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Legal Compensation Models and the New Nevada Legal Economy

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Law firm compensation structures are often kept as secretive as the formula for Coca Cola, and for good reason. Legal talent is far and away the most important commodity a firm has to offer. Everyone knows this and so, in the competition for legal talent, the more information a competitor firm has about a target attorney’s current compensation the more likely – all things being equal – the competitive firm is to develop a compensation package sufficiently attractive to lure him or her.
Commentators have categorized law firm
compensation structures in myriad ways. For the purposes of this article, we will use the following categories, recognizing that most compensation models do not fit neatly into any single category:
• • •
Equality Compensation Structure Lockstep Compensation Structure “Hale & Dorr” or Hybrid Structure1
Compensation structures and the associated battle for legal talent have evolved considerably in Nevada in the past 10 years. This has come with the entry of national and regional firms into the Nevada legal market. These firms have merged with a number of longstanding local firms, while recruiting individual attorneys and, in some cases, whole departments, away from the local firms. This article will discuss the most common law firm compensation models, pointing out how each may affect a firm’s ability to keep and attract legal talent – in the parlance of economics, how these compensation structures may incentivize or disincentivize attorney loyalty and mobility. Aside from the technical discussion, the real question is whether the national and regional firms – which are in many ways responsible for the recent evolution in the compensation models found in firms throughout the state – will benefit from the efforts to double down on legal talent, or whether they will suffer what economists refer to as the “winner’s curse.”
Nevada Lawyer
September 2010
Equality Compensation System
Equality compensation models function as the name suggests – that is, members of the firm share in profits equally according to their group association, whether they be senior partners, junior partners, senior associates, junior associates or categorized in some other fashion. So, for example, in a firm with five senior partners, 10 junior partners, five senior associates and seven junior associates, members of each group would share equally in a predefined percentage of the firm’s profits according to their grouping – say, 40 percent for the senior partners (8 percent of total firm profit per senior partner), 30 percent for the junior partners (4.2 percent of total firm profit per junior partner), 20 percent for senior associates (4 percent of total firm profit per senior associate) and 10 percent for junior associates (1.4 percent of total firm profit per junior associate).2 A premise underlying this type of compensation structure – whether recognized or not – is that each member of a given compensation group is equally important to the success of the firm.3 Of course, this is generally untrue and, as a result, there are few true equal compensation models in practice.
Incentives This type of compensation structure creates security and collegiality.4 There is less concern with individual performance than with overall firm performance, although the two are inextricably linked. However, while it sounds like an Eden among law firms, there are significant problems with the model.
Disincentives The primary difficulty with this type of compensation structure is that there are few incentives to do much of anything.5 Why go out and network, working to bring in new clients, when there is no reward? Why work 12-hour days when five-hour days will suffice? In general, this type of system does not work, except in the very beginning of a law firm’s lifecycle, where everyone is excited and working hard to build the firm.
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Lock-Step Compensation Structure
This structure is more common than the equality system and turns on the notion that each member of the firm is compensated according to seniority. For example, each member of the firm may receive a set increase in salary for each year he or she remains with the firm.6 This type of compensation structure is a common in government, where employees receive yearly seniority and costof-living increases.
Incentives The two most common justifications for a senioritybased system are: (1) that the senior partner’s past contributions are responsible for the firm’s current financial success and (2) that the senior partner’s greater experience makes him more valuable than a younger partner who appears to be responsible for a larger share of revenue.7 However, these justifications – like most other propositions which are asserted in defense of any compensation system – are testable propositions subject to empirical verification. Disincentives It is important that senior attorneys be able to establish empirically that they deserve higher compensation because they are responsible for the firm’s current financial success or because their greater experience makes them more valuable. Indeed, a senior partner who presides over a dying practice area may be more of a financial drain on the firm than a source of profit. Moreover, the law of diminishing returns indicates 8 Nevada Lawyer September 2010
that past some level of experience, the incremental value of each year of legal practice will be insignificant. The largest problem with a seniority-based system is that it fails to appreciate the performance differences among partners with equivalent experience. Indeed, a system which rewards all attorneys equally based on years of service is likely to result in the best attorneys
at each seniority level being under-compensated. Accordingly, in a market where lateral attorneys are being heavily recruited, law firms are likely to lose attorneys whom other firms perceive to be more valuable. As an added insult, those attorneys who remain at the firm have no incentive to work towards excellence because they will be rewarded the same whether their work is excellent or merely good enough. Thus, with a senioritybased system, law firms need to be very careful to use different incentives to retain their best attorneys and to encourage all attorneys to strive to improve.
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Hale & Dorr8 or Hybrid Structure
This model, named after the Boston law firm, has three attorney income categories: (1) Finder, (2) Minder and (3) Grinder.9 A “Finder” attracts the work from the client, a “Minder” is responsible for the client, and the “Grinder” performs the billable work for the client.10 Different variations of this compensation structure will assign different values to each of the three categories of responsibility; but for purposes of illustration, consider the following take on this model: • Finder: 15 percent of firm profits • Minder: 20 percent of firm profits • Grinder: 40 percent of firm profits • Discretionary Pool: 25 percent of firm profits may be allocated to a discretionary pool and awarded to attorneys based on criteria the firm decides are important.
In the alternative, a firm may value origination activity more than performance of the client’s work – this is the classic Rainmaker vs. Journeyman problem. Here’s an example of a reward system designed under these parameters: • • • • Finder: 40 percent Minder: 20 percent Grinder: 15 percent Pool: 25 percent
Experience George
Chairman of the Board Edward M. Nigro President / CEO Diane F. Fearon Board of Directors Antonio T. Alamo, M.D. Timothy Herbst William Hornbuckle Gary Johnson Rudy R. Manthei, D.O. Troy Nelson Todd A. Nigro Alan C. Sklar
Incentives This type of compensation structure does a great job of rewarding the various contributions attorneys make to a law firm’s success. The different categories of contribution can be modified – added to or truncated – and the size of the financial incentives associated with each category can be modified to achieve a firm’s goals. Moreover, this model focuses on the effort of the firm’s individual attorneys, rather than on the performance of the firm. To create or encourage certain behaviors, incentives must be focused upon the individual to be effective. The Hale & Dorr compensation model does precisely this. Disincentives Despite the strengths of this model, it also has problems. First, there is little value associated with seniority besides the higher billing rates more senior attorneys command, resulting in a greater share of the Grinder fees.11 In addition, where are the incentives for non-billable activities, at least in the short-term, that add to a firm’s prestige and reputation? Over the long-term, marketing presumably leads to the origination of new work; but this is often a long process of building relationships, cultivating them and waiting for an opportunity. Most often, marketing does not yield immediate results. Furthermore, there are several problems associated with variations of this model where origination is the most important activity. First, such a system discourages non-originating partners from working on matters originated by other attorneys even when he or she is
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otherwise been brought in by the senior attorney. Finally, an origination based system fails to reward partners who maintain, service and develop clients originated by other partners.13 Most troubling with this structure is that it can break down the whole notion of a firm in which all contribute and all prosper, creating instead a collection of individuals who happen to share office space.
Not surprisingly, partners normally advocate a compensation system which would most benefit them.14 Partners who have high billable hours but do not generate much of their own business obviously promote a system based upon billable hours.15 Partners who tend to bring in a great amount of business and allow that work to be done by others normally favor giving more credit to origination of work than to completion of work.16 As a consequence of the competing interests of individual partners, a compensation structure
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more suited to handling the particular matter.12 Second, there is a disincentive for partners to support and encourage marketing by junior attorneys, who will spend more billable hours on work which they originated themselves rather than that sourced by the senior attorney, and may get credit for bringing in work which may have
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must be about more than numbers. Any system that is based purely on a numeric formula will have at least three very significant problems: first, the inescapable desire of some people to try to manipulate the numbers for their own benefit; second, that no formula can take into account the intangible value of a partner who develops a new practice area, who acts as an exceptional mentor to younger associates or who performs any of the other numerous valuable law firm activities that that cannot be easily quantified; and third, that partners will have no incentive to engage in activity which is not rewarded by the formula. That being said, what is clear is that a compensation system is just that: a compensation system. It can only create incentives and disincentives. At the end of the day, lawyers are human beings and will bring their own values, morals, ethics and biases to their jobs. In spite of all the advice offered in this article, there is only test for determining the usefulness of
any compensation system: whether or not it encourages the specific behaviors that make the firm successful, according to the firm’s individual definition of success. If the system successfully encourages attorneys to spend time on activities which benefit the firm, then the system is working. If the firm’s partners are spending their time to benefit themselves at the expense of the firm, then the system needs to be changed. Although the effect of compensation on a firm’s culture must be considered, it is important to remember that a compensation system cannot replace a management system. Some law firm managers believe that if you compensate lawyers enough they will do whatever is asked of them and join the manager’s firm. Although this may be true for completely fungible commission-based sales jobs, if the lure is entirely monetary, a firm should not be surprised when its biggest rainmakers move to a firm across town for more dollars. If financial reward is the only reason a lawyer remains at his firm, it won’t be long until another firm offers a bit more, causing him to leave for greener pastures. The point, of course, is that compensation is but one part of a management system that includes many additional aspects such as mentoring programs, education programs, marketing programs, firm culture, etc. The signals which are communicated by and through a compensation system are at least as important as the actual dollars distributed. The messages about what gets rewarded and how each is partner is viewed not only affect the firm’s culture and atmosphere, but more importantly, fundamentally change the way that partners spend their time.
