Compensation Remains One of the Most Important Decisions for a Law Firm

With associate compensation dominating the headlines over the past several months, partner compensation has managed to slip under the radar. This isn’t particularly surprising, however, given how uncomfortable discussions regarding partner pay can be for lawyers and their firms. Despite the tendency to delay or even avoid such conversations, partnership compensation remains one of the most scrutinized decisions in a law practice. A survey published last month by legal search firm Major, Lindsey & Africa shows that law firm partners overall are doing well post-Great Recession. See, “2016 Partner Compensation Study,” available for downlaod at http://bit.ly/2dvMkrp. Both equity and non-equity partners have witnessed strong gains in their compensation compared with 2014, as average compensation increased by 22% (from $716,000 to $877,000). Median compensation also rose from $475,000 in 2014 to $575,000 in 2016 — a 21% increase. As in previous years, the study also shows a growing gap between equity and non-equity partner pay, with equity partners now averaging approximately three times the total compensation of their non-equity colleagues. Median compensation of equity partners increased by 15%, while median compensation of non-equity partners remained unchanged. Each law firm or partnership has to decide for itself how to design and implement its partner compensation models. The following are some considerations relevant to partners and law firms as they assess whether their partner compensation model fairly balances partners’ value to the practice with the practice’s financial future and viability. Formality Is Often a Function of Size Generally speaking, the formality of the process for determining partnership compensation is inversely related to the size of the law practice. Determining compensation for smaller practices often involve little more than informal negotiations among colleagues about how to divide up the profits after expenses are paid. This arrangement, however, is typically not an option for larger law practices because of the sheer number of partners. Even in smaller practices, an informal process is not without risk. After economic instability, the most frequent reason for partnership dissolution continues to be unresolved disagreements regarding partnership compensation or the division of profits. The attendant risks, however, are not limited to partnership breakups. For example, law practices are not beyond the legal protections imposed on all businesses against discrimination, fee splitting or other matters. The U.S. Supreme Court has specifically held that the laws against discrimination apply to law practices in the same manner as they apply to other commercial enterprises. Instructive on this point are figures in Major, Lindsey & Africa’s report bearing on gender and ethnicity. As to gender, male partners’ compensation continues to significantly outpace that of female partners. Although the gap is closing, average compensation for female partners remains 44 percent lower than for male partners, $659,000 vs. $949,000. [For more, see, “Lower Pay for Woman Partners,” on page 6.] As to ethnicity, Hispanic, African-American and Asian-Pacific partners saw significantly higher average compensation at $956,000 (100% increase since 2014), $797,000 (39% increase) and $659,000 (24% increase), respectively. The average compensation of white partners increased to $876,000, up 19% from 2014. Consequently, the safer course for law practices, regardless of size or location, is some formalized process. This does not mean that the process has to be reduced to an objective mathematical formula that is to be applied using numbers without regard to other subjective factors reflective of partners’ contributions to the practice. Instead, many firms elect to formalize the “how” without regard to what the process might include. Updating the Partner Compensation Model For most practices, partnership compensation rules that are adopted at the start of the year before the money comes in the door have a greater chance for success than do retrospective rules that divide the pot after the fact. Some practices have not changed their compensation process for decades. This is high-stakes poker. No one doubts that the practice of law, including the economics of the practice of law, has changed dramatically over the past few years. For that reason, most firms have, at some point, updated their process for determining partner compensation. Partner compensation involves a number of distinct possibilities. The range extends from pure meritocracies to egalitarian models with compensation compression so partner compensation varies little from the top to the bottom. Most law practices have models somewhere in the middle, involving both objective numbers evaluated in the context of a general formula as a reference point, plus subjective data evaluated in the context of contributions to the practice. Although objective models often sound the best, in some circumstances such models may negate one of the most significant purposes of a law firm practice as opposed to a solo practice: shared risk. Purely formulaic compensation models afford great reward in good years, with no protection during bad years. On the other hand, law firm practices with subjective elements to their compensation model are able to share that risk so no single year makes or breaks a partner’s compensation. It also means compensation goes up and comes down at a more controlled pace. In creating, re-evaluating or revising partner-compensation models, law practices might consider the following questions: