Cotterman on Compensation

Paying Partners Under AFAs

Jim Cotterman — Thu, 25 Feb 2010 21:44:48 +0000

Partner compensation decisions are largely driven by a lawyer’s ability to generate work for him/herself and others. And although personal productivity remains a key factor, it is not sufficient at the partner level. Other contributions become more important as law firms look for competitive advantage in the market. Accordingly public relations/marketing, professional development, client relationship management, business and fiscal management, collaboration and team leadership, and cultural fit carry more weight in the decision to promote and pay partners. More recently firms have begun to evaluate the profitability of the work done and incorporate that knowledge into their pay programs.

Now, with the increasing demand from clients for non-hourly based pricing, law firms must again expand the performance benchmarks in their compensation program to include new types of contributions. Under alternative fee arrangements in which bundles of work are priced at fixed fees, collaboration and service cost reductions become key elements to success. And partners want to know how this new way of serving clients will factor into the pay program. Here is where this all gets interesting.

Compensation decision makers will need new metrics to evaluate factors like labor utilization, service/process efficiency, matter/portfolio/client profitability, collaborative skills, ability to contribute as a team and team leadership. Because the service delivery model is still labor intensive, it is unlikely that the old metrics will be abandoned. However, they will need to give some ground — influence less of the pay decision — so that the new metrics influence pay decisions at a level commensurate with the importance the firm places on these initiatives.

There will be challenges. Traditional performance metrics are embedded in lawyers’ psyches - and they will not be given up easily. The lateral market for equity partners - currently driven by client portability (origination) will need to be re-thought if ‘client ownership’ is weakened by collaborative teaming. Independently minded practitioners will resist change. Then there is the matter of the new metrics. It will take some work to get these down right so that unintended consequences are avoided.

My partner Tom Clay and I will discuss this topic in depth at our May 11th seminar on Partner Compensation in New York City.

AFAs and Tracking Time

Jim Cotterman — Wed, 17 Feb 2010 20:55:17 +0000

As much as we would like to set aside the disruptive recession, it is a factor that has accelerated change within the profession. One of those changes is the interest in alternative fee arrangements (AFAs), which are essentially pricing mechanisms other than hourly rates times billable hours. For some lawyers such arrangements have been the norm — fees calculated as percentages of a deal or a recovery and fixed fees to conduct a closing or prepare a document such as a will or tax return are examples. But for a much larger portion of the legal market, the hourly rate and billable hour dominate pricing, which feeds into reporting and remuneration schemes.

Most law practices have leveraged technology to simplify the task of recording time. At the extreme some law practices have had to elevate time recording to a detailed coding process similar to medical billing. In others, where hourly pricing is not the norm, the regimen of recording time is not followed as carefully. It is possible that only associates or paralegals keep time. Or that time is recorded in blocks by activity or client but not by individual task for each client/matter. In those instances, fees are allocated among the timekeepers who worked on the matter using a purchase of work system or other agreed upon fee credit system. If partners do not record time, but other timekeepers do, then fees are often allocated first to the other timekeepers as determined by their time value recorded to the matter. The balance of the fee is then allocated to the partner. There are many permutations possible, such as whether time is allocated at standard, actual or realized rates; or if premiums and write-downs are allocated on proportional time value, allocated solely to the billing partner or allocated to individual timekeepers.

Key here is that time recording is important, whether it is used in the billing or compensation systems or not. It serves as the primary method to look back and learn how efficiently time was used to deliver services to clients. It aids in understanding how long a task takes, possibly leading to better future pricing decisions or re-engineering of how the service is handled. And it permits a review of non-time based allocation systems to ensure they reasonably and fairly reflect actual activity. Using AFAs to price legal work could, but should not, relax time recording.

Moving away from associate lockstep?

Jim Cotterman — Fri, 15 Jan 2010 18:23:34 +0000

Ok, so you have made the decision to change from your lock-step associate compensation program. What next? Here are five areas and key considerations to ensure success.