In the good old days, a license to practice law in Nevada was a golden ticket – competition for attorney talent was much more limited. But as well-respected litigator Von Heinz explained in his January 2009 article in Nevada Lawyer: Today, there are dozens of out-of-state law firms with offices in Nevada. Many of these firms are readily recognizable 12 10 Nevada Lawyer September 2010 Nevada Lawyer September 2010
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by the names they share with regional, national or international firms. It is difficult to imagine that the influx of out-of-state firms to Nevada could have been possible if these firms were forbidden to practice here under their own names. That, however, was precisely the case until Lewis and Roca LLP brought a lawsuit against the State Bar of Nevada that eventually led to the Nevada Supreme Court changing the ethical rules on law firm names.17 Heinz refers his firm’s legal challenge to Nevada’s original Rule 199, which stated: It shall be unprofessional conduct to use a firm name for a law firm unless each and every person whose name is used is a member of the state bar [of Nevada] in good standing and a bona fide member of the firm. However, the name of a deceased or retired member of the firm may continue to be used in the firm name of a law firm if the deceased or retired member of the firm was a member of the state bar [of Nevada] in good standing and a bona fide member of the firm at the time of his or her death or retirement from the practice of law.18 After considerable legal wrangling, and with a federal lawsuit still underway, the Nevada Supreme Court repealed Rule 199 in 2002, “substituting new rules governing the ability of regional and national law firms to practice in Nevada. The battle was over and the legal landscape in Nevada would never be the same.”19 With this history in view and while in the midst of the Great Recession, a number of firms have attempted to change their market positions through merging with a national law firm that previously had no office in Nevada, merging with the local office of a national law firm, acquiring particular
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practice groups from another law firm and/or heavily recruiting lateral attorneys. Underlying these efforts appears to be the belief that these firms will be able to leverage their positions in other markets to expand their positions in Nevada. These firms are, in part, gambling on Nevada’s economic recovery, assuming that if they double down when times are bad and everyone else is retrenching due to the troubled marketplace, they will gain market share and legal talent that will benefit them when good times return. Often missing from these firms’ analyses, however, is a recognition of what economists call the “winner’s curse.” In short, the person who wins a bidding war is the person mostly likely to have misjudged the value of the prize. As a consequence, when a law firm seeks to acquire another law firm, a practice group or an individual attorney by offering greater compensation, the law firm needs to recognize and understand why another law firm did not already acquire the target firm or practice group or why the existing firm is not increasing compensation to retain its practice group or attorney. The dynamics of lawyer movement since the Nevada Supreme Court repealed Rule 199 in 2002 create the possibility that within the next several years, Nevada’s legal economy may experience change – an evolutionary shift, of sorts – that could potentially remake the face of its legal marketplace. The only question for those firms that acquired new law firms, practice groups and attorneys will be whether they’ve acquired the best legal talent in Nevada or if they became victims of the “Winners Curse”.
Michael J. Anderson, “Partner Compensation: Systems Used in Professional Services Firms,” at 3 ( 2001). 2 See id. at 4. 3 Id. at 5. 4 Id. 5 Id. 6 Id. 7 Id. at 5-6. 8 Id. at 6. 9 Id. 10 Id. 11 Id. 12 Tamping Down Partner Compensation Discontent: Accommodating Origination v. Production Contributions, Compensation and Benefits for Law Offices, July 2009. 13 Id. 14 Tamping Down Partner Compensation Discontent: Accommodating Origination v. Production Contributions, Compensation and Benefits for Law Offices, July 2009. 15 Id. 16 Id. 17 Von Heinz, Lewis and Roca v. State Bar of Nevada: Regional and National Firms Come to Nevada, Nevada Lawyer, January 2009. 18 Id. 19 Id.
KETAN BHIRUD is an attorney in Lionel Sawyer & Collins’ Las Vegas office. He can be reached via phone at (702) 383-8907 or via e-mail at
BRIN GIBSON is an attorney in Lionel Sawyer & Collins’ Las Vegas office. He can be reached via phone at (702) 383-8901 or via e-mail at
September 2010
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