Cotterman on Compensation:
Should Performance Evaluations Be Linked to Pay Decisions?
April 22nd, 2014 by Jim Cotterman
There are a variety of views on this topic of linking pay and performance evaluations. My general response is to link the two because pay proportional to performance(r) is a critical element of best practices in lawyer compensation. They are both part of the ongoing cycle of plan, train, do, coach, assess, reward. The plan and assess elements often occur concurrently — assessing prior performance and planning for future (including career development). And it is important that the feedback from the performance evaluation and the compensation decision be consistent and understood by all, including the individual’s team leader.
But to decide, first assess a number of factors. Ask:
1. To what extent are the compensation decisions based on performance evaluations? For example, if the associate compensation system is entirely an automatic lock-step and bonuses are tied exclusively to a billable hour formula — then there is little reason to connect the two. The subtleties of a proper performance evaluation are not connected to changes in pay in this example.
2. Are there other dimensions to the pay decision outside of the individual’s performance (team, practice group, department, office, firm performance) and how important are each in the overall compensation philosophy? In this situation, the performance evaluation and the pay decision should both assess and discuss the same dimensions, how they interrelate and the relative importance of each in the overall compensation decision.
3. Is there sufficient flexibility in the compensation program for material differences in pay between high and low performers? Even if pay decisions are heavily influenced by the performance evaluation, if there is an immaterial pay differential opportunity between those judged high performers and those judged low performers, there is little reason and high risk to connect the two.
4. Is the performance evaluation process properly designed, implemented and supported so as to be effective? Are both performance and career development properly balanced? Is the review cycle the proper interval? Is there a need for a mid-period formal check-in and/or are there opportunities for informal review available? Are the metrics sufficiently descriptive to mitigate against differing views of performance (this generally rules out the simplistic “Does Not Meet, Meets and Exceeds Expectations” systems). Is the evaluation thorough, yet focused (remember that the partners have many, many of these to complete)? Are the reviewers trained in completing the evaluations? Are the individuals who aggregate the individual evaluations into a comprehensive assessment trained? Are the individuals providing feedback trained? Are prior year evaluations available to note progress and to provide continuity?
5. Have the stresses that highly integrated performance evaluation and pay programs create (tendency for less open communication, more conservative setting of performance goals, heightened focus on short-term performance rather than career development, grade inflation to achieve a desired compensation result — protection of ones key team members) been considered and mitigated to the extent possible?
March 29th, 2010 by Jim Cotterman
Over the past three decades, compensation issues in law firms have changed much. Back then, benchmarking one firm’s decisions against others across an array of variables such as firm size, location, practice specialty, and experience, comprised much of the analysis. Today law firms must evaluate decision quality for internal proportionality and external competitiveness (both relative to contribution/performance), as well as compatibility with culture and alignment with strategy.
However, one cannot fully understand the broader lawyer pay market if it does not first understand the associate starting salary market. In the 1980s, the profession experienced a rapid increase in starting salaries that cascaded upward throughout the associate ranks beginning a compression problem with younger partners that continues to exist today. The 1990s brought many years of little or no increase in starting salaries as a response to the recession at the start of that decade. However, by the end of the 1990s a hyperactive economy created a demand driven market and increases returned. Then the new millennium brought forth new and daunting challenges and the market slowed yet again. Mid-decade starting salaries again soared, only to be confronted in 2008 and 2009 with the greatest economic collapse since the great depression. This time starting salaries and salaries across the associate ranks were rolled back. Associate layoffs and hiring deferrals reach record levels as the demand for lawyers sank precipitously.
Traditionally, the key metric in lawyer compensation is working lawyer fee receipts. It explains 64% of the change in lawyer compensation over the career of a lawyer. It is almost the exclusive variable for associates, explaining 91.5% of the change in lawyer compensation in the first ten years of practice. After that, the key criterion by which partners are valued takes over – the ability to build relationships in the marketplace that attracts work to the firm. One’s skill at building a practice generally explains 80% or more of the change in a partner’s compensation. A firm’s culture and ownership structure affect the importance of this metric, but only in relative terms. No law firm can exist if its owners are not accomplished business developers.
Let us return to the recession for a moment, which profoundly affected the legal profession as it did nearly all other segments of the economy. Clients push harder then ever on value and there is the perception that pricing power is shifting from provider to buyer. Alternative fee arrangements gain ground over hourly billing as clients demand cost certainty along side of cost reduction. These conditions will likely alter the model for delivering legal services. If it does, then law firms will need to view compensation differently.
