Enduring Principles for An Effective Partner Compensation System (Perspective)

Editor’s Note: This article ties into a series by author, who is the former chair of a large U.S. law firm, on management principles.

Any regular reader of the legal business press can tell you that law firms are operating in a highly challenging economic environment. There is both empirical and anecdotal evidence that with the exception of the largest, most profitable firms, law firms are finding it tough to grow their business. Demand for legal services has remained flat, while the number of licensed attorneys, as well as alternative legal service providers, continues to increase. With the wealth of data regarding legal services pricing and law firm profitability, clients have become more sophisticated in their selection of outside law firms, and more reticent concerning the prices they are willing to pay for the services of outside counsel. Law firm billing audits, increasingly conducted by computer algorithms, are now common and often result in a discounting of fees. These and other factors have put a squeeze on law firm profit margins and the corresponding profit per partner profit metric.

As a result of these pressures many firms are re-examining and changing their partner compensation systems. Recently published articles, such as Nell Gluckman’s piece in the March, 2017 edition of The American Lawyer, have reported a trend toward a higher degree of short-term focus on objective measurements of performance, such as the not always easily quantifiable “book of business” metric. In certain instances, even short-time “underperformers” are reportedly seeing significant reductions in their compensation as money is shifted to those with currently more robust practices. In more extreme situations, partners who have contributed greatly over long periods of time, but have recently experienced a short term decline in productivity, have been de-equitized. Firm efforts which don’t produce short term ROI, such as monitoring and/or training of young attorneys, are being marginalized. Formerly open and transparent systems are being closed.

Given this environment, it is no wonder that law firm leaders are considering changes to their firm’s partner compensation system. While this is understandable, leaders should not overreact and fall prey to copy- cat syndrome. A firm’s partner compensation system is a critical component of its culture and major changes to that system, particularly if enacted upon short notice, will significantly impact that culture, often in unanticipated ways. In fact, abrupt cultural changes can be catastrophic to a firm. Firm leaders need to be cautious and analytic in their approach and, if changes are deemed necessary, they must communicate and discuss those changes with the firm’s partners prior to enactment. Partner input and buy in, as opposed to top‑down pronunciation, are absolutely key to this process.

It is conventional wisdom that no single partner compensation system is appropriate for all firms. Different cultures do support differences in that system. Nevertheless, there are certain concepts and principles which represent best practices for effective partner compensation systems. These include the following:

• The factors upon which decisions are made must be clear and published to all partners.
• Those factors must be applied consistently to all partners.
• The system should feature a subjective judgment of every partner’s overall performance based on careful review and analysis of both the objective metrics of that performance, which are directly related to the financial health of the firm, as well as the partner’s “soft” contributions, which indirectly influence the firm’s success.
• It should have an established range for the spread between the compensation of the top-earning partner(s), or average compensation of the top 2-5 partners, and the lowest paid partner(s) or average earnings of the lowest 2-5 partners (for example 5 to 1).
• It should also have an established maximum, usually expressed as a percentage for the largest change, upward or downward, in a partner’s compensation in any one year.
• The system should return flexibility with respect to the spreads and minimums which can be applied in truly extraordinary situations.
• It should include a partner interview/feedback process during which the partners are encouraged to comment on their performance relative to their individual goals and their views on compensation.

All of these elements must be in harmony with the firm’s long term strategic goals and, equally, should be based on analyses of not only short term (i.e., 1 year) but also longer term (multiple years) performance.

In future articles, I will do a deeper dive into these concepts and principles. For now, I urge firm leaders who are considering changes to their partner compensation system to do so only after careful analysis of all relevant information and meaningful communication with the firm’s partners and other key constituents. The objective of any reform should be to create a system that can achieve long term success.