This article appeared in Attorney at Law Magazine in January 2020.
In a previous article I discussed why firms should periodically assess their compensation systems. In Part 2 I describe how firms make decisions about compensation changes and the various factors which should be considered.
Is Your Firm Ready for a Compensation Change?
An effective compensation system must always be tied into the achievement of business and financial goals of the firm and recognize activities which most effectively contribute to attaining those goals. Compensation systems will not work unless a firm’s partners can agree to consider the firm as a business unit, and not just a collection of individual attorneys. In considering change, partners need to think longer term and not focus narrowly on how “their” numbers may change next year. Factors such as realization and profitability drive top line growth, aid in recruiting and retaining talent, and help to ensure an enduring legacy.
Although I recommend a firm evaluate its compensation system every 3-5 years, there are often events which may accelerate the timing of the assessment including:
- Inability to attract or retain associates and partners
- Declining partner profit/distribution
- Planning for succession/transition of senior partners
- Lack of partner accountability
- Decreased realization
- Partners expressing increased unhappiness with existing system
In my experience, most changes to compensation systems can be characterized as tweaks rather than substantial alterations. In other instances, an assessment of a compensation system merely validates that the system is appropriate.
Developing a Compensation Philosophy
Changes to compensation structure cannot be made in the abstract; they must be considered in the context of a law firm’s culture, history, values and goals. Partner compensation should reward overall contribution to the firm and be based upon subjective and objective information.
Compensation in a purely objective or formulaic system is calculated strictly on the basis of financial production, giving credit for hours billed and fees received. A formula is predictable and removes uncertainty and “politics” from the mix. Many attorneys like the concept, “If I do X, I will get Y!”
However, there are significant pitfalls to such a system, including manipulation of numbers, unprofitable intake, and little ability to influence behavior. People do what is measured and rewarded, and you can’t change behavior if you can’t affect compensation. Formulaic systems may unintentionally result in a system that does not recognize, reward or incentivize teamwork, collaboration and “firm first” behaviors. Firms with formulaic systems can also struggle with treating fairly partners who had an unexpected down year.
A subjective system may not be as precise or easy to implement but can effectively incentivize and reward important non-financial contributions that an objective system would not consider. Under a subjective system there tends to be more teamwork. Many firms structure subjective compensation on a points basis or percentage of profit, based on financial and nonfinancial criteria. Thus, a subjective system can smooth out the peaks and valleys of attorneys’ performances and income from year to year.
The resistance to a subjective system is that it is time consuming to manage, imprecise, and can be perceived to be political. Generally, subjective systems do not work well in firms where there is little trust among the partners.
Some firms use hybrid compensation systems in which a high percentage of a partner’s compensation is based on objective financial data, with a separate discretionary bonus pool set aside to reward efforts that may not result in direct financial gain, but are valuable to the firm.
Characteristics of a Successful Law Firm Compensation System
In speaking with clients who view their compensation plans as effective and successful, I have identified several common elements. The system and process must:
- Recognize and reward contributions toward the firm’s goals and objectives
- Be perceived as fair, consistent, and predictable
- Be both fundamentally fair (Do I get paid fairly for what I do?) and relatively fair (Am I paid fairly when compared to other partners?)
- Recognize and reward consistent contributions to the firm’s historical success
- Recognize and reward immediate past year strong performances and the prospects for major contribution in the immediate future
- Foster an atmosphere of unity, teamwork, collegiality, and harmony within the firm
- Avoid significant swings in base compensation from year to year
- Afford a reasonable process to allow partners to provide information, comments, and recommendation about themselves and other partners
- Consider the success of personal goals and objectives
- Recognize and reward a variety of contributions to the success of the firm by members possessing diverse strengths, skills and interests
There are almost as many compensations systems as there are law firms, and those looking for the perfect system will be disappointed. Most lawyers practice because they enjoy what they do, and the profession provides the opportunity to earn a good living. Lawyers, however, look at their value and contribution through different lenses and sometimes, like a successfully negotiated settlement, there needs to be compromise.