Subjective and Objective Compensation Systems

As we sift through the results from our recently published (yet still open to late-comers) Partner Compensation System Survey, the data draws us to consider a wide variety of questions about this vitally important management and leadership system. One critical question that deserves somewhat more detailed consideration is the basic structures of the systems used in the legal world today. While the majority of our survey respondents report using some form of subjective system, about 15% of the firms report that they use a purely formulaic/objective system.

From a theoretical or normative perspective, there is no “right” or “wrong” system. Each option has its strengths, weaknesses and applicability to any given firm's culture, leadership style, and the behaviors that the leaders want to incentivize and reward. Systems that will work well in one firm would fail abysmally in others, and we generally find that even many systems that look very much alike “on paper” are somewhat different in application.

We always enjoy listening to Partners who suggest changes to their compensation system because they hear that some feature works well elsewhere, and assume that if they were to adopt whatever feature they are touting, all the firm's issues would be resolved. While sometimes true, this is hardly a given, which explains why compensation systems vary among firms more than perhaps any other management system.

On paper, the difference between “objective” and “subjective” systems is one of the biggest ways in which compensation systems vary. But, as we look at the details behind all of the systems reported to us, we see that the degrees of separation between purely subjective and objective systems aren't nearly as extreme as they appear. This observation is based not on the theory behind the systems, but on the way in which most such systems are applied in practice.

Subjective vs. Objective

While objective systems begin (and in theory, end) with hard partner performance data, even the most subjective compensation systems are also informed by mountains of performance data from the firm's accounting system. The next step in the process for many “subjective” firms involves Partner interviews to understand the story behind the numbers, but the primary activities rewarded for most partners are some combination of origination (of client relationships) and personal production. In practice, these two factors typically drive 65%-70% or more of variation in compensation among partners, and in some “subjective” firms this exceeds 95%, at which point the system is effectively formulaic in all but name.

Like subjective systems, all objective systems start with performance data from the firm's accounting system. The appropriate data is plugged into the firm's formula and, in theory, a perfect set of results are produced and the process is over. Like subjective systems, in almost all formulas the dominant activities rewarded are origination and personal production. Further, like subjective systems, the perfect set of results is usually analyzed, but then something interesting happens ' someone observes that something just doesn't feel quite right. In many such cases, the Partners then add a subjective element to the process ' they develop an amendment to the formula to produce the desired results mathematically. This reverse engineering is often designed to address a specific scenario that the original formula cannot handle.

System Confusion

Over time, the number of amendments grows and in some firms each one is associated with a specific case or Partner (e.g., the “Mike Short rule”). If this process continues, the system becomes so cumbersome that it cannot be easily explained to anyone on the outside. (We have seen truly extreme cases where none of the partners actually understood the system they were using, and as a result were heavily reliant on a clerk in the accounting department, without whom no one would ever be paid.) The Partners sleep well knowing that they have preserved the objective nature of their system, but they have actually applied a heavy dose of subjectivity to their “objective” process. The only alternative to this is to add a significant “subjective” bonus pool, at which point the “objective” firm's leadership typically ends up spending more subjective time allocating the bonus pool than most subjective firms spend on the entire process.

Key Differences

Both objective and subjective systems rely heavily on data, reward basically the same behaviors as their primary drivers, and apply subjectivity to the process ' one before the results are announced and one after the initial results are calculated. Based on the real-life application of the two systems, they are much more similar than their designs would suggest. The true differences between these two systems are deep in the details and very nuanced. From our data, which is supported by our consulting experiences with compensation systems, we offer the following as some of the key differences:

