Human Capital Management in Professional Service Firms


Prof. dr. Frank Moers (Dept. of Accounting & Information Management/AIM)

Co-operation with Van Oers Accountancy and Advice

Further information

In this research project we aim to examine the management of human capital in professional service firms,

accounting/auditing firms in particular. We will focus on whether and how talent is recognized and fostered within the organization, the results of which have academic relevance as well as a direct impact on the management of human capital within Van Oers Accountancy & Advies.Professional service firms are often characterized by an active internal labor market. Internal hires move up to hierarchy to eventually be promoted to partner in the firm or be forced leave the firm. Although these up-or-out promotion policies avoid the problems of motivating unpromotable employees, they do impose costs on the organization when these employees are highly productive. In an external labor market characterized by increased shortage, such as the market for accounting personnel, up-or-out systems can become very
costly. As a result, there seems to be somewhat of a shift towards “up-or-stay” policies, which used to be typical for large hierarchical organizations.

Up-or-stay policies in professional firms trigger two questions: (1) how to decide who should go up?; and (2) how to motivate those who stay?

Inherent in these questions is the conflict between optimal matching and optimal incentives when it comes down to promotion decisions. We often observe that “between-job pay differential” are larger than within-job pay differentials. Given the money involved, promotions provide incentives, if effort affects the performance measure. Although this might be the case, we can identify the following benefits and problems associated with promotion-based incentives:

Benefits of promotion-based incentives
*  Only requires a rank order of employees
*  More at stake for the monitor

Problems with promotion-based incentives
*  Incentives are neither stable nor uniform
*  Some know they will never outperform their peers
*  Recent promotions reduce incentives for the closer
*  Limits the incentive to substantially outperform
*  Not a viable incentive mechanism in small and/or flat organizations

An alternative reason for the use of promotions is that firms sort employees on ability and reward ability. This begs the question whether we can use promotions for both incentives and matching. Unfortunately, this is not the case for the following reasons:
*  Incentives à effort provided in the current job drives promotion decisions
*  Optimal incentives requires a homogeneous group of agents
*  Matching à ability needed in the “next” job drives promotion decisions
*  Matching is only relevant when there exists a heterogeneous group of agents
*  Differ in their abilities to perform different jobs

Tacit Managerial Knowledge versus Technical Knowledge
Essential in the above discussion is that talents for the next level in the hierarchy are not perfectly correlated with talents needed in the current job. This begs the question, is there a lot of overlap between qualities that make an employee a good junior auditor and qualities that make an employee a good partner? Previous surveys of auditors’ perceptions of superior performance suggest that nontechnical knowledge, or better, tacit managerial knowledge becomes more important with rank. In line with these surveys, Tan and Libby (1997) find that technical knowledge distinguished good from bad performers at the (junior and senior) staff level, while tacit managerial knowledge distinguished good from bad performers at the experienced manager level. These results imply that indeed the talents
needed at the manager level are not perfectly correlated with talents needed at the staff level, which makes the conflict between optimal incentives and optimal matching a potential significant problem in accounting firms. However, Tan and Libby (1997) further show that significant learning of tacit managerial knowledge occurs between the experienced manager and senior staff level. These latter results imply that tacit managerial knowledge is a skill that can be developed.

In this respect, it is important to note that one area where there seems to be “no” conflict between incentives and matching is incentives for skill development or human capital acquisition incentive. Prendergast (1993) analytically shows that promotions are used as a commitment device that provides the agent with incentives to invest in firmspecific human capital acquisition, which subsequently allows for improved matching. Tan & Libby (1997) indicate that tacit managerial knowledge is job-specific. Given that the typical career change in an accounting firm is up or go to busines’, we can interpret tacit managerial knowledge as firm-specific. In sum, matching and incentives can be linked in our setting.

Research Questions
Given that tacit managerial knowledge is important at higher levels and it is a skill that can be developed, a fundamental question is: what are the drivers of tacit managerial knowledge? To answer this question, we focus on variables that can be categorized into the following three groups:
1. HR systems and Incentives in particular;
2. Personal characteristics;
3. Social networking.

If tacit managerial knowledge is fundamental to good performance at the manager level, then the next question is whether superiors are able to recognize star early on. More generally, what determines supervisors’ assessment of whether an employee is a star? In this case, we distinguish in particular between variables associated with:
1. Subordinates’ performance in the current job;
2. Subordinates ta cit managerial knowledge;
3. Social networking.

Good human capital management goes beyond recognizing talent to ensuring that rising stars are fostered. In a professional service firm, it is critical that talented employees are retained and motivated. Although the management control literature provides us with a basic understanding of incentive systems, little is known about whether and how
professional service firms’ HR and incentive systems are adjusted to especially cater to the more talented employees. What are the mechanisms put in place to ensure that the stars are motivated to stay? For example, do highly talented employees receive more compensation, preferred job assignments, and/or more opportunities for training? And, how successful are these mechanisms?; is it conditional? One thing that is important in answering the above questions is to know whether there are any differences between superiors’a ssessment of being a star and subordinates’s elfassessment. Are there any differences in superiors and subordinates starassessments and, if so, what explains these differences?