First, understand how much you have modified your program from a pure lockstep approach. Did you retain the right to hold associates at any compensation point along the way? Were bonuses tied to factors other then class year? It is likely that you were already incorporating some “merit” concepts in your existing program. This is important because it simplifies the transition somewhat and provides anchors of familiarity for the associates. It also may provide some of the elements of the new program.

Second, determine the elements of your performance evaluation program. What is the frequency — project or time based such as quarterly, semi-annual or annual? Is it a multi-factor evaluation incorporating both objective and narrative ratings? Is it tied to a set of increasing competencies, skills and experience that are level-, practice- and job-specific? Does it relate to promotion criteria? If a partner track position, does it integrate with partner expectations such that it logically builds towards a successful candidacy? Are assessments correlated across the practice group, office and firm to look for grading anomalies? Are the evaluators trained and given feedback on their evaluation skills? Good evaluations need to have a consistent grading perspective — one person’s “A” should not be another’s “C” — which is often a problem. How do you communicate the results of the assessment? Is it a written summary, oral or both? Who provides the feedback and are they provided training at performance counseling? And how does feedback mesh with forward looking individual, practice, office and firm planning efforts? Are your compensation and promotion decisions consistent with the conclusions reached in the evaluation? Moving away from lock-step only enhances the importance of a very robust performance monitoring and feedback program.

Third, provide transparency, which is an attribute of lockstep programs that is well received by the associates. Transparency may be available by publishing (at least internally) the pay scales associated with each grade or tier that you build into the program. This is quite common in wage administration everywhere else. A second means to build transparency is to create a documented bonus program that actually rewards performance well beyond the expectations for the position, and/or rewards group (practice, office or firm) performance in some sort of profit sharing. Remember, simply meeting expectations is what the salary is for. You may have much of this piece already embedded within your lockstep program.

Fourth, stress the importance of communication. There is no reason not to invite associates to participate in this process. They can provide meaningful guidance about what they like or dislike about what you are doing currently and what they would like to see. This provides you with a mechanism to then respond, acknowledging their concerns and addressing each either with a change or an explanation of why the status quo is preferable. They can “test drive” options so that much of the necessary fine-tuning is done before a big roll-out. And finally, this provides a way to ease the concerns that arise when something this important is under review. It takes some time to do this well and an ongoing participation and communication effort will assist to keep it all in the proper context.

Fifth, look at the economics of what you are doing. Are the salaries and bonus appropriate? How will you be positioned in the market? Will the new cost structure allow you to profit on work associates do for clients? Will the clients be willing to pay for these individuals to work on their matters at a sufficient hourly rate or effective hourly rate for an alternative fee arrangement? What is the cost/benefit to the firm of making the change from lockstep to merit-based pay? Model the economics of the program based on your best assumptions and plan elements. Will the partners support the investments contemplated in money, time and training? Continue to monitor and update financial models as experience develops.

Will law firms be forced to give up their best lever to enhanced profits?

Jim Cotterman — Mon, 23 Nov 2009 13:03:07 +0000

Law firms generate profits pushing chargeable hours, billing rates, realization, leverage and margin. Since 1985 (as shown in this table) law firm profits have been driven upwards largely because of increasing billing rates. Rate increases are comprised of three elements — experience, inflation and value. The experience curve of billing rates in the profession is how lawyers increase their productivity over a career when chargeable hours decline after about six to seven years of experience. These graphs illustrate the profession’s billing rate and chargeable hour profiles across a career.

We observed that the market struggled with rate increases (compared to historical patterns), realization (adjustments to pricing for discounts, inefficiencies and the like) and turnover (speed of collections) during the recession. And all of those were to the detriment of the law firm. This began in late 2007 and carried its way in varying degrees through 2009. In early 2009 Altman Weil surveyed law firms on a host of topics law firms were grappling with in response to the unprecedented economic conditions. In Law Firms in Transition we learned that a majority of the law firms participating (which included 32% of the NLJ 250) had made smaller than normal billing increases for 2009. This puts pressure on revenues. Missing a year in rate increases is not so bad in isolation, but when the cumulative effect is considered out into the future the compounded lost increase in pricing is significant.