1. No single factor has more relevance to the appropriate choice of compensation system than the ability of the Partners to have difficult, constructive conversations with each other. Partnerships that can do this simple, challenging task usually have a level of trust among Partners that can support a subjective system, which is a necessary but not sufficient criterion for subjective system success. If constructive, difficult discussions are not possible, the Partners' trust must be focused away from people and toward a formula.
2. The majority of Partners under objective systems are expected to bill fewer than 1,600 hours per year as a target. Conversely, the majority of Partners under subjective systems are expected to bill more than 1,600 hours. In formulaic firms, Partners can basically set their own levels of effort and reward without any real input from management ' other than begging or nagging ' because the rules are defined and clear. (Note, though, that even formulaic systems break down when partners are performing below some minimum level of contribution, which will be dependent in part on the firm's overall economic and cost structure.) Under a subjective system, the Partners cannot unilaterally decide their level of effort because firm leadership can link contributions to rewards.
3. Under a formula, individual Partner compensation can vary widely from year to year and the rewards are immediate and tied to recent contributions. Under a subjective system, the movements tend to be much more gradual and measured because the supporting data and contributions typically reflect two to three years of data ' not just one. In this sense, subjective systems take a longer view of contribution.
4. Investment time has no impact on any given Partner's compensation in the vast majority of formulaic firms. Under subjective systems, a vast majority report that investment time has at least some impact on compensation. We have yet to see a formula that can provide real accountability around investment time.
5. With care, a subjective system is capable of handling qualitative variation among partner contributions, including factors such as teamwork and the non-numerical outcomes of investment contributions. The challenge is to simply not allow the numbers to drive the entire outcome. In an objective system, this can only be done by reverse engineering ' and moving away from objectivity.
6. If allowed to unilaterally (and hypothetically) make any change to their systems, the majority of leaders of firms with subjective systems want to take their results from “open” to “closed” (with respect to the availability of system results to all Partners). Most interestingly, the leaders of about half of firms with formulaic or highly structured systems want to add more subjectivity to their processes.

Conclusion

On paper, the differences between the systems are vast. Based on practical applications and a more detailed analysis, the systems are more similar than different. The type of system needed in any firm and the procedural details are determined by many philosophical decisions and “soft” issues. As such, and as many Partners tell us when we're proposing revisions, the devil is in the details.

Michael (Mike) Short and Joseph Altonji, a member of this newsletter's Board of Editors, are Founding Principals of LawVision Group LLC, and can be reached respectively at [email protected] and [email protected]. Both work extensively on law firm partner compensation systems. Readers who are interested in participating in the authors' Partner Compensation System Survey on a late basis, or in attending one of their upcoming Partner Compensation System Workshops, are invited to contact Mike at the e-mail address above.

As we sift through the results from our recently published (yet still open to late-comers) Partner Compensation System Survey, the data draws us to consider a wide variety of questions about this vitally important management and leadership system. One critical question that deserves somewhat more detailed consideration is the basic structures of the systems used in the legal world today. While the majority of our survey respondents report using some form of subjective system, about 15% of the firms report that they use a purely formulaic/objective system.

From a theoretical or normative perspective, there is no “right” or “wrong” system. Each option has its strengths, weaknesses and applicability to any given firm's culture, leadership style, and the behaviors that the leaders want to incentivize and reward. Systems that will work well in one firm would fail abysmally in others, and we generally find that even many systems that look very much alike “on paper” are somewhat different in application.

We always enjoy listening to Partners who suggest changes to their compensation system because they hear that some feature works well elsewhere, and assume that if they were to adopt whatever feature they are touting, all the firm's issues would be resolved. While sometimes true, this is hardly a given, which explains why compensation systems vary among firms more than perhaps any other management system.

On paper, the difference between “objective” and “subjective” systems is one of the biggest ways in which compensation systems vary. But, as we look at the details behind all of the systems reported to us, we see that the degrees of separation between purely subjective and objective systems aren't nearly as extreme as they appear. This observation is based not on the theory behind the systems, but on the way in which most such systems are applied in practice.

Subjective vs. Objective

While objective systems begin (and in theory, end) with hard partner performance data, even the most subjective compensation systems are also informed by mountains of performance data from the firm's accounting system. The next step in the process for many “subjective” firms involves Partner interviews to understand the story behind the numbers, but the primary activities rewarded for most partners are some combination of origination (of client relationships) and personal production. In practice, these two factors typically drive 65%-70% or more of variation in compensation among partners, and in some “subjective” firms this exceeds 95%, at which point the system is effectively formulaic in all but name.

