A Firm's Culture Affects Partners' Compensation

The determination as to who gets what is probably the most crucial decision made in a firm today. Dissatisfaction with the process and result may be the single greatest factor in the decision of a lawyer to leave his or her firm. A failure to appreciate the process is responsible for a major part of this dissatisfaction. Further, the goals, objectives, and perhaps culture, as described in this article, change such that a firm may ultimately become something different from that which a lawyer originally joined.

Following are some observations on the process that deal with the issue in two parts: first, the standards of evaluation, and second, the compensation decisions based upon these standards.

Evaluation Standards

Implicit in the definition of “evaluate,” which Webster defines as “to fix the value of” or “to judge,” is the understanding that it is one's value to the firm that one is evaluating.

One must be able to define a firm's goals, strategies, and “culture” to fix the value of a partner to his or her firm. Stated another way, if a firm has as its goal to obtain as much new business as it can, it will give a higher evaluation in this regard to partners who account for this business than those who don't. If growth is not a major goal, but say, fraternalism is, then partners who best contribute to that goal will receive a higher evaluation.

Many compensation problems are really lawyers speaking out against what they view to be the standards of evaluation, i.e., they disagree with the firm's goals, its culture, and strategies against which their performance may rate poorly.
In many cases, their evaluation would be much better in another environment.

Thus, the first step in the evaluation process is the determination of firm goals (or objectives), and those factors which the firm views as essential attributes toward meeting these goals. These should be clearly understood and articulated so that compensation decisions, which are in whole or in part based on this evaluation, can be explained in a manner such that reasonable people can understand the results reached. This is not to say that there will not be disagreements over evaluation even if the evaluative factors are understood. The most unfortunate situations are those in which one partner's evaluation of himself clearly differs from the evaluation of him by his partners, using the same standards of evaluation. Frustration, resentment, discontent, and ultimately separation from the firm are the likely results. This result cannot be helped. Examples of various factors against which a lawyer may be evaluated are as follows:

1. Seniority;
2. Hours worked (billable and non-billable);
3. Legal ability/quality of work;
4. Business produced;
5. Reliability;
6. Administrative skills;
7. Client responsibility;
8. Past history of performance;
9. Present special performance;
10. Market value (what other firms would pay this lawyer);
11. Loyalty;
12. Legal reputation (writing, speaking, acknowledged authority);
13. Billing rate (profit to the firm);
14. Personality; and
15. Participation in training of associates.

Compensation Decision

Since the whole purpose of the evaluation process has been to make the compensation decision, the firm must decide what weight, if any, to give each factor of evaluation.

It is at this stage that the critical difference between firms using formula approaches and those on some subjective system manifests itself. To be on a formula system requires not only that a firm establish its goals and objectives, and articulate partner attributes contributing to those goals and objectives, but it further requires the attaching of a relative value to each which all partners know, can comment on, and to the extent they desire, can conform to. The anticipated results of using a formula approach, in whole or in part, can be as follows:

1. The compensation decision is already made, since it requires only a mathematical calculation and it can be reasonably anticipated that much of the discontent is over, after having reflected itself in the valuation and weighing process.
2. It focuses the firm on the setting of its goals and standards and their evaluation, and removes from the subjective that which can be quantified.
3. It makes clear to people joining the firm what behavior is expected of them, how they will be evaluated, and thus, what their chances of success or failure within the firm will be.
4. It tends to reinforce the behavior pattern of everyone within the firm and those joining the firm, i.e., it attracts people who will be happy and content to work within the values and standards clearly articulated, thus matching in many cases, personalities and the firm better.

The question of who should make the subjective evaluation decisions is incredibly difficult to deal with. The problem becomes harder, the larger the firm becomes, since it becomes more and more difficult to know what everyone is doing. Communication, both formal and informal, becomes essential so that every partner being evaluated against a subjective standard has an equal opportunity to have his or her case heard. Neither of the extreme possibilities here is likely to work in terms of the compensation decision, i.e., one person evaluating everyone, or everyone evaluating everyone. If a subjective standard is to be used in regard to the compensation of one or more partners, care must be taken to see that the evaluation is made by someone (or a group of partners) in a position to know.

