Incentivised leadership: A new model for managing partner compensation

There may have been a point in our history when law firms nearly ran themselves. They were small entities with most of the partners’ names on the door. Clients were institutional – they used the firm because they had always done so, and didn’t fret about the bills. Talent stuck – an associate joined out of law school and didn’t give a thought to leaving until retiring as a senior partner. The business plan wasn’t quite as simple as ‘print money’, but it wasn’t much more complicated than keeping the lights on. Under such conditions, the title of managing partner was more honorific than anything. And the idea of giving special attention to how the managing partner was compensated would have struck the partners as a curious one.

If such a mythical age ever
existed, it is far gone. Today’s law
firms are not small operations, but
multi-million-dollar – sometimes
multi-billion-dollar – businesses. Managing partners must deal with
a wide range of complex challenges,
including:

• the upheaval of the great recession and its lingering effect on the global and local economies;

• significant price pressure from corporate clients and a diminution

• in loyalty from those clients;

• greater client access to information about competing firms, including

• their fees;

• increased lateral movement

• between firms; and

• a business model that is

• clearly broken.

Despite these obvious changes, there is often a lack of serious consideration by partners as to how their firms are managed – and, in particular, to how
their managing partners are compensated. That inattention is a relic of another time and must be addressed within any firm that wants to thrive.

The modern challenges noted above require a managing partner to act with the skill and dedication of a true business executive. They also require that law firms, in order to remain competitive, convince their best executives to lead their firms. These demands call for a new approach to compensating managing partners, one that comports with the complexities of leading a law firm today.

Prevailing models

As a legal advisor to professional service firms and having served as a managing partner within my own law firm for 16 years, I have studied many compensation models. Most firms compensate their partners with utter disregard to the partner’s contributions to achieving the firm’s strategic goals and promoting its overall success. Instead, the predominant compensation model focuses exclusively on the partners’ achievement of individual goals.

This approach is bad enough
when applied to the partnership at large; when applied to the managing partner, however, it is far worse. And yet, many firms do just that. For years, law firms –
all professional service firms, actually – have compensated managing partners
like other partners, rather than as
leaders of businesses.

Many firms favour one of two prevailing approaches:

1. managing partners are compensated on the same basis as partners who do very different things for the firm (the one-size-fits-all approach); or

2. managing partners are assessed based on the firm’s profitability alone (the stock market approach).

Neither aligns the managing partner’s interests with the firm’s business strategy, which is critical to effective leadership. A third approach based on both objective and subjective criteria (the balanced approach) is needed.

1. One-size-fits-all approach

The one-size-fits-all approach is based on a false equivalency. Partners within law firms frequently charge their clients – and have their own compensation determined – by the number of hours they have billed (or the number of hours others have billed on accounts they originated).

In determining how to compensate their managing partners, one-size-fits-all firms lean heavily on time – the one compensation metric with which they are most familiar – awarding their managing partners ‘credit’ for their non-billable time.

In some cases, the credit system is structured in a manner that misguidedly encourages managing partners to remain ‘accountable’ for their share of the partnership’s billables, at the expense
of leading the firm towards success.
In all cases, using hours spent to measure leadership is, at best, a blunt instrument that pays no regard to the achievement
of results.

Should leadership be measured by how long a partner can stay at lunch with an ‘A’ level prospect who may or may not be truly interested? If the firm badly needs to turn around a practice group, but the managing partner is incentivised to instead focus on raising $100,000 in his or her own collections, is this good for the business? Firms that answer ‘yes’ are embarking on their own private death march.

2. Stock market approach

Let us begin with an agreement that profits are essential. Businesses are formed to, among other things, make profits for distribution to their owners. Firms adopting the stock market approach seek to focus their management’s attention on profits and, for that, they cannot be blamed. The problem, as
ever, is in the details.

The argument for the stock market approach is that, if profits go up, the managing partner should be compensated accordingly; equally, if profits go down, the managing partner’s compensation should be negatively affected, just
as leaders of public companies are rewarded and punished for trends in
their stock prices.

Many partners like this approach, based upon the short-sighted view that it will increase their distributions. But, firms with a stock market approach often revel in short-term profit increases, only to find out later (often too late) that their lack of forward thinking has stymied their firms.

In this respect, such firms parallel public companies, which regularly make silly decisions to satisfy investors demanding immediate gratification. Consider whether leaders of market-listed firms think seriously of reinvesting profits into necessary infrastructure upgrades, technology or the future of a practice group with great long-term potential.
If they do so, they are praiseworthy indeed, because they do it at their
own personal expense.

Further, greater effort and skill is required by a managing partner during a crisis, change initiative or turnaround, when profits are sometimes at their lowest. The stock market approach may be fine for partners looking to wring every last dollar out of the firm before the ship sinks, but not for partners seeking to create a sustainable business positioned well for the future.

Balanced approach

While most firms adopt one of the two above models, a smaller number have the courage to compensate their managing partner based on both objective and subjective criteria (the balanced approach). The failure of this approach to gain wider traction may be attributed to the fact that professional service firms are filled with very smart people who have ample capacity to make a solution more complicated than necessary.

Let’s simplify things for them by identifying a few underlying assumptions of a reasoned compensation system and then reviewing how to implement that system. The box ‘A fair and balanced approach to managing partner compensation’ provides a simple set of principles, none of which are beyond the capacity of a law firm to implement. It’s largely common sense, not brain surgery – the approach advised here involves establishing some reasonable criteria by which to evaluate the managing partner, conduct that evaluation and ensure that the people who conduct that evaluation are those most competent to do so.

