We’re two years into the Covid-19 pandemic, and things that we used to think of as unimaginable and unprecedented have now been seamlessly woven into our normal daily routines: Zoom meeting faux pas, home cooking conquests, podcast addictions, Peloton workouts. As comedian Shelby Wolstein put it, “Times are starting to feel precedented.”
And yet despite the disruption, advisory firms have had a smashing time. Markets favored them throughout 2021. Many firms enjoyed revenue growth that took them by surprise and allowed them to surpass their targets. It also required them to go on hiring sprees. That created its own set of challenges.
Fast-track growth is exhilarating, but it comes with equal parts apprehension and anxiety as firms anticipate how to accommodate new opportunities, and we know there are always casualties that accompany breakneck growth.
It’s not that growth isn’t good. In fact, it’s better than good, it’s necessary. But growing safely and sustainably requires a watchful eye.
De Pardo Consulting co-authored the 2020 “Growth by Design” study by TD Ameritrade FA Insight, a research report that surveyed financial advisors on a range of practice management topics. The report divided participants into two cohorts: “sustainable growth firms” and “growth at risk” firms. The sustainable growth firms reported 11% revenue growth in 2020 and 25% growth in assets under management, while the growth-at-risk firms reported 7% revenue growth and 20% AUM growth.
The key distinction between these two groups was that the firms at risk, while performing well, reported at least one negative side effect directly related to the growth. Growing, after all, sometimes comes with subtle but often harmful consequences.
For instance, 51% of these firms reported that their talent had become overworked. A further 29% of the firms experienced staff turnover associated with the growth, a result few can afford in an industry suffering from an acute talent shortage. A noteworthy 46% reported growing inefficiencies and 37% experienced increased operational errors, as talent struggled to keep pace with the rate expansion.
These people challenges confirm what we already know: Increased pressure on talent during periods of expansion creates vulnerabilities across a firm.
In December 2021, research from the University of Oregon painted a dramatic picture of what happens when talent comes under pressure. The study, called “Private Equity and Financial Adviser Misconduct,” was written by researchers Albert Sheen, Youchang Wu and Yuwen Yuan, and it examined the rate of misconduct in firms acquired by private equity both before and after the deals were done.
The authors asked the question: Does a strong profit and growth motive mitigate or exacerbate advisor misconduct? The marquee finding was astounding: Private equity acquisitions lead to a 147% increase in the rate of advisor misbehavior.
The population of advisory firms studied managed retail clients only. Growth in assets under management per advisor was analyzed as well, and the results indicated that aggressive expansion was consistent with elevated levels of misbehavior. The firms that had been bought were model citizens before, representing just 40% of the industry misconduct average before they were bought out. The rate of misconduct subsequently increased—in line with the industry average—after the buyouts were completed.
The research found that private equity ownership puts pressure on firms to drive growth while also avoiding increases in operating expenses. That increased pressure on advisors not only likely leads to more transgression, but it also likely curtails the firms’ ability to reinvest in talent, develop services and technology, and improve the client experience. Instead, the private equity oversight likely prioritizes and rewards higher client head counts, the pursuit of new assets and higher fees.
Those of us who have been around long enough might be feeling a little déjà vu. Growth combined with ineffective management and/or ill-conceived compensation models spells trouble for a firm’s clients, advisors, shareholders and culture. Our industry has experienced this before.
By now, the consequences of pursuing growth this way (and incentivizing advisors this way) should be obvious, right? It increases pressure to deliver growth and profit, which will burden leadership. And the tensions will compromise a firm’s culture, conduct and decision-making.
Firms have complex, unpredictable experiences in the ways they reward talent. Not everybody at a firm responds to incentives the same way. You certainly can’t get unmotivated team members to raise their game or drive growth with incentive compensation alone. These are just some of the reasons that effective incentive pay eludes many firms.
I recently spoke with owners at a successful RIA firm that had introduced generous advisor incentives. A significant share of revenue was paid to advisors for new clients generated, a reward that extended beyond year one, paid in perpetuity. In short order, advisors benefited from healthy levels of ongoing revenue from existing clients. But their focus promptly shifted; many advisors preferred to serve existing clients, avoiding the work required to find new ones and grow the firm. This response confounded the owners, who themselves would have enthusiastically chased such an incentive opportunity.
Another program that often doesn’t work is one in which firms offer their employees generous incentives for referring clients. Why? There’s a disconnect in the skills when someone from a non-revenue role, such as a client service associate, is asked to participate in revenue-generating activities. No amount of cajoling will persuade a client service associate to refer a prospect if they don’t feel equipped or confident in their ability to do so.
So there are two problems. On the one hand, firms acquired by private equity may risk reputational damage in pursuit of aggressive growth to meet expectations and generate rewards. On the other end of the spectrum are firms that cannot seem to offer large enough incentives even to inspire a focus on growth. Both incentive systems have failed, which shows the importance of achieving a more balanced compensation plan.
So where to go from here?
The “Growth by Design” research suggests that firms can avoid operational errors, inefficiencies, and stressed and dissatisfied staff by sharpening their focus during periods of growth. For example, firms might use incentive pay to reward non-revenue roles for contributing to process innovations, cost management initiatives, and employee value and retention programs that protect and aid growth.
The incentives for advisors, meanwhile, must align to their priority role functions, including their new and existing client accountabilities and the role they play more broadly at the firms. Their compensation can be combined with other essential ingredients: their ability to mentor and train others, for instance, or their adherence to a firm’s values.
A well-rounded, balanced compensation plan sends a very specific message about a firm’s values and priorities. The good news is you don’t have to get stuck in a frustrating compensation cycle that is not achieving the intended outcomes. And you don’t have to stick with a plan that’s not working. The most effective plans are reviewed at least annually to ensure talented team members are rewarded for their contributions, and in that way, a firm’s performance, values and culture are advanced.
Eliza De Pardo is founder and director of De Pardo Consulting.