Associate compensation is changing. Or is it? Many law firms rolled back wages last year, but now some are restoring the reductions. Law firms talked extensively about abandoning the traditional method of remunerating their associates, yet many new remuneration programmes appear more like modifications of the previous approach.
Since 1992, market forces have raised graduate starting salaries at a considerably higher rate than inflation. This has been driven by:
• A growing demand for graduates with a relatively static supply of new lawyers;
• Annual billing rate increases that patterned the salary increases;
• Clients willing to pay full rates with remarkably little adjustment (efficiency and value were not chief concerns); and
• Work practices that encouraged a high ratio of associate hours to partner hours on billable work.
Then came the recession and the market changed. The amount of available work diminished sharply and layoffs spread across the profession. Law firms moved aggressively to protect partner profits with overhead reductions, compensation rollbacks, diminished recruitment and deferred starting dates. It now appears that many of those efforts did, in fact, reduce the potential impact on partner incomes – at least as measured by profits per equity partner (PPEP).
Pressure on costs
Pricing constraints were pushed by clients who were themselves under tremendous cost pressure. In particular, corporate legal departments pushed back on the use of first- and second-year associates on their matters – some even to the point of restricting any involvement unless specifically approved. Value and efficiency became key selection criteria and alternative fee arrangements (AFAs) gained new converts. Make no mistake: clients demanded more efficient services and absolute cost reductions from their lawyers – and law firms had to be seen to respond.
One response to these changes has been the introduction by many law firms, particularly in the US, of associate apprenticeship programmes. These aimed to exchange lower compensation for better training and greater work-life balance – and to directly link compensation to performance and development. Such programmes usually include some combination of reduced salary, reduced billing requirements, reduced billable rates and increased training time.
Law firms will go to great lengths to protect PPEP. But programmes such as the apprenticeship model will require further adjustments if they are ever to be widely accepted in the profession. While further overhead reductions are possible within firms, they may come about only if the legal service delivery model changes drastically and only then after an investment in re-tooling processes and technology.
And while other businesses would likely infuse capital and incur debt for such an investment, law firms are notoriously light in capital and banks are much more careful about lending in the post-recession economy. So that leaves us with only one deep pocket left: PPEP.
A new model for trainees?
In my view, programmes such as the apprenticeship model, can work only if two main factors change.
Firstly, leverage must expand in a very major way — to levels more typically associated with large public accounting firms. This would require a radical restructuring of how services are delivered. And this expanded leverage would not look like it has in the past with legions of expensive associates working long days and nights, but rather would be constituted from an increased use of paraprofessionals and outsourcing.
Secondly, productivity must significantly increase. This does not mean working more hours; rather, it means getting more work done in each hour. This will most likely be driven by a radical shift in how legal services are managed and delivered, and by more use of AFAs.
So what’s next? The desire to link associate compensation to performance is positive. But is it a real change?
In the traditional associate compensation model, salary increases were automatic. However, most firms also incorporated significant bonuses into their programmes that were tied to exceeding certain thresholds in hours (a proxy for fees) or to fees themselves. This went a long way to ensure compensation reflected contributions. In addition, the number of associates would drop off over time; roughly 40% of associates have gone by year three and 62% by year four. This weeding-out process, no matter how or why, substantially increases the probability that those continuing on will meet the performance expectations contemplated in the traditional compensation programme.
Too late to turn back
Nonetheless, associate compensation needs to change to reflect this new and different market. To accomplish these changes, law firms will have to place a greater emphasis on skills and competencies, rather than class year experience, in establishing pay. They also need to have the flexibility to promote as warranted and needed. This is a very good step forward for everyone: associates, law firms and their clients.
Associate compensation works better for lawyers whether they progress faster (no resentment at slower pay recognition) or slower (less pressure to catch up). But it also means that the firm could defer promotions if it does not perceive a need for a higher level of associate in a given office or practice area. Accordingly, greater experience, skill and competency will be required for promotion, but together they will not be sufficient for promotion. Thus the associate becomes the bearer of market risk, just like an employee is the bearer of market risk in many other industries. And also like other industries, the defined associate career track, where only the law firm accepts the market risk, is going to disappear.
James D Cotterman is a principal of legal management consultancy Altman Weil, Inc. He is based in Florida