Best Practice #9: Conforming to standard business practice by linking compensation to individuals’ contributions to the long-term viability of the firm
An important point, rarely mentioned, is the current system’s odd focus on current cash flow. To state the obvious, cash flow differs from the bottom line, which is a measure of the difference between revenue flow and expenses. Consultants sometimes circle around this, as when they note that partners in practice areas with higher profit margins should be rewarded financially. To quote the Brian W. Bell of Hildebrandt Baker Robbins:
Very often celebrity lawyers...will...say ‘They’re not paying me enough money. I brought in $2 million worth of business.” I’ll look into it and I’ll often find that it costs $3 million to bring in that $2 million worth of business.
He continued: “If you measure hours, receipts and originations, that doesn’t take into account whether the work is profitable or not.”
Of course, cash flow is easier to measure than the bottom line. A particular challenge faced by law firms is that those who manage them typically have had no training in how to manage a large business organization—nor do most law firm partners have an appreciation for what they did not learn by choosing not to go to business school. The lack of sophisticated management in the part feeds skepticism about the potential for sophisticated management in the future. The result, notes David Maister, is an absence of trust that leads to “extreme short-term orientations of many law firms. If partners don’t believe the firm will remember or value contributions to future success, why would they make any investment that they may ultimately not get credit for?”
The basic principle is easy to articulate: “Compensation theory generally says that you ought to be rewarding people for the behaviors that you are trying to elicit,” notes Joel F. Henning, the Senior Vice President and General Counsel of Hildebrandt Baker Robbins. The typical approach in most business settings is to link compensation to the individual’s annual goals, which in turn reflect the organization’s strategic plan. One survey respondent noted that her firm had instituted such a system outside of the compensation context: “Individual must meet the specific written elevation criteria and reflect/support standards set forth in the firm’s strategic plan.” Other comments offer intriguing hints of systems designed to reward teamwork when asked what factors into compensation: “Cross-office fertilization (ability to generate work for lawyers in other offices); ability to generate marketing and billable opportunities for lawyers in other practice groups.”
Law firms’ failure to link partners’ compensation to lawyers’ contributions to the long-term viability of the firm has a disproportionate impact on women, for several reasons. Most important, women lawyers often are under significant informal pressures to make such contributions, for example through service on committees related to recruitment, associate development and diversity. In addition, due to women’s history of gender discrimination in the profession, women may feel a greater obligation than do men to mentor women, and to help other women develop their careers—contributions that help develop a firm’s human capital, but rarely play a significant role when partner compensation is set.
A straightforward fix is for firms to reward all of the different kinds of contributions partners are asked to make to the firm, both through mentoring and other programs, and through committee work, on the theory that if the firm requires partners to make this type of contribution, it is important enough to the long-term future of the firm be recognized when compensation is set—and that if a given type of contribution is not important enough to recognize when compensation is set, perhaps it is not important enough to be required.
How these factors are taken into account also matters. For example, we suspect that most firms represented by lawyers in our survey say that they take into account, when setting compensation, partners’ contributions to diversity, associate development, etc. Yet many of our respondents were notably skeptical; evidently many felt that their firms gave lip service, but did not actually, take such activities into account to a significant extent when compensation was set. This finding may indicate that firms need to communicate better now they actually do take these types of contributions into account. Alternatively, firms may need to set up more formal systems than they currently have; it may be that existing informal recognition (“it’s in the mix; we just don’t quantify it”) translate good intentions into few results.
More sweeping than a mechanism for adding additional factors into the mix in setting law firm compensation is to shift to the type of compensation systems adopted long ago. For example, Ernst & Young’s compensation system weighs partners in four different arenas: quality, people, markets, and operational excellence.
Quality is, quite simply, the quality of the partners’ work—something rarely considered explicitly in law firm compensation systems. At Ernst & Young, detailed assessments of quality are performed for each major “engagement,” as client matters are called.
“People” concerns whether a partner is “actively involved in attracting growing and training our people,” said Cathy Salvatore, Director of Career Development, “because our people are the only thing we have.” Partners can choose how they will contribute to human capital development of others in the firm: “I tell them, these are the people who are going to pay for your retirement,” Salvatore said. Some partners choose to focus on recruiting, either on-campus or experienced hire recruiting. Individuals are given responsibility for recruiting from their alma maters. “They own it. It is their responsibility to see that we get what we need, and to make sure the relevant professors are happy.” Other partners focus on inclusiveness and diversity, or serve as Service Program leaders, teaching in-house training programs, and recruiting others to do so. Also included is how a partner interacts with his or her team. “How they are going to engage with people on the job? It is very easy for a partner to never be on the scene—to come in at beginning, at the end, and other than that only if there’s a problem. Younger people love to see the partners,” Salvatore noted. But a partner who spent all his or her time with their engagement team, who was totally invisible at office events and “was not driving anything cross functionally” would be penalized under the “People” category. The focus is on strategic development: “how are you contributing to what E & Y needs to do to make sure we have the strongest workforce, period—across all accounts not just your account.” A single respondent reported a law-firm system that reflects some of these concerns: her firm’s partner compensation took account of associate evaluations of partners.
“Markets” includes revenue generated, but goes far beyond that. It measures the extent to which a partner engaged in strategic development of new markets—not only for him or herself but also for the firm as a whole. Markets also measures whether the partner has brought in work, and worked strategically to penetrate new markets or develop new products. One consideration is “account planning—how you prepare to get your teams ready to deliver whatever service has been contracted for,” Salvatore noted. It also includes strategic work to penetrate a new market: “Who are we going to go after and how are we going to go after them.”
Operational excellence focuses on whether work is performed, and revenues are collected, efficiently and in a timely manner. So if a partner has “a lot of days of revenue sitting uncollected,” or has a significant number of write-offs, this would show up in the operational excellence metric. Also considered is “fee-sharing”: efficient deployment of the person with the relevant skill set who is closest to the geographical locale of the engagement. This discourages partners from using people they know over and over again because it may be more cost-efficient to use someone closer to the client,” said Salvatore.
A straightforward approach would be to adopt this kind of system: law firms who inquire will find that many of their larger clients have a similar system. Firms that feel this is too large a leap, could adapt their current systems by awarding points for a variety of institutional investments (from management to developing the firm’s human capital). A third alternative is to set aside a specific percentage of firm profits to be distributed based on institutional investments.