One must always be sensitive to the fact that it is a finite pie being divided, i.e., whatever I get, you don't. Compensation decisions based on subjective factors require the philosopher-king approach on the part of those making them. They must truly be made in such a way that most, if not all partners will perceive them as being in the best interest of the firm. If they are not so made and so perceived, considerable dissatisfaction will result and one will find oneself perpetually fiddling with the question of who is best able to judge. This becomes a vital question, since when subjective criteria are used, no two people will see them quite the same way. The same is true when objective criteria, such as new business brought in, are weighed in a subjective manner.

As a firm grows, or in the case of smaller firms, its personnel changes, its values and goals may change, and consequently it may come to value different attributes in its partners. This may cause some people who were very happy with the old values to become unhappy with the new ones. One should view the decision-making process as a flexible one, not as etched in stone; always remembering that for each year the decision is made without disastrous results, we have accomplished some sort of a miracle.

Effect of Contingent Fees

The big problem presented by the presence of large contingent fee matters, particularly if they are not recurring from year-to-year, is that for a law firm keeping its books and records on a cash basis method of accounting, the costs incurred in contingent fee matters will be charged to a different accounting period than the income received. This is the same problem a growing firm faces, i.e., a firm may earn a substantial accrual profit in a given year that is reflected in increased accounts receivable and work-in-process with little cash profit because of the increase in business and the costs attendant thereto. The difference in time period from a compensation viewpoint is irrelevant, so long as the partners of the firm are the same and share in the same relationships when costs are incurred as when the income is received. All too often this is not the case, however, it is suggested that some matching of income and expense may be necessary in the interest of fairness.

To the extent some accrual method of accounting is used to match income and expenses, how should an unusual profit on a major case be credited to the varying interests of the partners in the firm and over what time period? Some alternatives are:

1. All excess profit should be treated as profit in the year received, to be allocated by the firm in accordance with its standard procedures.
2. It should be allocated to the year when the case originates.
3. It should be allocated over the years the matter was being handled in some form or other.

One factor should never be lost sight of: It is inevitably the capital of the firm that provides the stakes in the contingent fee gamble. It would, to paraphrase a famous judge in a famous case, be unseemly indeed to attribute the fruit to a different tree than that upon which it grew.

Joel A. Rose, a member of this newsletter's Board of Editors, is president of Joel A. Rose & Associates, Inc., a firm of management consultants headquartered in Cherry Hill, NJ. He may be contacted at [email protected] or 856-427-0050.

The determination as to who gets what is probably the most crucial decision made in a firm today. Dissatisfaction with the process and result may be the single greatest factor in the decision of a lawyer to leave his or her firm. A failure to appreciate the process is responsible for a major part of this dissatisfaction. Further, the goals, objectives, and perhaps culture, as described in this article, change such that a firm may ultimately become something different from that which a lawyer originally joined.

Following are some observations on the process that deal with the issue in two parts: first, the standards of evaluation, and second, the compensation decisions based upon these standards.

Evaluation Standards

Implicit in the definition of “evaluate,” which Webster defines as “to fix the value of” or “to judge,” is the understanding that it is one's value to the firm that one is evaluating.

One must be able to define a firm's goals, strategies, and “culture” to fix the value of a partner to his or her firm. Stated another way, if a firm has as its goal to obtain as much new business as it can, it will give a higher evaluation in this regard to partners who account for this business than those who don't. If growth is not a major goal, but say, fraternalism is, then partners who best contribute to that goal will receive a higher evaluation.

Many compensation problems are really lawyers speaking out against what they view to be the standards of evaluation, i.e., they disagree with the firm's goals, its culture, and strategies against which their performance may rate poorly.
In many cases, their evaluation would be much better in another environment.

Thus, the first step in the evaluation process is the determination of firm goals (or objectives), and those factors which the firm views as essential attributes toward meeting these goals. These should be clearly understood and articulated so that compensation decisions, which are in whole or in part based on this evaluation, can be explained in a manner such that reasonable people can understand the results reached. This is not to say that there will not be disagreements over evaluation even if the evaluative factors are understood. The most unfortunate situations are those in which one partner's evaluation of himself clearly differs from the evaluation of him by his partners, using the same standards of evaluation. Frustration, resentment, discontent, and ultimately separation from the firm are the likely results. This result cannot be helped. Examples of various factors against which a lawyer may be evaluated are as follows:

1. Seniority;
2. Hours worked (billable and non-billable);
3. Legal ability/quality of work;
4. Business produced;
5. Reliability;
6. Administrative skills;
7. Client responsibility;
8. Past history of performance;
9. Present special performance;
10. Market value (what other firms would pay this lawyer);
11. Loyalty;
12. Legal reputation (writing, speaking, acknowledged authority);
13. Billing rate (profit to the firm);
14. Personality; and
15. Participation in training of associates.