 

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A fair and balanced approach to managing partner compensation

• Managing partners should not be compensated based on the system used for other partners. Instead, the criteria used to determine managing partner compensation should focus on improvements in the business and its positioning for future success.

• Depending on the size of the firm, the criteria may include the maintenance of a professional practice, as long as the burden of leadership is considered in setting the relevant standards. They should phase in over 18 months, allowing a new managing partner to adjust to the new role.

• The evaluation of managing partners should include input from the management team, practice group leaders and the partnership – especially key partners.

• The criteria established should be evaluated by people inside or outside the firm who understand the job of a managing partner and how the firm wants itself to be led. This analysis will be more subjective than objective, so this group must have the courage to judge.

• Managing partners should be evaluated on multi-year goals, which should be segmented with milestones and revisited periodically. The managing partner should be judged on progress made towards those goals, as well as the ability to effectively adjust and pursue better options.

• As the business priorities within the firm change from year to year, the evaluation criteria should change as well. The criteria should be based on a dialogue between the managing partner and the committee performing the evaluation at the beginning of the evaluation period and throughout it as necessary.

• As a baseline, those who assume the managing partner role should be paid at least 80 per cent of the amount earned by the firm’s highest-paid partners. The evaluation committee will determine whether and how extensively a managing partner’s compensation should depart upwards or downwards from that baseline. This is where a trained eye will be able to distinguish between leading and managing, the former being the more important part of the package. Anyone can check a task list; inspiring others takes something special.

• A managing partner returning to practice should have compensation protection for a set period. The amount and its parameters should be agreed upon acceptance of the role.

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1. Reasonable criteria

The balanced approach uses a mix of objective and subjective criteria, all of which should be consistent with the firm’s long-term goals. Managing partners can enhance their chances of success by working with the firm’s executive committee to clearly define their long-term goals, achieve buy-in from the partnership and proactively develop concrete plans to achieve their goals.

Objective criteria might include revenue growth, profitability percentage, the recruitment of key personnel and the performance of the firm as a whole. Business originations can be a factor in the equation, but if it is weighted too heavily, the managing partner might just as well go back to work full time and dispense with the charade.

The other, more subjective criteria, will of course depend on the particular circumstances of the firm and what it wants to achieve. Regardless, these should not be criteria that the managing partner can satisfy on his or her own but, rather, that which the managing partner can only achieve by improving others’ performance. The managing partner might, for example, be charged with getting a new CFO up to speed within two years.

Frequently, the criteria that the firm found important in selecting a managing partner for the job can and should become the basis for evaluating him or her in the job. Any firm that intends to survive past the next generation should have those criteria firmly in mind and make them part of a succession plan
to ensure a smooth transition.

2. Performance evaluation

Assuming the right group is conducting the evaluation, it won’t be difficult for it to assess the managing partner’s performance and, in turn, compensation. You don’t need to have an MBA to understand management by objectives – you either achieve the objectives, have understandable reasons for changing or deferring their accomplishment, or fail to achieve them.

To be clear, both the first and second alternatives are positives – and sometimes the second alternative is the preferred action to take. Take a law firm that wants to acquire a litigation practice group and has integrated that goal in its managing partner’s evaluation criteria.
A managing partner should be applauded for passing on a contemplated acquisition if and when it becomes clear that it is too expensive, or the deal has other warts on it that threaten the law firm’s long-term interests. The evaluating committee would understand that not checking that particular box is an executive decision worth rewarding.

3. Evaluation committee

Who should be evaluating the managing partner’s performance? Probably not the compensation committee, which has expertise in assessing the performance of individual practicing partners but not in assessing the executive job of the managing partner.

It may be difficult for partners to accept that the managing partner is judged through a separate system outside of the purview of the compensation committee, but much of what managing partners do takes place behind the scenes of the firm and can only be measured best by those who actually understand the position. Few do, but
the most concentrated group of them
in any one law firm will be in its governing body, which makes that the best group
to perform the evaluation.

In addition, it is a good idea for the group to seek input from an independent former managing partner on the value and performance of the current managing partner. If necessary, this person can also teach members of the evaluation committee what it is like to be managing partner, relieving the current managing partner of attempting to give that explanation without sounding arrogant
or self-aggrandising.

Income protection

Managing a firm is a consuming task which, when performed with any degree of seriousness, interrupts a partner’s professional practice. A departing managing partner cannot be expected to simply pick up where he or she left off; instead, the former managing partner should be given a period of compensation protection when transitioning to a return to practice.

The rule of thumb many firms use is one year of income protection for every three years as managing partner. Like the 80 per cent income baseline (see box), this might be adjusted upward or downward based on the success of the managing partners’ tenure, the degree of immersion that a particular managing partner role requires, and the extent to which the former managing partner effectuated a smooth succession.

The firm should afford protection to
a departing managing partner not only out of fairness but also in its own self interest of attracting qualified candidates to the role. Ideally, an agreement regarding compensation protection should be made at the outset of a tenure so that the firm has tied its own hands in advance. If, for any reason, the partners are tempted to treat a departing managing partner poorly and give in to that temptation, there are few who will want to follow in the next managing partner’s footsteps.

Law firms need their best people to lead, not the least unwilling. I suspect that was true even in the halcyon days of our imagination. I know it is true today, when the challenges facing managing partners are unlike any we’ve ever seen.

Bryan Schwartz is chair of US law firm Levenfeld Pearlstein (www.lplegal.com)

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