Take some time to look at what you are doing:
1. Evaluate partner and associate pay programs to determine if the compensation decisions reflect what is important in your firm (performance, culture, work/life balance, strategy and the like).
2. Examine the profit profiles of your timekeepers (partners, associates, paralegals, etc.) and by experience for lawyers to see if the compensation decisions are economically rational and if the margins are appropriate.
3. Use the compensation process to engage people and seek out opportunities to discuss pay and performance as it relates to strategy and culture.
4. Review your expectations of owners with the owners and consider how your ownership structure affects the vitality of the firm and interacts with your compensation programs and decisions.
Paying Partners Under AFAs
February 25th, 2010 by Jim Cotterman
Partner compensation decisions are largely driven by a lawyer’s ability to generate work for him/herself and others. And although personal productivity remains a key factor, it is not sufficient at the partner level. Other contributions become more important as law firms look for competitive advantage in the market. Accordingly, public relations/marketing, professional development, client relationship management, business and fiscal management, collaboration and team leadership, and cultural fit carry more weight in the decision to promote and pay partners. More recently firms have begun to evaluate the profitability of the work done and incorporate that knowledge into their pay programs.
Now, with the increasing demand from clients for non-hourly based pricing, law firms must again expand the performance benchmarks in their compensation program to include new types of contributions. Under alternative fee arrangements in which bundles of work are priced at fixed fees, collaboration and service cost reductions become key elements to success. And partners want to know how this new way of serving clients will factor into the pay program. Here is where this all gets interesting.
Compensation decision makers will need new metrics to evaluate factors like labor utilization, service/process efficiency, matter/portfolio/client profitability, collaborative skills, ability to contribute as a team and team leadership. Because the service delivery model is still labor intensive, it is unlikely that the old metrics will be abandoned. However, they will need to give some ground — influence less of the pay decision — so that the new metrics influence pay decisions at a level commensurate with the importance the firm places on these initiatives.
There will be challenges. Traditional performance metrics are embedded in lawyers’ psyches – and they will not be given up easily. The lateral market for equity partners – currently driven by client portability (origination) will need to be re-thought if ‘client ownership’ is weakened by collaborative teaming. Independently minded practitioners will resist change. Then there is the matter of the new metrics. It will take some work to get these down right so that unintended consequences are avoided.
Open or Closed Compensation Programs
August 31st, 2009 by Jim Cotterman
I was recently asked about my views on open or closed partner compensation programs. Here is my response.
Law firms predominantly have open programs; about 80% to 85% are open; 3% to 5% semi-closed (either management compensation is disclosed or certain statistics reflecting the decisions are published, but not individual decisions) and the balance closed. Traditional professional partnership values support an open program as consistent with partners entitled to see the books and records and their desire for a transparent partnership. It also greatly aids the ability of partners to determine the degree to which they believe that the program is a fair meritocracy. This is critical to ensure the overall success of a compensation program that is dependent upon it being widely accepted as a fair meritocracy. Internal comparisons are the prime evidence in such an evaluation. And as a practical matter, in most firms the decision makers change leadership roles over time so the closed nature of the program deteriorates over time.
Firms that embrace a closed program generally advocate the practice as a means to focus each partner solely on his/her performance and pay. And accordingly reduce the intra-partner bickering and competition that can result in an open program. A number of compensation committees in closed firms have indicated that it gives them more freedom to make the decisions they believe are in the best interests of the firm — a dangerous slope to be on when the judgment is limited to a select few.
Others have stated that it makes it easier to bring laterals into the firm. Our assessment is that firms have frequently overpaid laterals as an enticement to make the deal and then in many cases those same laterals did not quickly produce the business and benefits that were the stated basis of their compensation. Admittedly it is not an easy task, even for the lateral, to really know how much of his/her practice is portable or how quickly it can or will transition to the new firm. That scenario also indicates firms are likely paying more for lateral talent then they would pay their own partners. That can breed resentment and disrupt a collegial/collaborative environment.
For a closed program to work the firm must have a very high degree of trust, especially for leadership. It also must develop other means to ensure that the partners feel that the program is fair and a meritocracy. The best closed programs have been firms with a strong benevolent founder who had unassailable credibility and who remained in control for many, many years.
