Live Our Values, Demonstrate Our Behaviors, Support Our Strategy…

Maister, the author in 1985 of the original points summarized above, updated his article in 2006 with his colleague Jack Walker.  Much had changed since then, including the self-immolation of Arthur Andersen, one of the firms held up as a shining example of this concept.

In our view, many professional service firms are currently engaging in activities that undermine loyalty and create fault lines, including:

• Growing for growth’s sake, by incoherently adding laterals and merging;
• Expanding into unconnected practice areas and markets;
• Hiring primarily semi-experienced lateral associates rather than hiring and training entry-level applicants;
• Eliminating social and partner/officer meetings as a cost-cutting measure;
• “Pulling up the ladder” to partner or owner status and establishing complex membership hierarchies, including nonequity levels, not to serve clients but rather to relieve inside pain; and
• Obsessing about the short-term bottom line: treating financial success as the goal rather than as a byproduct of a well-run firm.

Some of you may recognize the title of this blog post as the PricewaterhouseCoopers LLP mantra.  So much has changed even in my professional life, which only goes back to the early 80’s. Front and center are the threats to the global network of all the firms (which isn’t mentioned above) and the focus on aggressive growth while diluting the partnership culture of the firms by perverting their compensation structure.  These systemic problems with the audit firm model are found in all the Big 4 firms, but I’m going to use PwC as an example.

Partner performance assessment has become a short-term, self-serving tool to throw disproportionate wealth to a small group of senior leadership.  This top heavy, both in pay and influence, structure is due to the loss of a true consensus leadership model. A decreasing percentage of active partners, estimated by insiders at PwC for example to be 10%, are actually true “equity” partners. The firms are nowadays run more and more like major global corporations than closely-knit partnerships.  Maybe that’s inevitable.  Huge, global firms with hundreds of thousands of employees, billions in revenues, and far-ranging lists of services don’t lend themselves to having thousands taking a vote every time there’s a decision to be made.

But they do try to maintain the illusion.

(Ok, I concede, what’s the point of requiring a partner to sign an audit report in their own name when they can’t be held personally liable? They’re essentially “at-will” employees acting as an agents of the firms.)

Regardless of the language used and the ongoing illusion of fraternity, the current Big 4 partner compensation plans, using PwC as an example,  are generally based on a salary component (responsibility income), a share of profits (equity income),  and a corporate-like bonus for a few (exemplary award).  In PwC’s case, what’s funny is that even though the firm purports to have as their primary FY10 goals growth of the business, enhancement of the brand, success of business model changes, and dominance of their network over competitors, they have an “all the children are high performing” performance appraisal methodology that contradicts these goals. Notice that none of these stated goals for FY10 have anything to do with client (shareholder) service, audit quality, technical competence, or a restoration of faith and trust in the profession.  They have everything to do with their “burning platform for growth.”

I’ve written quite often about the performance appraisal process for staff and the concept of forced ranking. “Jim’s better than Bob but not as good as Mike.” In a nutshell, that’s forced ranking.  In the partner world it has a different name, relative performance.  When it comes to performance rankings, this means you may be judged to have met your objectives or exceeded them, but your peers may have “met them more.” Therefore, you are relatively not as good as them and must significantly improve your performance, not against a set of clear objectives that lead to firm success, but against the performance of an ever changing, subjective, out of your control, set of peers.

So what does it mean to be rated “High Performing” as a partner at PwC?  Not much since you’re part of a band of brothers that includes 89% of your partners in FY09 – the same percentage as in FY08.  What has changed is percentage on the right and left side of the “bell curve.”  In FY09, 4% of partners are considered “Exemplary” and 7% are considered “Under-performing.”  Interestingly enough it was just the opposite in FY08, 7% at the top of the heap and only 4% in the slush pile.

Even though “only” 7% were rated as Under-performers, it’s clear to leadership that this is not going to cut it. Given that PwC Global revenues declined 7.1 % and North America also declined, “we have a greater number of partners who may have met their plan but are contributing below their peers.” That’s the bad kind of relative performance.

What happened?  Were plans at an individualal level not set to add up to the total result that was needed to exceed last year?  Did the wrong people meet or exceed plan and the ones with biggest bang for the buck completely blow it? Rest assured, the 7% under-performers will have responsibility levels reduced (salaries) and shares reduced (equity income.) You’ve started down the relatively short slide out the door.

Let’s go back to the 4% this year who were rated “Exemplary.”  Now, and in the future, the message is that the “Exemplary” rating and the bonuses that go along with it will be allocated based on “going above and beyond to reach strategic priorities.” Those strategic priorities, which we mentioned earlier, are focused on the “burning platform for growth.” These awards do not have an upper limit, have a floor of $50,000, and averaged ~100k to the 90 or so partners who received them.  Good thing that a large number of those partners are in the two lowest responsibility levels because when I look at what they earn on average and the median total compensation for these partners, let’s just say the others don’t really need the bucks. Relatively speaking.

That’s not to say that the highest paid partners in a firm like PwC US really make that much either.  Relative to their clients, the top 25 client service partners, the top four US leadership partners, and the rest of the Leadership team are making pocket change.  Even the highest paid client service partners, on average, are making chump change when you consider that their audit clients in the US include some of the largest financial services survivors of the crisis.