Like subjective systems, all objective systems start with performance data from the firm's accounting system. The appropriate data is plugged into the firm's formula and, in theory, a perfect set of results are produced and the process is over. Like subjective systems, in almost all formulas the dominant activities rewarded are origination and personal production. Further, like subjective systems, the perfect set of results is usually analyzed, but then something interesting happens ' someone observes that something just doesn't feel quite right. In many such cases, the Partners then add a subjective element to the process ' they develop an amendment to the formula to produce the desired results mathematically. This reverse engineering is often designed to address a specific scenario that the original formula cannot handle.

System Confusion

Over time, the number of amendments grows and in some firms each one is associated with a specific case or Partner (e.g., the “Mike Short rule”). If this process continues, the system becomes so cumbersome that it cannot be easily explained to anyone on the outside. (We have seen truly extreme cases where none of the partners actually understood the system they were using, and as a result were heavily reliant on a clerk in the accounting department, without whom no one would ever be paid.) The Partners sleep well knowing that they have preserved the objective nature of their system, but they have actually applied a heavy dose of subjectivity to their “objective” process. The only alternative to this is to add a significant “subjective” bonus pool, at which point the “objective” firm's leadership typically ends up spending more subjective time allocating the bonus pool than most subjective firms spend on the entire process.

Key Differences

Both objective and subjective systems rely heavily on data, reward basically the same behaviors as their primary drivers, and apply subjectivity to the process ' one before the results are announced and one after the initial results are calculated. Based on the real-life application of the two systems, they are much more similar than their designs would suggest. The true differences between these two systems are deep in the details and very nuanced. From our data, which is supported by our consulting experiences with compensation systems, we offer the following as some of the key differences:

1. No single factor has more relevance to the appropriate choice of compensation system than the ability of the Partners to have difficult, constructive conversations with each other. Partnerships that can do this simple, challenging task usually have a level of trust among Partners that can support a subjective system, which is a necessary but not sufficient criterion for subjective system success. If constructive, difficult discussions are not possible, the Partners' trust must be focused away from people and toward a formula.
2. The majority of Partners under objective systems are expected to bill fewer than 1,600 hours per year as a target. Conversely, the majority of Partners under subjective systems are expected to bill more than 1,600 hours. In formulaic firms, Partners can basically set their own levels of effort and reward without any real input from management ' other than begging or nagging ' because the rules are defined and clear. (Note, though, that even formulaic systems break down when partners are performing below some minimum level of contribution, which will be dependent in part on the firm's overall economic and cost structure.) Under a subjective system, the Partners cannot unilaterally decide their level of effort because firm leadership can link contributions to rewards.
3. Under a formula, individual Partner compensation can vary widely from year to year and the rewards are immediate and tied to recent contributions. Under a subjective system, the movements tend to be much more gradual and measured because the supporting data and contributions typically reflect two to three years of data ' not just one. In this sense, subjective systems take a longer view of contribution.
4. Investment time has no impact on any given Partner's compensation in the vast majority of formulaic firms. Under subjective systems, a vast majority report that investment time has at least some impact on compensation. We have yet to see a formula that can provide real accountability around investment time.
5. With care, a subjective system is capable of handling qualitative variation among partner contributions, including factors such as teamwork and the non-numerical outcomes of investment contributions. The challenge is to simply not allow the numbers to drive the entire outcome. In an objective system, this can only be done by reverse engineering ' and moving away from objectivity.
6. If allowed to unilaterally (and hypothetically) make any change to their systems, the majority of leaders of firms with subjective systems want to take their results from “open” to “closed” (with respect to the availability of system results to all Partners). Most interestingly, the leaders of about half of firms with formulaic or highly structured systems want to add more subjectivity to their processes.

Conclusion

On paper, the differences between the systems are vast. Based on practical applications and a more detailed analysis, the systems are more similar than different. The type of system needed in any firm and the procedural details are determined by many philosophical decisions and “soft” issues. As such, and as many Partners tell us when we're proposing revisions, the devil is in the details.

Michael (Mike) Short and Joseph Altonji, a member of this newsletter's Board of Editors, are Founding Principals of LawVision Group LLC, and can be reached respectively at [email protected] and [email protected]. Both work extensively on law firm partner compensation systems. Readers who are interested in participating in the authors' Partner Compensation System Survey on a late basis, or in attending one of their upcoming Partner Compensation System Workshops, are invited to contact Mike at the e-mail address above.