Connecting Compensation to Long-Term Value

Volume 39 Number 5

By

About the Author

Mitch Kowalski maintains a small boutique commercial law practice in Toronto and teaches legal services innovation at the University of Ottawa Law School. A frequent writer and speaker, he is the author of the ABA book Avoiding Extinction: Reimagining Legal Services for the 21st Century and was selected as one of the Fastcase Top 50 Global Legal Innovators in 2012. 

Law Practice Magazine | September/October 2013 | The Finance Issue

IN MIDSIZED TO LARGE FIRMS, we are seeing structural changes to the legal marketplace that have resulted in partners no longer having permanent tenure, associates having little chance of becoming partners, and more contract lawyers and paralegals replacing full-time attorney hires. In addition, new technologies will continue to reduce the need for the huge waves of graduating law students who wish to be solicitors and will cut deeper into the bread-and-butter work of small law firms. We’ve also been told repeatedly that Generation Y lawyers and the coming surge of Millennial lawyers have different attitudes, motivations and expectations about work—that many are not motivated by the lure of partnership 10 or 15 years (or more!) down the line, or by buckets of money. They need other incentives to retain them at a firm.

On top of this, job prospects for U.S. law graduates have been dismal over the last four or five years and will continue to be so. Blogger and consultant Bruce MacEwen, in his blog on adamsmithesq.com, determined through combining data from the U.S. Bureau of Labor Statistics and the ABA that “between 2010 and 2020, the U.S. economy will produce 218,800 job openings for lawyers and judicial clerks … [but U.S. law schools graduated enough JDs from 2010 to 2012 to fill] 61 percent of all available lawyer jobs for [that] … decade.” In other words, the U.S. is awash in legal talent and will continue to be so for years to come.

What does all this mean for compensation models?

In my view, a lot.

For the most part, compensation models in small and midsized firms have been fairly one-dimensional: pay a flat salary, a percentage of billing or a combination of the two. But now, with overcapacity in a legal marketplace filled with a generation of lawyers with very different workplace attitudes and expectations, firms now have an opportunity to be much more creative in how their attorneys are paid and to use compensation as a way to drive long-term value. Sadly, there will be many in the marketplace who will use the existing attorney overcapacity to overwork lawyers at lowball salaries. This article is not for them.

LEARNING FROM CORPORATIONS

Good compensation lessons can be learned from the corporate sphere, where Enron and WorldCom revealed the danger of creating compensation models based on short-term value creation. My experience with executive compensation suggests that attorney compensation packages for the 21st century should be better designed to attract, retain and motivate excellent lawyers to work with others in order to achieve long-term value for the firm. This is seconded by a working paper of the Canadian Coalition for Good Governance, Good Governance Guidelines for Principled Executive Compensation, published in June 2006. Many law firms assume that achieving annual short-term goals will automatically lead to the long-term viability of firms. I disagree. Just as in the corporate sphere, any law firm that rewards only short-term value creation (such as achieving an annual billings target) in no way assures its own long-term viability. We have also seen with the recent DLA Piper scandal, discussed at length in the Hot Buttons column of this issue, that rewarding lawyers solely for short-term value (annual billing targets) can result in “churn that bill, baby” behavior. Ironically, DLA Piper’s compensation system, which its management team believed would make the firm financially secure over the long term, may have the opposite effect. Instead of encouraging behavior that creates long-term firm value, it incented behavior that damaged the firm’s reputation to the point where both short-term and long-term revenues may suffer.

CREATING SUSTAINABLE ADVANTAGE

To create long-term value and retain good attorneys, a firm first needs to design a strong, coherent and attractive strategy. This is often where many law firms get lost. All too often I hear lawyers say that their strategy is “to be the best law firm.” Aside from the obvious problem of defining what the best means, being “the best law firm” is not a strategy at all—it’s an outcome that results from following a successful strategy. Strategy, in the words of Roger Martin’s February 5 blog entry in the Harvard Business Review, is the making of an integrated set of choices that collectively position the [law] firm … so as to create sustainable advantage relative to competition and deliver superior financial returns. … You can’t execute a strategy without initiatives, investments, and budgeting. [But] before you start on those things [you must focus on] … the strategy that will make these initiatives coherent. … [T]here is one strategy for a given business—not a set of strategies. It is one integrated set of choices: where will we play; how will we win; what capabilities need to be in place; and what management systems must be instituted? That strategy tells you what initiatives actually make sense and are likely to produce the result you actually want.