It will be interesting to see if the law firms hold to the GC expectation of law firms holding the line on billing rates for 2010. In a recent ACC survey, general counsel identified reducing expenditures on outside counsel as their primary concern. They also predicted that law firm billing rates would not increase in 2010. Altman Weil has recently conducted a study on law firm billing rate intentions. With 40% of the NLJ250 participating we will soon know how law firms intend to respond.

And on December 3rd my partners Ward Bower, Tom Clay and Dan DiLucchio will present their thoughts on the changing legal market and what’s in store for law firms in 2010 in a special Altman Weil Advisory webinar. They will discuss pricing and a range of other issues such as service delivery models, staffing structures and balancing value and profitability.

Start Working on AR Now

Jim Cotterman — Mon, 02 Nov 2009 16:44:50 +0000

Today’s Wall Street Journal had an article on corporations hoarding cash. While not directly citing a slow down in paying bills, the mindset of holding onto cash to retain “operational and strategic flexibility” is not a good sign. With two months left in the year it may be prudent to begin that final push to bill and collect a bit earlier this year.

What Ever Happened to Mandatory Retirement?

Jim Cotterman — Thu, 29 Oct 2009 19:07:35 +0000

Whatever happened to mandatory retirement? Just two years ago in 2007 the New York State Bar Association (NYSBA) and the American Bar Association (ABA) developed position statements urging abandonment of mandatory retirement. According to the NYSBA report, “We do not suggest that partnership is, or should be, a guarantee of life tenure, and we are well aware of the economics of law firm practice and the need for senior partners to pass on client responsibilities to younger partners.” Then the ABA recommended that law firms evaluate their older partners on the basis of individual performance. “The time has come for law firms to put mandatory age-based retirement policies out to pasture.”

In September 2007 Altman Weil’s Flash Survey on Lawyer Retirement, a survey of managing partners in law firms with more than 50 lawyers, found that while 50% of those responding had mandatory retirement provisions only 38% agreed with enforcing such policies.

Following closely in October 2007 on a separate but related issue was the EEOC v. Sidley Austin LLP age discrimination case. Here a federal judge approved a $27.5 million consent decree with the EEOC involving partners allegedly forced from the partnership because of age.

Several firms have since announced that they support ending mandatory retirement. And we expected that the stage was set for a great many more firms to begin a dialogue about how to handle senior partners in a manner that complied with best practices and served the needs of the firm, clients and individual partners. Unfortunately along came the credit crisis and great recession. Many important leadership issues had to be set aside temporarily. But now as we sense that we have found economic bottom (absent some destabilizing event), it may be very appropriate to re-engage on these issues.

The clock does not stop for recessions and the economic tsunami that has swept the globe has ravaged personal financial and real estate assets — the foundations of our retirements. The profession and society continue aging. And although the recent improvement in asset values is certainly welcome there remains a long road ahead. Many partners are going to want to continue the practice of law well beyond the years typically associated with mandatory retirement. Many will still hold solid relationships with key clients, be prominent in their communities and still enjoy advising and representing clients.

It is our view that the EEOC clearly signaled its desire to extend employment protections to self-employed partners under certain facts and circumstances. We do not believe that is likely to change. We think that mandatory retirement will be replaced with more actively managed programs that involve transitions from leadership, management, ownership and eventually the practice of law. We suspect that there will be career oriented performance and quality standards put into effect along with a rigorous evaluation process for partners. Compensation and return of capital arrangements will provide a means for varying transition programs, even within a single firm. There may even be a return to deferred compensation arrangements, but these will almost certainly be self-funding and selectively available.