Transitioning either way is a major change and will likely alter the firm’s culture and intra-partner dynamics. Even if the decisions were well done in a closed program it will likely be unsettling when partners are first exposed to the reality. We have found it difficult to close an open program without a major catalyst such as a merger of equals or some traumatic “life-changing” event.
Some Thoughts on Origination
July 10th, 2009 by Jim Cotterman
Measuring the source of new work for purposes of remuneration decisions continues to challenge law firms. Clearly when a partner or team of partners bring a new client to the firm there is measurable origination. And there is at least implied agreement that origination should be shared when multiple individuals hold meaningful relationships within a client organization and those relationships draw work to the firm. I say ‘implied’ because there is very little sharing taking place — it appears that fewer then one-quarter of the clients in law firms are shared for origination purposes; with a sizable portion of firms not sharing at all (Compensation Systems in Private Law Firms Survey, ALM Legal Intel, 2009). Now one might say that only the largest clients at large law firms may present realistic opportunities for multiple relationships. And we can see from surveys, larger firms, which have correspondingly larger clients, exhibit a greater degree of sharing. Still this issue of getting lawyers to sell and service clients collectively challenges leadership. It is a critical issue in succession programs, as well as for remuneration. Even if clients are not large enough to support multiple relationship partners, some thought should be given to creating a team that will ensure relationship continuity over time.
When tracked, small law firms are least likely to reallocate origination. Large law firms, while more likely to reallocate origination credits, engage in individual partner negotiation as the primary method to determine when and how origination will be adjusted. Large firms are also more likely to focus on the current client relationships when discussing origination reallocation. Many firms do not track origination because of the fear that a corrosive internal competition will result. This does not mean that those firms do not consider this contribution when making compensation decisions. Origination reigns supreme as the most critical partner compensation factor. This metric, more then any other, determines whether a lawyer becomes – and remains – an equity owner in a law firm. And it may well be a determining factor in when and how lawyers exit the firm in their senior years. So not tracking origination says more about culture and operating philosophy then it does about its importance.
Unfortunately, tracking origination is very much like trying to maintain a mailing list. You work hard to keep it updated only to find it is 30% wrong whenever you go to use it. Such it is with the tracking methods for origination. Going to matter level tracking aids is a more current and hopefully realistic tracking method. If done well it can provide real-time assessments specific to each matter and should reflect evolving relationships over time. The best origination records still require compensation decision makers to make inquiries of practice leaders and other partners so that informed adjustments can be made.
Getting this wrong can cause all kinds of havoc. Example, Partner Paula is not given recognition for origination of a $1.5 million portfolio of a $5 million client where she has worked hard to build a trusted advisor relationship with the business unit CEO. She leaves her firm and takes $1 million of work with her. Clearly she was off in her estimate of $1.5 million, but the firm was also off in not recognizing the possibility of the $1 million. The new firm recognizes the $1 million as Paula’s origination. This scenario plays out in firm after firm, year after year. This is why leaders in many firms are constantly reinforcing organization and team values. It is also why the compensation decision makers work hard to get behind the numbers to understand, as well as anyone can, how work gets to the firm.
Alternative Fee Arrangements and Compensation
May 26th, 2009 by Jim Cotterman
Firms wrestling with alternative fee arrangements (AFAs) often raise the question about how these arrangements will affect compensation decisions. They raise concerns about how to recognize performance if hours are no longer indicative of contribution. But hours are not the primary consideration in most owner compensation programs in US law firms. We know that fees collected as working and originating lawyer are the top two performance metrics for compensation purposes. This is not likely to change in the short term.
But in the context of AFAs, the effect of the initiative on profitability is as key a consideration as winning the engagement and generating the revenue. Determining an effective means to assess profitability is critical.
AFAs are likely to involve risk, innovation and possibly some trial and error to ultimately bring a successful approach to market. All three (risk, innovation and trial/error) are appropriate to consider in compensation decisions along with the profits and fees ultimately created.
Thoughts on Leadership Compensation
May 1st, 2009 by Jim Cotterman
Leadership compensation is a topic we are getting questioned about. We thought a few comments might help get the discussions moving in the right direction.
1. If a firm wants good leaders (defined for now as managing partners, practice chairs and office managing partners), it will not create them through compensation incentives. It takes a talent, time and training to become an effective leader. Compensation’s job is to appropriately recognize and reward their contributions.
2. How to approach the compensation piece depends on the role. The full-time world-wide managing partner role is vastly different from the 1/3 time office managing partner. The scope and scale of the role must be considered. Some roles can be effectively rewarded within the existing partner compensation scheme, others may require a specially conceived program. And let’s not forget about life after leadership. Law firm leaders used to be older when they entered the position and could easily retire afterwards. Today leaders are younger and have many years before retirement when they move out of the role. Some consideration to transition in role and compensation is worth discussing when setting up the program.
3. Compensation programs should recognize both efforts and results. Too many programs today only consider one or the other. Historically the focus was on effort, measured in hours required or by a time budget allotted usually creating some sort of fictitious fee credit for compensation purposes. Other law firms defaulted to a simple stipend based on perceptions of effort required. Not satisfied with how this worked, firms embarked on a mission to pay for results only. The key to a results-based system is to understand what the objectives are and how they will be measured. Unfortunately, results don’t often fit nicely within the 12-month period that compensation programs measure. Many initiatives require extended time periods to bring about results and that can complicate the recognition and reward objectives of compensation.
4. A final consideration is whether and when to reward failure. The best businesses take risks — innovation and growth, responses to rapid market changes and the ability to discern longer term shifts all involve risks. P&G’s chairman stated “You learn more from failure than you do from success, but the key is fail early, fail cheaply, and don’t make the same mistake twice.” If law firms want to implement strategic objectives in a competitive and changing market; it will want to encourage smart strategic risk-taking and consider rewarding failure.
The Two Forces Raising Rates and Compensation
April 27th, 2009 by Jim Cotterman
I discussed the strong alignment of associate billing rates, the time value associates generate and the compensation paid associates during the recent Altman Weil Webinar, Financial Strategies for the Current Economy. In fact, the correlation is so strong that during those associate years one can explain 92% of the variability in associate pay looking only at time value.
During the presentation I also used the analogy of this progression as being driven by two forces — the elevator and the escalator. The elevator is the general rise in rates and compensation that law firms have traditionally engaged in year-after-year for the past three decades. Generally, each year the starting salary for new graduates is adjusted upwards. The exceptions have been during and immediately after recessions. But the competitive forces of supply and demand usually take hold and the elevator rises again. Once the starting salaries are set there is a ripple effect throughout the associate ranks with each class increasing to maintain the lock-step progression so entrenched in associate pay programs. The same holds true for billing rates. Each year law firms generally increase rate schedules usually for at least at the rate of inflation or a bit more. The billing rate schedules largely resemble the lockstep pay programs in that each year of additional experience garners a billing rate higher than the last. Thus, the elevator lifts all upward. It is a perfect description of inflation adjustments.
The escalator effect is the progression as one gains experience. The first year associate becomes a second year associate. Her rate and compensation increase simply with this passage of time and the accompanying increase in experience. The escalator is the lockstep program.
In almost all years the associate benefits from both the elevator and the escalator. First, there is an increase because the firm says: “Inflation was 3% last year and our costs have increased — rates must go up 5%. And we must increase our starting salaries – another 5%.” Thus, the elevator ride up. Then the associate gains experience – the escalator – and she benefits from the pay differential in the lock-step program for 2nd year associates.
Compensation for the New Partner
January 27th, 2008 by Jim Cotterman
The variables for setting compensation of a newly promoted partner can be a challenge to get right for all concerned. Let’s look at an example.
Last year as an associate Sally’s total compensation consisted of a $200,000 salary, a $50,000 year-end bonus, $24,000 for a top shelf package of health/dental, life, disability and LTC insurance, $29,500 in employer pension contributions, $9,900 in employer paid payroll taxes and $1,600 in misc. reimbursements of business-related clubs/dues. Total compensation was $315,000. Sally must make three annual $25,000 payments to have a seat at the partnership table – her buy-in requirement.
Let’s assume that Sally generated a healthy and typical 30% profit to the partners as an associate and that per timekeeper overhead was $150,000. This means that her working lawyer fee receipts were $665,000. Let’s also assume that Sally has worked hard at positioning herself in the marketplace and has built a $400,000 portfolio of client relationships mostly from existing clients plus a few of her own new clients. The new clients, while small in number, are right in the sweet spot of the firm’s strategic intent.
What is a fair compensation for Sally assuming this year’s performance is as good as her last year as an associate? We will also assume for ease of discussion that everyone else repeated their prior year performance and the firm’s overhead remained steady.
