on Partnership-Compensation Models
Denise Dickins, Thomas G. Noland, and Kenneth M. Washer
2005 - Partner compensation is one of the most controversial
and least understood topics among accounting professionals.
Accounting professors do not discuss partner compensation
with students, nor do firm partners explain the system to
new hires and senior staff. One reason for this silence is
that many different partner-compensation models exist, each
with its own advantages and disadvantages.
the authors’ discussions with partners, the themes
of fairness, retirement, and rewarding top performers continually
emerged. While each firm and partner are different, the
following basic tenets should be considered when adopting
a partnership compensation model:
The model must be perceived as fair by both junior and
model must not bankrupt the firm upon the retirement of
model must reward top performers.
model may have to be changed as the firm evolves.
to the Partnership
senior managers have demonstrated some success, they may
be asked to join their firm’s partnership. What’s
next? Should the partner contribute money to the capital
account immediately, or over a period of years? Does the
firm even require a capital contribution? Two methods for
admission to the partnership are discussed below.
capital contribution. Arthur Andersen used
this approach, where each partner purchased a fixed number
of partnership units (which generally ranged from 150 to
300, depending upon the partner’s classification).
The purchase price per unit was routinely increased. At
the time Andersen ceased its public accounting operations,
new partners were required to make an initial contribution
of approximately $250,000; financing was arranged through
the firm. Andersen then credited interest to each partner’s
capital account based on the partner’s capital account
balance and current interest rates. From an individual partner’s
perspective, the weakness of this model became apparent
when Andersen dissolved and the partners lost the money
in their capital accounts. Many newly admitted partners
owed large note balances while no longer having an income
source. The strength of this model is its new infusion of
cash as new partners are admitted and old partners retire
and withdraw their capital from the firm.
of this model requires new partners to contribute capital,
but no interest accrues on the account. One regional firm
requires new partners to contribute $50,000 upon admission
to the partnership, an amount that has not changed for more
than 20 years. The primary weakness of this model is that
the individual partner’s $50,000 investment has a
zero growth rate. Another weakness is that, because the
required contribution is not adjusted for inflation, new
partners contribute less than older partners did upon joining
the partnership. A strength of this model is that a retiring
or departing partner can withdraw her $50,000 from capital
immediately, as it will be replaced with a new partner’s
contribution with no effect on the current cash reserves.
capital contributions. This model requires
no immediate capital contribution, instead requiring new
partners to contribute a percentage of their pay over a
period of time. For example, if a firm required a total
capital contribution of $150,000, the amount may have to
be paid over five years ($30,000 a year). One strength of
this model is that it requires no immediate cash outlay
for a new partner. Unlike the Andersen model, if the firm
ceases to exist, newly admitted partners do not remain liable
for a large note. From an organizational perspective, a
weakness of this model is that partners may not see themselves
at risk and may simply view their compensation as a net
of the annual amount received.
accounting firms are structuring compensation similar to
a corporate model, with a guaranteed salary and a bonus
based on performance. Other firms pay their partners compensation
based upon the percentage of ownership. Others use a hybrid
of these two methods, with annual pay, a bonus, and then
the remaining profits split based upon ownership percentages.
Some firms pay junior partners only a salary and have a
fixed time period before they can join in profit-sharing.
Some firms call certain professionals partners even if these
individuals have no ownership percentage. Several managing
partners stated that one of their biggest challenges is
to ensure that both junior and senior partners perceive
the compensation model as fair.
structure. This model pays partners a “guaranteed
salary” and a bonus based on performance. Any profits
remaining at the end of each year are paid out based on
the partner’s ownership percentage in the firm. By
paying out a guaranteed salary, the firm recognizes that
each partner should be paid for the job they do every day,
before dividing profits. Normally an executive committee
or a managing partner establishes salary and bonus objectives
at the beginning of the year, so that each partner knows
what performance level has to be reached to maximize compensation.
Additional ownership shares of the partnership may be assigned
or sold to a partner based on factors such as the retirement
of other partners, new business development, and leadership
potential. Each partner may be required to keep a fixed
dollar amount or a percentage of compensation in an individual
basic strength of this model is that top performers can
still be rewarded in down years. By establishing bonus objectives
at the beginning of the year, one partner may have a big
year while another earns only a base salary. A weakness
of this model is that it may encourage reckless behaviors
as individual partners attempt to maximize their personal
income. For example, if other controls are not in place,
a partner may take an overly risky client, or may compromise
an accounting position in order to retain a client.
apprentice. This model admits a partner to
the partnership, but makes them ineligible for profit-sharing
for a fixed time. One firm fixes new partners’ salaries
for the first three years (adjusted annually) and then begins
profit-sharing in the fourth year. Each new partner is assigned
or can purchase the same ownership percentage, which can
be increased each year by factors such as revenue growth
of the entire partnership, client volume managed by the
partner, the partner’s billable hours, the partner’s
administrative duties, and the write-off percentage. This
model allows existing partners to see how new partners perform
before they share in the profits. Animosity, however, may
result as young partners work for three years without immediate
Similar to standard partnership structures,
this model provides no guaranteed salary to its partners.