Sustainable competitive advantage for a law firm can come from any combination of initiatives, such as the following:

  • Firm A determines that one of its important multiyear initiatives is to collate years of billing data so that the firm can take a more disciplined approach to pricing work for clients.
  • Firm B decides that one of the components of the firm’s overall strategy is to gauge and improve client service by instituting postfile client interviews, with a goal of achieving a “very satisfied” or higher response from 90 percent of clients in year one.
  • Firm C determines that a component of its strategy of being mobile and always accessible is to move the firm to a cloud-based platform.
  • Firm D decides that its strategy is to rely upon organic growth in the firm (instead of making lateral hires), which requires a strong focus on mentoring by senior lawyers and their willingness to pass clients down to the next generation of attorneys.

COMPENSATING FOR INNOVATION

Once a firm has created a set of initiatives that align with its strategy, it’s critical to ensure that attorneys are rewarded for achieving these initiatives. As Michael Leboeuf said very simply and elegantly in his book The Greatest Management Principle in the World, “[T]he thing that gets rewarded, gets done.” We have seen this to be true with billable hours targets; billable hours targets have been rewarded, and they usually get done. But if you think about the projects in your own firm that don’t get done, they’re typically those for which no reward was offered. After all, it’s human nature to focus on and complete tasks for which rewards are offered, with other tasks coming in a distant second. In other words, it’s critical to link compensation to firm strategy. Designing a compensation system that is disconnected from every initiative within the firm’s strategic plan will result in a failure of that strategic plan.

You will note that none of the initiatives developed by Firms A through D were connected to billable hours. Some, perhaps all, create no short-term return on investment, yet all can have enormous impact on the long-term viability and profits of these firms. All of the initiatives were designed to favor firm achievements over individual achievements, and so the compensation systems of these firms will be designed to reward accomplishments that add significant value to the firm as a whole over the long term, rather than simply rewarding individual attorneys for reaching billable hours targets. The mentors and senior lawyers in Firm D will need to be rewarded for their efforts, otherwise nothing will happen. Likewise, the initiatives in Firms A and C—without a great deal of luck—will not get off the ground without incentives or rewards. Firm B’s initiative requires the entire firm to score well all year long before any rewards are given, creating a strong firm-first approach to their files.

Compensation for achieving initiatives connected to firm strategy can be rewarded in a variety of different ways: through physical prizes (think: tablets, spa days, ball game tickets, dinner vouchers or even additional vacation days); through monetary bonuses or major firm recognition/celebration (think: “mentor of the year”); or through special workplace environments or educational opportunities (especially attractive for Generation Y and Millennials) such as unlimited CLE courses, university courses or winning the ability to work remotely several days a week.

FINAL THOUGHTS

David Maister has said that there is almost no celebration inside law firms today. As Amy Knapp quotes in her April 3 blog on notknapping.com, “We just wait until the end of the year, then cut under-producers’ pay and say ‘That’ll teach ’em,’ which is not exactly a positive human reinforcement system. A series of small, celebrated successes is what gets the [lawyer] to the finish line.” While Maister’s comments are in relation to financial goals, they are nonetheless applicable to goals that have no readily discernible financial return. Celebrating and rewarding each milestone within each initiative not only positively reinforces the efforts of attorneys, it also demonstrates that a fair and transparent compensation system is in place at the firm—one which attorneys and firm management can use to objectively assess a level of achievement or a level of performance. Keep in mind, however, that the metrics used to reward or compensate attorneys should never become static. They must be constantly evaluated to determine if the compensation or reward is incenting the desired behavior—so as to avoid a DLA Piper scandal.

In conclusion, we can look at the seemingly perfect storm that has hit the legal services market with the view of Chicken Little or we can view it as an opportunity to redesign our compensation models to create greater value for the firm as a whole and, by extension, for our clients.

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