Let’s look at their colleagues in the UK and the UK Chairman Ian Powell.  In the UK, the firm issues audited financial statements, on an IFRS basis, complete with executive compensation and retirement plan disclosures and plenty of operating metrics. Here in the US, the firms fight transparency.

“The toll of the recession on the big accountancy firms is illustrated again today with PwC revealing the firm has seen growth, but by only half of one percent.

Results from the firm, released alongside its annual report, show UK revenues have gone up by around £10m to £2.25bn for the year ending in June.

PwC’s advisory business grew by 5% to £737m (fm note: This the US$100m Lehman bankruptcy advisory effect which was not shared hardly at all with anyone else), while assurance saw a drop in turnover of 1%, to £861m, as did tax but by the slightly larger margin of 4% to £650m.

Profits per partner fell to £777,000 (US1.3m), down 3%, a and Powell earned £3.3m (US $5.5m) for the year, against £5.2m ($US8.8m) for Deloitte’s chief executive John Connolly…”

I can tell you that Dennis Nally, as the US Senior Partner prior to his ascendancy to the Global Chairman role, did not make as much last year as even his UK counterpart but that’s maybe just an exchange rate difference. For some reason, the PwC Global Annual Report likes to provide comparisons in constant dollars, as if the impact of the fluctuation in the US dollar last year was just a rounding error. The UK/US cross currency rate alone went from .502 on June 30th of 2008 to .607 on June 30th of 2009 and is at .602 today.

Then again, Mr. Powell had a slightly better year than Mr. Nally.

The Lehman UK bankruptcy administration put an enormous sum in the UK coffers and made their Advisory practice look like heroes. It’s expected to be a gravy train for them for a while.

In the report, PwC revealed that in their first year working on the case they have charged £154m (€168m) in fees for work on the company’s winding up.

The report notes that there has been a “general downward” trend in the average hourly charge-out rates for PwC partners and staff.

The average hourly rate has dropped from £329 to £309 over the past six months, say the administrators.

The profit per partner in the UK is substantially higher than profit per partner average in the US of $810k (a decrease from 2008) and the average or median income payout to US partners who are not on the leadership team or not in the group of highest paid 25 partners ($100k lower.)  The highest paid 25 client service partners at PwC are the ones who manage the audits of clients like AIG, JPMorganChase, Bank of America, etc.  And yet, their total payout for all that work is equivalent to a Wall Street guy’s custom tailoring allowance. Ok, throw in the Starbucks and dry cleaning budget and call it a couple mil.

So what has this done to the goal of being a “one-firm firm” at PricewaterhouseCoopers?  Well, in addition to the overwhelming focus on growth, aggressive growth, “address the burning platform” growth that is contrary to Maister’s model, we see a deterioration of the partner compact based on a compensation scheme that pits partner against partner in a never ending game of trying to top each other.  They’ve reduced the “partners” to essentially “hired hands.” What does it do to partner morale when they realize the obstacle for getting paid a market wage for hard work, long hours, and significant effort is not losing the engagement to the competition but having your peer partners arbitrarily deemed harder working, more successful and bigger team players than you?

Maybe I’m giving the average partner too much credit.  Are the 90 % of the partners who aren’t leading the largest engagements and on the leadership team really working that hard?  How often do you see them at your client or at your office if you’re a client? Hey PCAOB: How many hours do they charge to engagements on average?  1%, 5% , certainly not 10%.  And how many subordinates do they have, on average? With the way they manage the staff performance appraisal process you can see that the connection to staff is tenuous at best and true mentorship and ongoing supervision is an exception.  I saw quite a few partners who had no team, or had a team in name only, as staff was pooled and no one higher than a Manager ever coached, trained, or mentored them on a day-to-day basis.

And what’s the incentive to stay in client service when you can make so much more in an administrative job on the leadership team?  No client complaints, no risk and quality paperwork, no PCAOB inspections, no revenue pressures, no liability, no hassles. Just endless meetings and conference calls.  Why not aspire to get out of the rat race of client service if it’s never going to pay more than a few million at the very most?

It also means that we shouldn’t be shocked that the audit partners for these large public companies don’t act or feel like equals to their clients’ CEOs, don’t sit across the table from these leaders regularly, aren’t called into the huddle during crisis weekends when the fate of Wells Fargo, Merrill Lynch, Lehman Brothers and Bear Stearns are decided.  Money is the ultimate scorecard and Wall Street, in particular, is operating in a different league than the audit firms, especially in the US.

At least in the UK, Mr. Powell, Mr. Connolly and their counterparts at EY, KPMG, even BDO are routinely sought after by the FT, the Guardian and the Times of London for their opinions on the economy, the markets, the future of capitalism, and general economic trends. Here in the US, if it’s not about an accounting related topic on their lobbying agenda or a new pet initiative such as “green” or “sustainability” you just don’t hear from them.

Maybe “you get what you pay for” here in the US.

Main page photo credit

Inside video credit: The train paradox is a famous example of the strangeness of relativity. Demonstrates just how non-intuitive reality can be. “Whenever you get a paradox of relativity almost invariably what you are intuitively assuming is that things that seem simultaneous are really simultaneous when really the concept of which came first depends on your frame of reference.” Professor Richard Muller of the University California, Berkeley.