By David Bilinsky and Laura Calloway

"The love of money is the root of all evil"—or so the saying goes. At the very least, the words assuredly strike a chord with anyone who has ever faced the task of developing or modifying a law firm's compensation system. That is a project that all too often seems like a "mission impossible."

Developing a compensation system can be a weighty task. And that is especially true if you set out to do it right—which means establishing a system that reflects the new realities of practicing law while preserving the principles on which the firm was founded.

How can you accomplish the goal? To guide you, let's explore the different components, issues and other things you need to think about when developing or modifying your firm's compensation system in a way that will best suit the firm and its members.

 

The Firm's Business Objectives

What gets measured gets done. What gets compensated gets measured and done. When looking at your firm's mission statement, do you see objectives that are laudable but more often observed in the breach than in the performance? Perhaps the root cause is a misalignment between your firm's compensation formula and your mission statement.

There are many items that can be taken into account when deciding how to slice the profit pie (several of which are covered in the following sections). However, if the reward for performance is felt to be less than the effort required, or if the performance is not explicitly rewarded, then certain activities will be given only lip service—or ignored entirely. A notorious example is the "eat what you kill" system, which, in its simplest form, solely rewards collected fees. Under this system, it is hardly surprising that no partner or associate in the firm wishes to spend any time on any task that does not result in billable hours—especially ones with a high probability of being collected.

Even under other compensation systems, activities such as time spent converting an agreement into a firm precedent or time spent on firm administration usually fall into the compensation gap. Accordingly, if something is important enough to be included in your mission statement or stated to be a firm goal, then it should be recognized in the way the firm rewards performance.

 

The Formula Approach: Allocations at a Set Percentage

There are many methods used to divvy up the profit pie. The formula system has an explicit list of items that are rewarded, with each item weighted at a specific percentage to determine final compensation. As an example, let's assume the following:

• A small firm has a basic formula system under which 50 percent credit is given to collected fee revenues and 50 percent credit is given to fee origination.
• There are two partners—partner A, who bills $350,000 in a given year, and partner B, who bills $200,000 in the same year.
• Partner A originated 0 percent of the work, and partner B originated 100 percent of the work for the firm.

The compensation formula for the firm is:

(partner fees collected) + (partner fees generated)
	x 100
(total fees collected) + (total fees originated)
= % partner's share

In this example, the result for partner A is:

($350,000) + (0) = $350,000
	x 100
($550,000) + (550,000) = $1,100,000
= %32

The result for partner B is:

($200,000) + (550,000) = $750,000
	x 100
($550,000) + (550,000) = $1,100,000
= %68

So, while Partner A bills more, he is only entitled to 32 percent of the firm's profit because of the weight given to the fee origination credit. Partner B, although she bills less, is nevertheless entitled to 68 percent of the profits owing to her rainmaking efforts.

As you can see, both the inclusion (or exclusion) and the weights assigned to the different factors in the compensation agreement can have a profound impact on the final distribution of the firm's profit pie.

 

The Subjective Approach: Distribution by Committee

Other law firms use a purely subjective distribution system. In this approach, there is no precise formula used to determine the profit distribution among the partners. Instead, the firm's compensation committee decides the profit allocation from year to year based on purely subjective grounds.

This system, of course, allows for great latitude in how profits get distributed each year—and it can also allow for the factoring in of different items from year to year as conditions change. However, it can quickly result in the breakup of the firm unless a great deal of trust is placed in the ability of the compensation committee members to reward each of the firm's lawyers fairly and equitably.

 

The Blended Approach: Adjustable Criteria

Then there are the blended compensation systems, which combine a formula with the subjective system. They do so by taking into account an explicit number of factors—which account for, say, 80 percent of a lawyer's compensation—together with a pure subjective factor for the remaining 20 percent. This allows for an adjustment of the overall compensation along subjective criteria. Thus, the firm rewards its explicit goals through the formula but also allows for the reward of criteria that may not be specifically taken into account in a true formula approach.

For example, the firm's formula could recognize items such as the following:

• Fees collected
• Fees generated
• Time spent on firm administration
• Time spent mentoring younger associates

At the same time, the subjective criteria could take into account items like these:

• Pro bono work that generated high publicity for the firm
• Bar association activities
• Time spent on continuing legal education and the like

Note that in both the blended system and the straight formula system, another issue to consider is whether to use the compensation formula to determine the division of next year's profits (prospective) or the year just ended (retrospective). There are firms that follow each method, and there are pros and cons to each.

 

Other Things to Think About

Along with deciding which approach to gear your system toward, there are (as you might guess) a host of other issues to consider when developing a law firm compensation system. Here are some essential ones for savvy firms.

Metrics. Remember, what gets measured gets done. That is why it's smart to development some quantitative answers to questions such as the following:

• What is the ratio of the highest paid partner to the lowest?
• How does the compensation of different practice groups or practice areas compare?
• What about the compensation paid to different offices?
• How important are these perceived differences, and what effect do they have on performance and culture in the firm?
• To what degree are certain partners able to influence the compensation division?

You should consider these questions in the context of your own compensation system—at least to acknowledge that there are many levels on which compensation will influence behavior in the firm.

Communication. Almost as important as the split of profits is the method used to communicate the compensation decisions to the members of the firm. Most firms would want to share only the criteria used to determine compensation. After all, how do you use the compensation system to change behavior unless the compensation criteria and their importance are known? Others will go further and distribute to all partners a list of what each partner receives in compensation.

In either instance, the firm wants to ensure that the criteria for rewarding extraordinary effort (but not necessarily the resulting bonuses) is made known to all partners and associates, in order to communicate that there are rewards for going beyond ordinary expectations.

Full faith. Almost all firms will use a compensation committee in determining how to slice up the pie—even if that "committee" is composed solely of a beneficent despot. In any case, to make compensation decisions on a fair and equitable basis, the compensation committee must have the trust and respect of the firm's partners. Otherwise, the compensation dialogue will degenerate and (as indicated earlier) may even result in the breakup of the firm.

Input from others in the firm. If your compensation system employs subjective criteria, to what extent are the opinions of various partners, practice group chairs and important staff members sought? Unless yours is a pure eat-what-you-kill firm, the importance of teamwork cannot be underestimated. And, as such, the opinion of team members is vital in determining compensation so that teamwork and effort are properly rewarded.

 

So, Did It Work?

The final criteria for judging the appropriateness of any compensation system gets assessed after you have given the particular system "a try." Specifically, after allocating a year's profits, you need to ask whether your system did, indeed, promote the goals that you set out in your business plan. Here you have to determine the tools used to measure your progress (or lack thereof) and whether your compensation system needs to be modified as a result.

Given the importance of retaining talented partners and associates in today's competitive and more mobile society, the compensation system should not be a reason to lose talent to the competition around the corner. The goal of any compensation system is to recognize extraordinary performance and reward it, while motivating everyone to perform above their current comfort zone.