Ask a managing partner whether the compensation plan is working and you will usually get an answer about the last allocation meeting. It went fine. Nobody stormed out. A couple of partners grumbled and then signed. The plan must be working.
That is the wrong test, and it is the one almost everyone uses.
A peaceful partnership tells you the plan is predictable. It doesn’t tell you whether the plan is paying for what the firm needs to achieve its strategic goals. Partners who have worked out how their number gets set stop arguing about it and start playing to it. If the plan pays for personal billings and originations, that is what you will get. The peace you are enjoying in January is the sound of that arrangement running smoothly.
Here is a better test. Take the three or four things your strategic plan says the firm needs to do over the next two years. For each one, find the specific component of the compensation plan that makes a partner financially better off for having done it. The strategy asks for cross-selling and the plan pays for originations. The strategy asks for orderly succession and the plan lets a retiring partner hold client credit until the day he walks out. Partners follow the money every time, and they are right to.
The clearest version of this shows up in delegation. The proper use of leverage is the most commonly ignored profitability lever in law firms, and compensation is usually the reason it gets ignored. When a partner’s pay turns on personal billable hours, every file handed down to an associate is money out of that partner’s pocket, so the partner keeps the file. Your most expensive person does work a third-year could do. The associate does not develop. The matter gets billed at a rate your client is increasingly unwilling to pay. None of this comes up at the allocation meeting, and there is no line item for it anywhere in your financials. It shows up three years later, as a partner class you cannot promote.
And these days, AI adoption and implementation is likely listed as one of the most important strategic goals for most firms. However, many law firms’ compensation systems are not equipped to address this issue. If your firm has an “eat what you kill” system, how do you reward partners for dedicating non-billable time to helping build AI systems which benefit the whole firm?
The next place to look is the equity itself. Ask how many of your equity partners would be admitted to equity partnership today, based on their current performance. Firms cut associates and staff when times get tight and leave the partner ranks alone. That protects the current year and gives away the leverage that carries the next five.
That brings you to the plan’s underlying design. Generally speaking, firms with subjective compensation systems are more profitable than formula-based firms. Formulas are easier to administer and easier to defend, but they push partners toward personal production at the expense of everything the firm needs that a formula cannot see. An eat-what-you-kill approach can stunt the growth of an otherwise healthy firm. In my experience it produces conflict and resentment between partners who each believed they were behaving reasonably.
A subjective system asks more of your governance than a formula does. Someone has to decide, and the decision has to hold up in front of people who will dislike it. In my experience, top-down centralized management is the most efficient and effective way to manage, and compensation is where that view gets tested hardest. Give a small committee real authority and a written process it has to follow. Publish the criteria before the year starts, while partners can still respond to them. Then give every partner a written explanation of their own number. Having to write the reasoning down improves the reasoning, and that is often the larger benefit.
Partners will accept a number they dislike if they believe it was reached on the merits. They will not accept a number they cannot trace, however carefully you arrived at it. Trust in the process is worth more to a firm than how precisely the formula is calculated.
If you want a rough read on where your own plan sits, I have put together a short diagnostic below that walks through the areas where compensation tends to work against the firm. It takes about four minutes. It is a starting point, not a substitute for a proper compensation review.
TAKE THE PARTNER COMPENSATION SYSTEM DIAGNOSTIC
Contact me if you’d like to discuss.
