Guaranteed multi-year partner compensation contracts, in an open system where all partners know what everyone makes, was probably ground zero of the Dewey & LeBoeuf disaster. High partner compensation, with no tie to the firm’s realization rate and without an escape clause to allow for adjustment in a declining market, no doubt sealed Dewey’s fate.
Closed compensation systems, where salaries are confidential, are now preferred in over 60% of all law firms. However, even in closed compensation partnerships, the partners should at least know that the law firm is using the same method to compensate everyone. All partners should have the same opportunity to earn what their peers earn if they perform in the same way regardless of which compensation method the law firm selects.
Lucrative employee compensation packages that use different methods and are radically different in substance and structure are a sure way to damage a law firm’s culture. When the differences reach the point where some partners have economic guarantees and others do not, what happened at Dewey should not be a surprise to anyone. Dewey was obviously not prepared for the inevitable question among its partners, “Why not me?”
Guaranteed contracts for attorneys came into vogue a decade ago when the legal industry was thriving and competition for lateral partners was fierce. In order to lure away star attorneys, firms offered fixed compensation packages that were not tied to the performance of the firm or the individual attorney.
In the case of Dewey, about a third of the firm’s partners had guaranteed compensation, according to several reports. Many top partners were guaranteed yearly salaries of up to $4 million and for terms as long as four years. When the law firm’s profits declined, and partners were asked to restructure their contacts, many simply left the firm. Of the roughly 300 partners at the beginning of 2012, there are only 50 left.
As I mentioned in my previous blog on why law firms fail, the legal industry has changed dramatically since 2008. Most analysts would say that a paradigm shift has occurred and that most things that worked before 2008 will work no longer. Multi-year compensation contracts, with guaranteed payments, are one of those things whose day is past. Today, the trend is for the performance based compensation model that rewards partners who bill an agreed upon number of hours to clients who pay and creates meaningful upside potential for rainmakers. Even then, the compensation levels should never be fixed for more than one year, and the law firm’s overall realization rate must be paramount in the calculations.
Amidst all of the drama surrounding Dewey & LeBoeuf’s rapid demise, there are still many lessons to be learned by law firms of all sizes. One of the most important lessons is the same as what our parents taught us—with the exception of death and taxes, nothing in life is guaranteed.