Compensation Ratios are Spreading in Big Law (Perspective)

Editor’s Note: The author is a former Big Law executive and senior partner at The Boston Consulting Group.

Historically, the range of partner compensation at old-line firms has been relatively low. Reportedly, the highest-compensated partners earn three times the comp of the least-compensated partners. This norm of a 3:1 high-to-low comp ratio was established in an era when the variability in the inherent profitability of different partners’ practices was not nearly as high as it is today and when it was a rarity for partners to change firms. The norm survives because aggregate levels of compensation are stunningly high, discussion of redistributing compensation has social costs to a partnership, and narrow comp ratios make life easier for firm leaders.

However, the non-indigenous super-high profit firms — the arrivistes — grew up differently. Their compensation philosophies link compensation more closely to the economics of partners’ practices; inherently these vary widely. They also avail of the ‘some day’ aspiration: partners earlier in their careers will forego current compensation in exchange for the prospect of very high compensation later. The arriviste’s high-to-low compensation ratios are high, and getting wider — for example, Kirkland & Ellis reportedlyrecently increased to a 9:1 ratio. Even at this wide a ratio, the variation in compensation is probably lower than the range of inherent profitability of different partners’ practices when looked at on a contribution margin per partner hour basis, the right way to look at practice profitability.

The arrivistes have always leveraged lateral hiring to grow. The data suggest they are good at it — the most recent five year look back I conducted shows that Latham & Watkins and Kirkland & Ellis have the highest and second-highest lateral partner retention rates, respectively, for Am Law 50 firms hiring 20 or more laterals in a year. To date, much of their hiring has been from firms lower down the PPP ranks. But with these firms increasingly picked over, and the desire for growth unabated, the arrivistes are sure to look more to their indigenous peers for new partners. In this, their higher comp ratios give them an edge: the top third of partners — the firm’s economic engines — would receive higher compensation at an arriviste ratio firm than at an indigenous ratio firm, (see analysis below). The invisible hand of markets dictates that service providers will drift over time to where their endeavors receive the highest reward. Accordingly, top partners will drift in increasing numbers to the arrivistes; a battle royal among the super rich will have been joined.

What should firm leaders do? If you’re the leader of a super-high profit firm with a wide comp ratio: congratulations, keep going, and consider widening the ratio more. If you’re at a super-high profit firm with a narrow comp ratio: it’s time to start widening the ratio. This won’t be easy as many more partners stand to lose than to gain. It will have to be done gradually, probably with the introduction or amplification of an explicit profitability element in the determination of compensation. If you’re a medium-high profit firm: you should widen your comp range further. This will help but, on its own, it won’t be enough. You have to get concrete about a strategy that gets more and more of your business out of the realm of offerings for which clients have multiple credible providers and among whom they choose increasingly based on price. Widening the comp range buys you time to fix your strategy fundamentals.