Instead, all partners share in the firm’s residual
income based on their share of ownership. Partners
receive distributions periodically throughout the year depending
upon expected earnings, which are adjusted throughout the
year. At the end of the year, distributions are “trued
up” based on the firm’s actual performance.
At Andersen, which used a version of this model, substantially
all newly admitted partners received (purchased) the same
number of partnership units. Every two years, each partner
was eligible to purchase additional units, contingent upon
performance. Performance evaluations considered technical
skills, knowledge sharing and client development across
the firm, retention and development of staff, and achievement
of financial goals. As with the partnership apprentice model,
if partnership ownership percentages are not reduced as
partners approach retirement and their personal production
decreases, dissatisfaction among younger partners is possible.
and Dismissal from the Partnership
firms have both a mandatory and a minimum retirement age.
Most firms provide a retirement benefit, although the amount
can vary dramatically. In some cases, partners that leave
before the established minimum age face stiff penalties.
One firm requires an individual to serve at least 10 years
as a partner before being eligible for retirement. Another
firm levies a 20% reduction in accumulated benefits if a
partner does not give a two-year notice before leaving the
firm. A minimum payout period allows the firm to have an
orderly withdrawal of funds if several partners leave at
the same time.
a partner leaves on her own before the minimum retirement
age, she may be entitled only to the money in her capital
account, which is often paid out over a certain period of
time. Some firms allow an individual partner’s capital
to be repurchased at its fair value at the time of retirement
or dismissal. Some firms, like Andersen, buy back the amount
of each partner’s capital account, plus accrued interest.
contributions are treated more like loans than like capital.
a partner is dismissed, in addition to the return of capital,
he may be entitled to a severance package. One firm gave
a lump-sum payment equal to the partner’s last full-year
compensation as part of a severance agreement, contingent
upon the dismissed partner’s not practicing public
accounting within 100 miles for a three-year period. This
partner was also entitled to accumulated retirement benefits
based on the firm’s retirement formula.
retirement. There are two versions of this
model. In the first, the partner contributes a percentage
of pay or a fixed dollar amount to his own retirement account
on an after-tax basis. Contributions are set aside in each
partner’s name, and earnings are periodically credited
to individual accounts and included in taxable income. Upon
retirement, withdrawals other than current interest are
tax free. The strengths of this model are that the individual
partner’s retirement benefit is generally a function
of the individual partner’s performance during her
tenure; the firm can maintain its capital in the event of
several retirements at once; and existing or future partners
do not have to fund current retirement benefits. A weakness
of this model is that the tax rate attributable to the retirement
benefits is generally higher than it would be if the partner
were taxed at the time of receipt instead of at the time
a second version of funded retirement, the firm, rather
than individual partners, contributes to partners’
retirement accounts. The firm’s contributions are
usually calculated to be an amount necessary to provide
a defined retirement benefit. Upon retirement, withdrawals
are taxable to the partner. A strength of this version is
that partners are “forced” to set aside money
for retirement, in the form of receiving smaller distributions
during their tenure. Because the income is deferred to retirement,
the tax rate on benefits received should be lower. A weakness
of this model is that retirement benefits are not necessarily
a function of each individual partner’s performance,
depending upon the methodology established to determine
the amount of the retirement benefit.
retirement. Retiring partners are often paid
a percentage of their earnings at the time of their retirement
over a period of 10 to 15 years. This retirement benefit
is paid by the firm out of current earnings before distributions
to current partners are paid. A weakness of this model is
that active partners’ compensation could be severely
impacted in a bad year because of the requirement to pay
retired partners first. One
firm had an unusual variation of this model. Upon retirement,
partners were paid a percentage of their pay for the next
10 years. But instead of paying them based on their final
year or an average of several years compensation, the firm
based the benefits on their compensation from 10 years earlier.
One weakness of this model is that it allows partners to
coast into retirement, secure in what their retirement pay
will be. A weakness from a strong performer’s perspective
is that the individual is not rewarded for the last 10 years
they work. The firm benefits from this model because it
does not have to pay retired partners for inflation adjustment
increases over the last 10 years.
regional firm stated that adjustments needed to be made
to their retirement model because of the expected retirement
of several key members of the firm at the same time. The
impact of funding several retired partners for 10 years
from current profits might hurt the firm when potential
new partners consider the 10-year impact on firm profits.
is no fixed model for partner compensation. Each firm must
adopt a model that fits its needs while taking into consideration
fairness among the partners, retirement needs, and rewarding
top performers. A firm that follows these basic tenets will
likely have partners that are satisfied with the firm’s
Dickins, CPA, is a PhD candidate at Florida Atlantic
University and former partner-in-charge of Arthur Andersen’s
South Florida Audit Division.
Thomas G. Noland, PhD, CPA, CMA, is an assistant
professor of accountancy at Georgia Southern University.
Kenneth M. Washer, DBA, CPA, CFP, is an assistant
professor of finance at Texas A&M University—Commerce.