Compensation Cost Trends Mid-Recession – What Worked

In 2009, when James D. Cotterman wrote his piece for the ABA’s Law Practice entitled: “Managing Change: How Law Firms Are Answering The Wake-Up Call”, he was beginning to see across-the-board pay cuts—from 10 to 20 percent of a cut in base salary.   Cotterman championed the idea of “the balance of the profession” doing likewise. Additionally, this legal management consultant  had a few other ideas for helping law firms out when they were “in triage mode”.

The way things stood in the midst of the recession, traditional law firms had what Cotterman called an economic law model.  This cost structure model was divided up into segments, expense-wise.  The cuts of the pie went something like this:  78 percent labor, 8 percent facility and technology and the remaining 14 percent “other”.

Breaking these segments down, Cotterman deduced that the 14 percent facility and technology were tied up in contracts and long-term leases, and as thus, couldn’t be tinkered with.  Next came the “other”, and since a good portion of this included operating costs, he determined that this amount wasn’t going away.

That left labor and its associated costs. So what did many firms elect to do in cases where immediate relief was called for?  There were two options, per Cotterman:  the drastic staff-reduction which would immediately soften the blow, or the preferred and more manageable method, one which would open up a whole new level of opportunities.

The more manageable way involved “altering” lawyer compensation. But how to go about it?  “It’s a critical question, given that law firms are such labor-intensive businesses. That is where the money goes, and that is where the savings options are,” Cotterman noted.

There were many factors at play here, and they had to be looked at carefully. One very real risk—talent bailout—had to be weighed, he stressed.  If key talent sensed that they were about to be inadequately compensated, they would “take their clients and leave”.   There were still many financially stable firms that would welcome such partners.  (As we now know, these bailouts were precisely what caused a few rocky boat scenarios in large firms.)

Cotterman couldn’t stress this concern enough.  “Sadly,” he cautioned, “the drain on talent usually starts at the top of the chain and works its way down. If management allows a drain like that to continue for even a short while, the lawyers remaining in the firm may not constitute a sustainable enterprise.”

He reminded readers that the downturn had “eviscerated entire practices” and stressed that firms were rethinking economic contribution expectations. “[F]irms are considering more individualized compensation adjustments if a first round of across-the-board reductions is insufficient.”

Too, greater weight was given to recent performance when it came to devising a compensation package.   (Previously, past performance averages and trends were considered equally with the current year’s performance.)

Finally, a more consistent set of decisions involving compensations had to be arrived at and stuck by.  Firm leaders had to formulate a plan that would send a viable message to everyone inside the firm as well as to future candidates for recruitment.  This was not easy.  “The challenge of getting this right in the midst of so much turmoil is daunting,” he explained.

Cotterman didn’t believe in overhauling the lockstep compensation system.  In fact, he believed that lockstep was a good thing; that there are reasons it’s lasted so long.  First, it’s easy to administer. For single-tier firms, turnover is a necessary thing.  Secondly, “for all its shortcomings”, it remains remarkably merit-based.


Cotterman explained how the variation in compensation can be evaluated by an R-squared formula that arrives at performance measured by value of the associate’s recorded time. He explains it this way: “Based on our large databases of associate time and productivity, the strength of the relationship (R-squared) between the value of associates’ time and compensation is remarkable at 0.92 where 1.0 is the maximum value. Essentially only 8 percent of the variability in associate compensation is explained by all factors other than productivity.”   You couldn’t get more merit-based than that!  For more, go to http://www.americanbar.org/publications/law_practice_home/law_practice_archive/lpm

-ERM

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