The Case Against Incentive Compensation

By Bob Veres

Even though NAPFA advisors have adopted a Fee-Only, non-sales business model, many are still operating with artifacts of the sales model built into their operations.

AUM is one such artifact; I think of it as commissions in drag, where advisory firms are paid purely based on how much clients are willing to invest with them. Yes, the AUM revenue model offered a great way to transition away from direct commissions. But I don’t know of any true profession where, when somebody asks how much your services cost, your answer is, I’m not sure. How much have you got?

It’s interesting to me that the brokerage firms—which very definitely do NOT have a Fee-Only mindset—adopted the AUM revenue model with no problem. If NAPFA members were ever to create an association policy where they always offer a flat fee or hourly option to their clients (perhaps as an AUM alternative), I doubt the brokerage firms would be quick to follow.

The Case Against Tying Compensation to Specific Behaviors

I was recently made aware of another option, courtesy of Brett Davidson of FP Advance in London. He wrote a white paper (https://fpadvance.com/whitepaper/incentives/) that suggests incentive compensation—basically paying people to do their best work and/or encouraging them to engage in certain behaviors—is taken directly from the old sales culture. If you sell annuities, you get paid a commission. If you don’t, there’s no commission. Is that so different from; If you spend X hours a month mentoring these staff members, you’ll receive this money set aside for you? Or: If you successfully onboard X percent of the prospects you meet with over the course of a quarter (or a year), you’ll receive this incentive.

In the white paper, Davidson makes various cases against incentive compensation tied to specific behaviors. He says that when the firm defines in advance certain behaviors it expects and will pay for, the result can be demotivating, and it also stifles people's creativity in pursuing a course that benefits the clients and the firm. And it can lead to unintended consequences. The white paper mentions an incentive program for bus drivers in London to complete their routes on time. This incentivized drivers who were caught in rush hour to whiz by stops full of passengers to get to the terminal at the prescribed time and not lose their incentive compensation.  

Davidson argues that these incentive structures can almost always be gamed. Take the example of requiring an advisor to onboard a certain percentage of the prospects she meets. She might decide to refuse to meet with prospects who would like to explore a possible relationship but seem to be on the fence about becoming a client. If she only meets with prospects she’s more certain about, she’ll hit the target.

It also can feel insulting for the company to tell you the behaviors it expects in concrete detail. You want to do your best work, but here are the things we expect you to do (and by implication don’t believe you will do unless we specifically tie some money to them).

Alternative Solutions to Motivate

There are a number of alternative solutions cited in the white paper, including an excerpt from "Six Dangerous Myths About Pay" by Jeffrey Pfeffer. Pfeffer notes how the head of North American sales and operations for the SAS Institute finally threw up his hands and decided, after a difficult experience, he wasn’t smart enough to design an incentive system that couldn’t be gamed. So he tried a novel, creative approach: he and other SAS managers actually sat down and told their team members what was important for the company and why. 

In Daniel Pink’s book, Drive, he distinguishes between extrinsic and intrinsic motivation—noting the latter is what you want in your staff. Davidson’s final point is that if a staff person is primarily motivated by extrinsic rewards instead of an internal drive to do an impressive job at whatever is presented to him, then that may not be the ideal person to have on your team.

I’m in an extended conversation with industry consultant Angie Herbers of Herbers & Co. about a keynote presentation at my next annual conference, and she emphasizes the three factors that are coming to the fore in this current business environment:

• Capacity, which is driven in part by the effectiveness, creativity, and responsiveness of your team in an environment that is constantly fluctuating and therefore presents challenges that can’t be predicted in advance
• Attracting and retaining talent, which obviously requires competitive salaries, but the firms that tend to be most attractive to the best advisors and staff members are offering a culture of collaboration and innovation
• And related to the first two: a culture where people can do their best work (Incentive compensation is not just an artifact of sales; it’s also a disguised form of micromanagement, which is not characteristic of an environment where people thrive, or where the best people want to work.)

Bonuses—yes. Profit sharing—yes. Recognition—of course. But all the white noise out there about this or that “best” incentive compensation system can, I believe (with Davidson’s help), be safely ignored by today’s Fee-Only advisory firms.

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Bob Veres is the publisher of Inside Information and one of the strongest advocates of Fee-Only planning in today’s profession. If you think his columns are full of the stuff that hits the fan, tell him so directly at bob@bobveres.com.

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