driven by greed?"
Even as firms roll out these new compensation approaches, Johnson warns that just adding a new pay-at-risk program may not be enough to solve the larger compensation problems firms face. "Many firms have antiquated pay systems for everything from salary to bonus to the performance review," he said. "This is just a symptom of the more intractable problem of a culture and history that says, 'You have to pay your dues.'
Next time: A closer look at these new compensation programs.
Sidebar: PowerPoints:
• While most firms view equity-sharing as critical to their efforts to attract and retain talent, much of the new compensation structures are a work in progress, and likely beneficiaries have seen no change to their compensation packages to date.
• Firms are grappling with the risk inherent in many of these equity compensation approaches, as well as the increasing appetite for risk among consultants.
• In some cases, firms have designed their equity-sharing programs to benefit from existing laws. BCG, for example, has structured its plan to make sure it produces a capital
gain rather than ordinary income, in order to minimize taxes for recipients.
Sidebar: Did you hear what they're up to?
A number of firms are putting a new twist on compensation.
• In June, Deloitte Consulting plans to introduce a new compensation program designed "to create a more performance-based system that has a value piece" linked to the firm's venture capital fund, according to the firm's newly appointed CEO, Douglas McCracken.
• This spring, Andersen Consulting announced a new annual incentive program that will be linked to overall firm performance, with payouts limited to the firm's top performers. At the same time, the firm is also looking to accelerate the time it takes to become a partner so that high performers can own units in the firm more quickly than in the past.
• KPMG Consulting made its first stock option grant to employees in anticipation of its eventual IPO. Grants are also available to the firm's new hires. Overall, the firm plans to make performance-based stock option grants a permanent part of employees' overall compensation package.
• Boston Consulting Group is developing what it calls a venture capital–style compensation structure for its consultants working on deals within the New Economy.
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