US law firms, having become accustomed to the 'free agent' market for the best and brightest lawyers controlling sizeable books of profitable business, have begun extending this market as they increase their European presence.
US firms are willing to pay top compensation for those lawyers who can give them their desired European base. While the goal for US firms is to gain an edge in this competitive market, compensation practices have implications for European-based firms as well.
To understand these practices, it is best to look at parallels in the corporate world. In the US, corporate leaders are more highly-compensated than their European counterparts, partly due to a fundamental difference in the perception of their role in, and importance to, a company.
The European view tends to be that corporate leaders are stewards guiding an organisation. The organisation is the primary repository of economic value. In the US, corporate leaders are viewed as having a unique value that they transfer to the company to generate or ensure its success.
US law firms hold a similar view of their top performers. Partner incomes are generated primarily through the personal efforts of the lawyers, including mainly the efforts of partners to generate and service a high-quality clientele.
For a limited number of the strongest firms, an element of firm-related goodwill may contribute to the profit generating capacity of the firm, but for most firms significant goodwill is attached to individual partners.
Partners are compensated, in part, for contributing their own goodwill to the enterprise. As such, they are entitled to a significant share of the profitability they help to create.
US law firms place economic value on various contributions partners make. The most important of these include:
l Developing and maintaining a substantial base of profitable business. The most highly-paid US law firm partners typically control client business of several million dollars, and sometimes as much as $10m or more.
l The work the individual partner carries out. Successful partners in major US firms work very hard, often generating receipts for their own efforts of $750,000 or more.
l The value of the reputation and expertise of the individual lawyer, which increases the prestige of the firm.
l Other contributions to the firm, such as leadership and management.
On top of this, firms may be willing to pay a premium to get the right lawyers to establish a competitive presence in key markets.
It is easy to see how partners whose contributions to the firm include, say, $5m in business and more than 2000 hours billed at top firm rates can command more than $1m in compensation packages.
While not formulaic in their approach to compensation, most US firms are quite prepared to tie partner compensation directly to economic performance. Add to this the high level of income generated by the strongest US firms, and it is easy see why these firms are offering significant European compensation packages. Finally, it is important to note that the philosophical underpinnings of US compensation systems lead inevitably to significant spreads in partner compensation.
Lockstep systems are rare (although they work well in a limited number of the strongest New York firms) and 'merit' is the driving force behind compensation. This leads to the conclusion that some partners should be paid substantially more than others.
Partner compensation spreads within most strong US law firms are in the range of 4-5:1. As a result, a firm with average partner compensation of only $500,000 is likely to have a number of partners paid in the $1m-$1.3m range.
Firms with higher average incomes – including many of the larger New York-based firms – will have a number of very highly compensated partners. It is hardly a stretch for these firms to compensate high-performing laterals at similar levels.
However, if a firm is paying 'above scale' to attract a lateral candidate, it will expect that partner's performance to quickly justify the compensation. Such justification might include objective performance well above other partners – or a rapid and credible entree to a new market.
Highly-compensated laterals present various management challenges for the acquiring firm. Consistent with the merit-based compensation philosophy, such lawyers must deliver, and do so quickly. While most laterals are an investment for the first year, there will be a clear expectation for payback the second.
Most firms will not long carry a highly-
compensated partner who is not living up to
expectations. Furthermore, integrating these high-performance partners into the firm is a critical and on-going challenge. The managing partner must be prepared to work diligently to achieve a smooth integration.
In spite of the challenges, successful US firms are built on successful individual partners. Those partners are rewarded handsomely for their contributions. As US law firms increase their presence in Europe, the compensation approaches that fostered their success are likely to follow.
C Randel Lewis and Joseph B Altonji are consultants at the international legal management consulting firm Hildebrandt Inc.