Thursday, November 12, 2009

Innovation in Employee Compensation - Efficient but Unfortunate

Our country is fairly quietly experiencing a major transition in the ways that professionals are compensated. The shift at hand causes services to be measured in more discreet increments than ever. The new ways that professionals are paid can be seen in medicine, law, and banking. Furthermore, the reforms in each undoubtedly will cause major change in the nature of each industry.

Putting aside the healthcare reform discussion for a moment, doctors currently are paid on a procedure-by-procedure basis, a system which some argue creates a strong economic incentive to over-prescribe procedures. One suggested answer so far has been to compensate physicians on an "episode-by-episode" basis, which would mean paying, for example, for a few months of cancer treatment at a time. The idea is to provide less incentive to over-prescribe, while staying away from simply paying one price for all healthcare.

Similarly to paying for "episodes of care," many law firms are switching to flat-fee arrangements. This fee-for-service approach means rather than paying attorneys by the billable hour, companies will pay a single price for services rendered. An example of fee-for-service would be paying one price for bundled tax service rather than paying by the hour. The shift will likely hit corporate attorneys first, and will almost always result in reduced earnings. Some companies have reported anticipating 15-20% reductions in legal expenses.

Investment Banking has taken national spotlight lately, especially with regards to employee compensation. In the wake of our economic collapse, G-20 (The Group of Twenty Finance Ministers and Central Bank Governors) has put forth new compensation guidelines. According to a Wall Street Journal article about the ways one company has adjusted to satisfy G-20, "the guidelines focus on shifting bankers' pay away from annual cash bonuses toward a compensation model based on deferred stock and the potential for firms to claw pay should performance suffer" (Wilson). Again, the emphasis is on being paid for no more than the necessary services - in the case of investment banking, only paying for services that create profit.

New, industry-wide pay systems are clearly innovative because they represent new ways of solving an old problem - namely, how to properly pay for services rendered. Each industry's approach to this problem has its own origin: purely from governmental regulation in the case of investment banking, from perceived societal needs in the case of medical care, or from general market forces as seems to be the case in the legal industry. Whatever the cause, though, each industry has an expressed need for new ideas about employee compensation. I think these innovations in employee compensation strive to increase efficiency throughout the economy. However, as an individual interested in two of the three professions mentioned above, I am not very enthusiastic about these changes.

Goldstein, Jacob. "Beyond Fee-for-Service: Paying Doctors for ‘Episodes of Care’." Web log post. WSJ Health Blog. Wall Street Journal, 30 Jan. 2009. Web. 11 Nov. 2009. .

Koppel, Nathan, and Ashby Jones. "'Billable Hour' Under Attack." Web log post. WSJ Law Blog. Wall Street Journal, 24 Aug. 2009. Web. 11 Nov. 2009.

Wilson, Harry. "Commerz Revamps Pay System." Wall Street Journal 11 Nov. 2009: C2. Print.


  1. In law firms clients have been asking for this type of pricing for a few years now, but the firms have been resistant. However, given the economy and the way law firms are suffering right now the firms are having to meet the demands of clients. Making it clear that this type of innovation, at least for law firms, is a 'need-pull' model.

  2. This seems to tie directly to the article that I posted last week about BMW executive compensation. I would say that all industries are changing compensation practices not just the professional class. It may just be a bigger change from the traditional salaried positions of professionals.