The Changing Associate Model

Jim Cotterman — Fri, 16 Oct 2009 23:32:43 +0000

The recession has challenged businesses everywhere. Law firms have been more profoundly affected by these extraordinary times then any I can remember. Unfortunately these changes have disrupted lives and livelihoods — significant associate layoffs, associate pay reductions, reductions in first-year class size and starting salaries, and deferrals of employment start dates, among others. However, the news is not all bad. Law firms are also making changes that actually make associate careers better, such as moves away from traditional lockstep compensation and a return to real apprenticeship programs. How well these changes take hold depends on many variables.

Join us on Tuesday October 27 at 1:00 ET for a 90 minute webinar to explore the strategic and financial implications of these changes. For more information, visit Leverage, Lockstep and the Changing Associate Model.

Discussing Law School Change

Jim Cotterman — Thu, 10 Sep 2009 11:42:11 +0000

Paul Lippe, Founder of Legal OnRamp, wrote an interesting commentary, Welcome to the Future: Time for Law School 4.0. In it he advocated a change in direction for the nation’s law schools including an accelerated curriculum, more practice orientation in teaching, better use of technology, a more empirical approach to practice, a move back to mission-centered management and a long term commitment to skills development. Worth considering as law schools consider how best to respond to a changing legal and education marketplace.

Open or Closed Compensation Programs

Jim Cotterman — Mon, 31 Aug 2009 12:36:24 +0000

I was recently asked about my views on open or closed partner compensation programs. Here is my response.

Law firms predominantly have open programs; about 80% to 85% are open; 3% to 5% semi-closed (either management compensation is disclosed or certain statistics reflecting the decisions are published, but not individual decisions) and the balance closed. Traditional professional partnership values support an open program as consistent with partners entitled to see the books and records and their desire for a transparent partnership. It also greatly aids the ability of partners to determine the degree to which they believe that the program is a fair meritocracy. This is critical to ensure the overall success of a compensation program that is dependent upon it being widely accepted as a fair meritocracy. Internal comparisons are the prime evidence in such an evaluation. And as a practical matter, in most firms the decision makers change leadership roles over time so the closed nature of the program deteriorates over time.

Firms that embrace a closed program generally advocate the practice as a means to focus each partner solely on his/her performance and pay. And accordingly reduce the intra-partner bickering and competition that can result in an open program. A number of compensation committees in closed firms have indicated that it gives them more freedom to make the decisions they believe are in the best interests of the firm — a dangerous slope to be on when the judgment is limited to a select few.

Others have stated that it makes it easier to bring laterals into the firm. Our assessment is that firms have frequently overpaid laterals as an enticement to make the deal and then in many cases those same laterals did not quickly produce the business and benefits that were the stated basis of their compensation. Admittedly it is not an easy task, even for the lateral, to really know how much of his/her practice is portable or how quickly it can or will transition to the new firm. That scenario also indicates firms are likely paying more for lateral talent then they would pay their own partners. That can breed resentment and disrupt a collegial/collaborative environment.

For a closed program to work the firm must have a very high degree of trust, especially for leadership. It also must develop other means to ensure that the partners feel that the program is fair and a meritocracy. The best closed programs have been firms with a strong benevolent founder who had unassailable credibility and who remained in control for many, many years.

Transitioning either way is a major change and will likely alter the firm’s culture and intra-partner dynamics. Even if the decisions were well done in a closed program it will likely be unsettling when partners are first exposed to the reality. We have found it difficult to close an open program without a major catalyst such as a merger of equals or some traumatic “life-changing” event.

Credit Markets

Jim Cotterman — Thu, 20 Aug 2009 11:02:44 +0000

While not as bad as the 4th quarter of 2008 and the 1st quarter of 2009, credit markets continue to be less friendly. Credit limits are often lower as banks modify their ratios. Loan covenants are more onerous and banks are more strictly enforcing them. Those friendly waivers are harder and more expensive to obtain.

The latest trend appears to be line of credit facilities are commonly being written with variable rates tied to some benchmark rate plus a rate floor (”at no time will the rate be less than…….).