Compensation Decision

Since the whole purpose of the evaluation process has been to make the compensation decision, the firm must decide what weight, if any, to give each factor of evaluation.

It is at this stage that the critical difference between firms using formula approaches and those on some subjective system manifests itself. To be on a formula system requires not only that a firm establish its goals and objectives, and articulate partner attributes contributing to those goals and objectives, but it further requires the attaching of a relative value to each which all partners know, can comment on, and to the extent they desire, can conform to. The anticipated results of using a formula approach, in whole or in part, can be as follows:

1. The compensation decision is already made, since it requires only a mathematical calculation and it can be reasonably anticipated that much of the discontent is over, after having reflected itself in the valuation and weighing process.
2. It focuses the firm on the setting of its goals and standards and their evaluation, and removes from the subjective that which can be quantified.
3. It makes clear to people joining the firm what behavior is expected of them, how they will be evaluated, and thus, what their chances of success or failure within the firm will be.
4. It tends to reinforce the behavior pattern of everyone within the firm and those joining the firm, i.e., it attracts people who will be happy and content to work within the values and standards clearly articulated, thus matching in many cases, personalities and the firm better.

The question of who should make the subjective evaluation decisions is incredibly difficult to deal with. The problem becomes harder, the larger the firm becomes, since it becomes more and more difficult to know what everyone is doing. Communication, both formal and informal, becomes essential so that every partner being evaluated against a subjective standard has an equal opportunity to have his or her case heard. Neither of the extreme possibilities here is likely to work in terms of the compensation decision, i.e., one person evaluating everyone, or everyone evaluating everyone. If a subjective standard is to be used in regard to the compensation of one or more partners, care must be taken to see that the evaluation is made by someone (or a group of partners) in a position to know.

One must always be sensitive to the fact that it is a finite pie being divided, i.e., whatever I get, you don't. Compensation decisions based on subjective factors require the philosopher-king approach on the part of those making them. They must truly be made in such a way that most, if not all partners will perceive them as being in the best interest of the firm. If they are not so made and so perceived, considerable dissatisfaction will result and one will find oneself perpetually fiddling with the question of who is best able to judge. This becomes a vital question, since when subjective criteria are used, no two people will see them quite the same way. The same is true when objective criteria, such as new business brought in, are weighed in a subjective manner.

As a firm grows, or in the case of smaller firms, its personnel changes, its values and goals may change, and consequently it may come to value different attributes in its partners. This may cause some people who were very happy with the old values to become unhappy with the new ones. One should view the decision-making process as a flexible one, not as etched in stone; always remembering that for each year the decision is made without disastrous results, we have accomplished some sort of a miracle.

Effect of Contingent Fees

The big problem presented by the presence of large contingent fee matters, particularly if they are not recurring from year-to-year, is that for a law firm keeping its books and records on a cash basis method of accounting, the costs incurred in contingent fee matters will be charged to a different accounting period than the income received. This is the same problem a growing firm faces, i.e., a firm may earn a substantial accrual profit in a given year that is reflected in increased accounts receivable and work-in-process with little cash profit because of the increase in business and the costs attendant thereto. The difference in time period from a compensation viewpoint is irrelevant, so long as the partners of the firm are the same and share in the same relationships when costs are incurred as when the income is received. All too often this is not the case, however, it is suggested that some matching of income and expense may be necessary in the interest of fairness.

To the extent some accrual method of accounting is used to match income and expenses, how should an unusual profit on a major case be credited to the varying interests of the partners in the firm and over what time period? Some alternatives are:

1. All excess profit should be treated as profit in the year received, to be allocated by the firm in accordance with its standard procedures.
2. It should be allocated to the year when the case originates.
3. It should be allocated over the years the matter was being handled in some form or other.

One factor should never be lost sight of: It is inevitably the capital of the firm that provides the stakes in the contingent fee gamble. It would, to paraphrase a famous judge in a famous case, be unseemly indeed to attribute the fruit to a different tree than that upon which it grew.

Joel A. Rose, a member of this newsletter's Board of Editors, is president of Joel A. Rose & Associates, Inc., a firm of management consultants headquartered in Cherry Hill, NJ. He may be contacted at [email protected] or 856-427-0050.