1. As a partner, Sally drops below the line. The $315,000 compensation package ceases being a firm expense. Good for the firm. Sally is now “self-employed” so she must plan for making quarterly estimated tax payments as the firm no longer “withholds” for taxes or remits the employer’s share of social security and Medicare taxes. The firm will continue to pay the insurance premiums and remit the dues on her behalf, but the tax reporting and treatment of those items will change. So, to stay even Sally needs a draw, distribution and payments in kind totaling $315,000. For the moment we will ignore any individual income tax effects.
2. What about a cost of living adjustment? Inflation for 2007 was 4.1%. Wouldn’t we all like to be immunized against economic forces? Yet the firm wants Sally to be excited about her first year as a partner and is concerned about the message no adjustment sends. Associates would be getting increases and should the firm maintain some separation between the young partner and its senior associates?
3. Let’s not forget that Sally also has that buy-in requirement of $25,000 for each of the next three years. Possibly more after that. To keep Sally “whole” her compensation package needs to be $340,000. But any increase over the $315,000 dilutes the profits for the remaining owners. Should they make less so she takes home the same? And should the firm pay the new partner’s capital for them (Which is essentially what this suggests)?
4. What would a lateral be worth with Sally’s metrics? The firm would like to be competitive with what the market is paying. The market might pay anywhere from $390,000 to $520,000 with a significantly greater likelihood for the lower third of that range IF the portfolio of client relationships is truly portable. That might be a big assumption since her portfolio is largely based on long time clients of her current firm. Again, if all else remains the same then the remaining partners’ earnings are diluted when paying Sally at “market.”
5. Are newly minted partners still profitable? Sally produced a 30% profit margin in her last year as an associate. What is typical when one becomes a partner? Partners share in profits, correct? Yes, technically they do share in profits; but as a practical matter young partners slowly recapture that profit margin over a period of years, not immediately.
6. What about locking Sally in and say that growth in her earnings is dependent on growth in firm earnings. She will earn more than her $315,000 as the firm earns more. There is a degree of logic here, particularly if the sharing of earnings growth is generous. In this situation the partners are saying we built the firm to “x” and your $315,000 is fair for that.
These are typical considerations for firms making first year partner compensation decisions.
What is a Bonus?
January 14th, 2008 by Jim Cotterman
Some firms consider a bonus any payment in addition to base pay. So a distribution beyond draw/salary made in accordance with a defined allocation is a bonus. No attempt is made to distinguish performance from individual to individual; or for any one individual, from actual to expected contribution. Such payments commonly arise out of point, percentage, tier and lockstep systems that align the distribution with the underlying pre-existing allocation for base pay.
A slight variation of the above occurs when there is a pre-determined distribution allocation that differs from base pay allocation. Sometimes there may be more than one such distribution tier. For example, the first $1,000,000 is distributed on base pay, the next $1,000,000 is distributed equally, the next $1,000,000 on some other basis. A variation of this for admitting new owners is properly examined in an upcoming post.
Sometimes firms use a bonus to reward extraordinary contribution. When best done, extraordinary contribution is narrowly defined. Recipients are few and the size of each bonus large. Under this definition only about 2.5% to 5% of contributors would qualify for a bonus. A large bonus exceeds 20% to 25% of base pay.
Other firms will award a bonus when an individual’s performance exceeds that expected for his/her base pay. Usually the exceptional performance must warrant a bonus of at least 10% of base pay. Under this definition many more individuals might qualify for a bonus.
Then there are the firms where a bonus may be awarded an individual who measurably outperforms his/her peer group. This is generally more common in point, tier and lockstep systems that have a bonus modifier. Here one must not only excel but excel beyond that of his/her peers.
Again, the differentiable performance should probably warrant a bonus of at least 10% of base pay.
These are the most common bonus types. If you have experienced a different approach, please join in with a comment.
The next question may very well be which method is best? That largely depends on the underlying base pay program, the desired values and behaviors as well as the strategic intent of the organization. There is one type of bonus system that the author has little regard for — small differentiated payments to nearly everyone. That approach is likely to create more trouble than it is worth. One might be better off running an extra payroll. You are likely to accomplish much the same result with significantly less effort and less downside risk.
Another question typically asked is why minimum bonuses of 10% or 25%? By setting a minimum bonus as a percentage of base pay the threshold automatically adjusts as pay increases. For example, a $10,000 bonus for someone making $100,000 or less conveys something very different from that same amount for an individual with $1,000,000 in base pay. Another reason is to recognize the lack of precision possible in pay decisions.
Compensation System Selection
January 3rd, 2008 by Jim Cotterman
The success or failure of any compensation system is not simply inherent within the structure of the program. Compensation is just one element of how law firms operate. What we tend to forget is that the purpose of a compensation program is to make good compensation decisions. It is a tool. Certain tools are better than others depending on the circumstances.
For example, a pure lock-step program largely requires the firm to assess a senior associate’s ability to progress as a partner over the remainder of his/her career. Essentially you are making some thirty or more years of future compensation decisions at one time. Such an assessment requires much more careful attention to the qualities of being a partner. And such attention is rare.
Before we dismiss any particular compensation program or quickly accept the “conventional” wisdom of a current favorite approach; we should think about how well the program will fit the firm and how well it will facilitate good compensation decisions.
Let’s start off the year with a look at a law firm partner compensation approach that many consider an antiquity, yet 8% of firms still use. Lockstep compensation for partners has vocal proponents and detractors.
What are some of the key positive attributes of such a system?
1. It supports a single firm philosophy.
2. There is little internal competition.
3. Leadership has more time to lead without the annual compensation ritual.
4. Non-traditional roles and new postings are more easily undertaken.
What are the main arguments against lockstep?
1. There is no accountability.
2. Stars are not specifically recognized monetarily (at least not instantly).
For a more extensive review of this approach read my article, Lockstep Compensation – Does it Still Merit Consideration?
Paying For Management
November 20th, 2007 by Jim Cotterman
One of my first blog entries dealt with the transition of managing partner compensation. Today let’s look at how law firm leaders are generally paid while in the role.
There are three broad approaches to compensating management:
- Based on inputs. Discuss and arrive at an appropriate hours budget with the incumbents for each position. Attribute working lawyer fee credits for the time spent up to budget at the individual’s average effective rate. Attribute hours in excess of budget only upon approval—the incumbent should justify why the additional time was required. This may occur in a year of a relocation, significant technology migration, merger exploration or other episodic and important event.
- Based on results. Pay a percent of firm fees and/or a percent of the partner income pool—a small percent designed to yield a pay decision that compensates at about what they are making now if the firm performs the same level, more if they advance the firm’s performance or less if they dilute performance. Alternatively pay a percent of average partner income to position the person again where they are now if the firm performs the same. It is difficult to get partners to forgo marketing and practicing law and undertake a significant management role if they are to be paid less by doing so.
- Fixed. Pay a stipend based on the demands of the job or add a bonus to factor in how well you do that job.
The method used is largely a product of the firm’s size, management sophistication and the partners’ collective sense of the appropriate role of a law firm leader. At the end of the day, paying for leadership is a “tax” paid by all partners for the centralization of management functions and the benefits of leadership in running a more competitive law firm. The very large law firms with full-time lawyer leadership positions have come to realize that they need a compensation program that is specifically geared to their leaders; yet aligned with the values and culture that all partners are compensated under.
The Altman Weil 2007 Senior Leadership Survey provides insights into the leadership roles, responsibilities and compensation of managing partners and executive directors. We have conducted this survey five times over the past 15 years. The link below opens a table that illustrates for all firms the relative compensation position of the managing partner and executive director relative to other partner compensation benchmarks.
October 28th, 2007 by Jim Cotterman
The spread is usually described as a ratio of the highest paid partner’s income to the lowest paid partner’s income. So a firm where the highest paid partner earns $1,000,000 and the lowest paid partner earns $100,000 has a spread of 10:1. We are often asked about whether a particular firm’s compensation spread is appropriate. There are two answers to that.
The first is what most firms are initially asking — are we in line with what other similarly situated firms are doing? Now the simple solution is to turn to survey data, determine the comparables and compare. But let’s explore this a bit further. Are we asking about all partners or just equity partners? Firms with two tier ownership might be interested in a different number then a single tier structured firm. Do we exclude the part-time or semi-retired partner? Do we exclude the outlier partner at the top of the pay list who is an anomaly? The ratio is going to vary, possibly quite a bit, based on how we address each of these questions.
