I mentioned in my last post that creating a non-equity tier as a place to put your under-performers is a bad use of a tiered structure.  Other similarly weak reasons to create a tiered structure include managing earnings (profits per equity partner) to appear more profitable in the published rankings; to restore operating leverage; or to create a place to put “technicians”.  Compensation equity, operating leverage, quality control, admission standards, performance evaluation and motivation are all solvable and are independent of partnership structure.  Partnership decisions, like compensation decisions require discipline and rigor.  Tiers should not become dumping grounds for the mediocre.

As Professor William Henderson at the Indiana School of Law writes in his May 2006 paper titled An Empirical Study of Single-tier Vs. Two-tier Partnerships in the AmLaw 200, “…this study documents that average PPP are significantly higher in single tier firms, even after controlling for geographic market segment and firm leverage.  The higher profitability of single-tier firms appears to be a function of higher levels of prestige, which enable single-tier firms to (a) attract and retain a more lucrative client base, and (b) run a more rigorous promotion-to-partnership tournament in which associates work longer hours and are less secure in their futures with the firm…”

So should anyone consider a second tier?  Perhaps.  There are still some benefits to a second tier including  establishing a career option for critically important senior advisors and the very best technical specialists who do not want the responsibility of full ownership — the “pride of partnership”; or, as a proving ground for those who have yet to demonstrate sustained business generation in acceptable quantity and quality but who you consider are more likely than not to do so.  Undertaking tiers still requires carefully stated objectives (including how this structure relates to the firm’s strategic intent; clearly articulated rigorous admission standards for both tiers; that the firm design the tier to be a desirable career path; and, that the equity partners reach consensus that this is a good thing to do.

It is interesting to observe how law firms cycle in tune to the economy.  In robust years, law firms are apt to be more generous in both promotions and pay increases.  The sentiments behind those actions are good, but the unintended consequences are usually not.  This is the third economic down cycle that I have experienced as a consultant.  In each, as law firms grapple with declining revenues, the call volume on how to deal with “over-paid” or ”under-productive” partners escalates.

Why does this happen?  Law firm owners must be able to create market presence, build trust based relationships, be alert to business opportunities and bring in work for their firms.  In good times it is easier to do this.  When the marketplace contracts, those who are least skilled, least experienced and least well positioned to get business will be hurt the most.  Add to that what might, upon reflection, have been an excessively generous promotion or pay increase.

Obviously, a firm would prefer not to have the problem.  But that takes discipline during good times to appraise an individual’s ability to sustain performance in a variety of circumstances.  Therefore compensation committees must look beyond the numbers, engage in realistic appraisals of sustainable performance and potential, make compensation decisions and promotions much more carefully and to discuss their conclusions with each individual.  Frank, candid and constructive dialog consistent with the firm’s values and strategy are the most effective means to manage expectations and to build credibility as a leader.  These steps will not eliminate the problem, but will go a long way to reduce the severity of the issues later on.

However, if a law firm is in the midst of the problem there are hard decisions to make.  Some firms will turn to “non-equity” ownership structures as an answer.  This is not a good reason to create a tiered ownership structure, but if you already have one it had better have clearly articulated and enforced performance standards for admission and retention into each ownership tier.   Secondly, you have maybe a two to three year window of opportunity to improve contributions from those who are in a tier not warranted by the individual’s sustained performance or immediate potential.  After that, leadership’s credibility is damaged.

But the problem is now - and the heavy hitters are getting restless.  Now is not the time to fully reverse course and to overreact in the opposite direction.  Leaders must move with deliberate speed to address the situation.

First, assess the situation with brutal honesty.  How bad is the market change?  How long is it likely to last?  What shape will the recovery likely take?  What might not come back at all?  What resources does the firm have to ride out the cycle?

Second, take the pulse of the firm.  To what extent are the heavy hitters willing to ride it out?  How well informed are the partners regarding the firm’s fiscal health, market forces and their own ability to contribute?  Get assessments and projections for each major practice.

Third, craft a plan consistent with your analysis of the current situation and likely future.  Balance the response to the facts and circumstances.  Look at a range of fiscal and operational opportunities, yet do not forgo all investment for the future.  Develop a time-line for each corrective action.  When to begin the corrective action, how long it will take to be fully implemented as well as the time-line for how it will affect the firm’s finances. 

Fourth, communicate, communicate, communicate.  Engage in constructive discussions regarding the most promising corrective actions.  Keep people informed, invite feedback and dialog.  Remain open, candid and upbeat in all of your interactions and communications. 

Lastly,  treat people with respect and compassion.  This is important to each leader for how they are perceived by others, to each affected person for their legacy perception of their firm, and to everyone else as the clearest possible indication about how they could be treated in the future.  How you treat people in difficult times defines the true values of your firm.