What we have found in our research is that the acceptance of a greater spread (higher ratio) increases with size. Also the differences between single tier and multiple tier spreads becomes noticeable in firms with more than 10 lawyers and significant for firms with more than 75 lawyers. While smaller law firms (20 or fewer lawyers) are generally comfortable with all partner ratios under 3.0; large law firms (over 150 lawyers) are more likely to have all partner ratios of 4.0 to 9.9 to 1.0. The diversity of views on this is remarkable. 6% of these large law firms have ratios in the 2.0 to 2.9 range while another 6% have ratios in excess of 20 to 1.
The second answer is related to the culture of the firm. Here the answer depends on the individual firm’s ownership environment. Some law firms manage the spread and some do not. When they do manage it, the reason is often a cultural attribute. It is their collective sense of propriety for the relationship among the owners. A partner once asked me if I make 10 times one of my partners, is that partner really a partner of mine? Interesting question that articulates the relationship that exists between pay and culture. When the ratio is managed it is in a structured compensation/ownership system of points or tiers or similar arrangement. Other firms take a decidedly different view — one that says this is an unimportant and/or irrelevant factor. This is more likely in confederation style law firms or law firms that prize individual enterprise as the key differentiating factor. Note that while one might expect that firms with formulaic compensation systems would have higher ratios, this has not been borne out in our research. Certainly, there might be a greater tendency for this result in a system that is unmanaged by subjective factors, but it appears that the lawyers drawn to law firms with such systems tend to join and stay together because there is not a significant performance difference among them.
Transition of Managing Partner Compensation
October 16th, 2007 by Jim Cotterman
Let’s begin with a slightly different perspective on the currently hot area of succession. When we talk about the need for succession and transition within a law firm, we tend to focus on individuals age 60 and over and their role. Today let’s focus on one position where a younger partner is more and more likely to find him or her self — Managing Partner.
Managing partner used to be the final act. Retirement afterwards was common. But today we see more and more fifty something managing partners who are ready to step down from that post, having held it for five to ten years. Still in their 50s, most do not seek to leave their firm or the practice of law. Yet for many, particularly those who have left the practice for ten years to serve the firm’s interests, the return presents some challenges and questions. One of those questions is: “What happens to my compensation?”
The common refrain on this (if there really is one) is one year for every two years as managing partner with up to three years protection of current compensation. We prefer a slightly more nuanced approach to this: One year of no downward adjustment from the average of the last three year’s compensation position for each two years as managing partner up to a maximum of three years protection. Position is different from compensation. Position considers where the managing partner has been compensated relative to average, top, median and entry level partners. The protection seeks to maintain the “sustained position” (hence the average of prior three years) as a floor for compensation of the managing partner during the post-managing partner protection period. It does allow for the compensation to go down if the overall profitability of the firm declines, which we hope many would find a reasonable position.
But when a specific program is being developed, the common refrain or even my twist on it becomes a bit tricky unless the firm just wants to provide an unencumbered entitlement to the departing managing partner (which may be fine as well, if it is deliberate). We believe there is a more fundamental question: ”What do you do with a managing partner, when he stops being a managing partner?”. The answer to that guides you on the answer to the program specifics. And the answer to our question is driven by a number of variables: firm size, incumbent age, firm governance charter, practice area, clientele and the like. What might make sense for the 70-year-old managing partner of a ten partner firm who is retiring at the end of term may make no sense for the fifty year old managing partner who after ten years as managing partner of a two hundred partner firm is very much interested in returning to the practice of law.
- So it is helpful to engage in a dialogue about the following. The exact wording and scope will vary depending on the answers (some of which may already be well known by all parties).
- Is this for someone about to step down or is a new candidate requesting this before signing on for the job?
- How old is this person?
- How long has the managing partner been in the position?
- Was the position full-time (turnover of client relationships and cease practicing law)? If not, how much did the managing partner position intrude on practicing law, business generation and market presence?
- What kind of practice and client following did this person have? How permanent was the relationship transfer?
- How visible was the position in the market (i.e. did it have a high-profile public CEO face or was it more of an internal COO orientation)?
- What is the role of an ex-managing partner upon leaving the post (is there any transition, formal or otherwise expected of this person)?
- What kind of compensation program is used for the general population of partners?
- What compensation program is used for the managing partner position?
- What does this person want to do – We know the managing partner often says that he/she wants to return to the practice of law, but there are varying degrees of that statement and it helps to understand what each side is thinking.
The best program is one that works to meet the managing partner and firm’s interests and considers the challenges and timeframes to transition from the formal leadership role of managing partner into the next role — whatever that may be.