Pot of Gold

How big firms decide what to pay each partner

The engine of every law firm is the compensation committee. It determines which partners make the most — and the least — money. These judgments can encourage collaboration. Or they can promote selfishness and kill morale. Here’s how they work
The engine of every law firm is the compensation committee. It determines which partners make the most — and the least — money. These judgments can encourage collaboration. Or they can promote selfishness and kill morale. Here’s how they work

IN 2013, BRIAN RECEIVED A PAY CUT OF $100,000. But, to be honest, he wasn’t going to miss the cash. By this point in his life, he had practised on Bay Street — at the same large, corporate firm — for close to two decades. He had done quite well. “Most big-firm partners are very fortunate,” he says. “We make lots of money.” With plenty of those lifetime earnings in savings, he was in tiptop financial health. And he was still a well-paid partner at a top firm: a six-figure dent in his annual income wasn’t going to change his day-to-day life one bit. He could still afford his mortgage. He could pay his two children’s private-school tuition. And he could continue to take nice vacations with his family.

“I wasn’t stressed about the money,” recalls Brian, who asked that we not use his real name. “But it was still a total kick in the gut.” There were a few main issues that he found troubling. First of all, the firm’s compensation committee never pointed to a particular problem with his performance. Brian had continued to rack up a consistent number of billable hours; he always took excellent care of his clients. This absence of logic made the committee’s decision feel oddly personal, as if he had fallen out of favour with the popular crowd. “It seemed like the partners who ran the firm viewed me as less important,” he recalls. “That felt shitty.”

But what nagged him most was the knowledge that, soon enough, the latest batch of compensation figures would be grist for the law-firm gossip mill. At the largest firms in Toronto, the result of the compensation process is open. This means that, within the equity partnership, everyone knows the exact dollar figure on everyone else’s paycheque. And so, Brian wouldn’t be able to hide the fact that he had fallen down the pecking order. “That definitely made it hurt more,” he says. “That symbolic loss hurt me 100 times more than earning a little less money.”

Eventually, Brian looked over the revised compensation of the entire partnership. It was revealing. The committee had decided, without warning, to reward a coterie of top rainmaking partners — by, say, doubling their annual compensation — and to pay for it by drastically cutting the income of some partners. Brian was one of the casualties.

But he never complained to the top brass. Nor did he look for another job. “To be honest, I’m a stick in the mud,” he says. “I put my head down, worked hard and hoped that the good days would return. I know it’s not a very flattering self-image. I’m too conservative for my own good.”

Then he caught a lucky break. He received an offer from another top-tier firm and he accepted the position. His earnings haven’t skyrocketed, but he’s in a better place. “This seems like a transparent, well-run firm,” he says. “I’ve only been here for four years, which might not be long enough to feel jaded and cynical, but, so far, I have absolute trust in the management.”

Brian’s story demonstrates that it’s pointless to talk about money without, first, probing human psychology. It’s true that, in a literal sense, compensation committees dole out their firm’ annual profits in the form of cold hard cash. But, in a more meaningful sense, they are distributing something else: prestige and social standing.

PeacockWhen big-firm partners earn less than their colleagues, it might bruise their wallets a bit. But it really stings their egos. If their incomes plummet for no good reason, they don’t have to sell their house or pull their children out of private school. They feel betrayed and, at the same time, embarrassed. “Human beings generally, and perhaps lawyers more than most, are status-seeking animals,” says Brian. “That should be the starting point for any conversation about partner compensation.”

PARTNER COMPENSATION USED TO BE SO SIMPLE. Historically, the largest law firms in Toronto operated under the so-called lockstep model. In this regime, one metric determined annual compensation: seniority. As partners ascended the law-firm hierarchy, their incomes rose. This system rewarded loyalty and tenure.

But it had one glaring weakness: there was no mechanism to reward rainmakers. And this flaw proved to be fatal. As partners with the sharpest business-development skills felt increasingly short-changed, some started to defect to competitors who were happy to abandon the rigidity of lockstep in exchange for an improved client roster. Others founded their own firms, where they wouldn’t have to share their profits with undeserving colleagues.

Over the past several decades, most firms have scrapped the lockstep model. Instead, they now tie compensation directly to performance. Billable hours and client development are particularly important, but partners can also earn credit for a broad range of profit-generating behaviour. This might include sharing a client with a different practice group or landing enough work to keep a team of associates busy. The upside of this reform is obvious: it allows firms to reward (and retain) their best rainmakers, while also taking a holistic view of what it means to be a profitable partner.

But this model is also subjective. No committee can collect enough data to determine, with mathematical certainty, the amount of money that each partner deserves to take home. So when partners notice that they’re earning less than their colleagues, those income gaps become more difficult to stomach.

WHY WOULD BAY STREET PARTNERS, WHO SIT ATOP THE SOCIOECONOMIC LADDER, BE SO VULNERABLE TO ENVY? There is strong evidence that income inequality — the knowledge that you make less money than someone else — can devastate the human ego and disrupt the social order. And this phenomenon affects the inhabitants of every income bracket: the poor, the middle-class and the rich.

That’s a mighty claim, but academic research bears it out. Let’s take a walk through some of the best evidence. In 2016, two psychology professors — one at Harvard, the other at the Rotman School of Management — published a study on air rage. They found that when economy passengers board an airplane at the front, thus passing through first class on the way to their seat, they are twice as likely to abuse and antagonize crew members or jeopardize flight safety (compared with passengers who board at the middle of the plane). The upshot? When we know we’re at an economic disadvantage, we feel bad and act out.

Now let’s peek inside the first-class cabin. As the people sitting up front see the economy passengers move toward the back of the plane, they must feel so fortunate to have that extra leg room and free alcohol — and, as a result, they should be on their best behaviour, right? Nope. They’re about 12 percent more likely to commit acts of air rage. The authors of the study were not surprised. Previous research, they write, has shown that when members of the upper class make “downward social comparisons to the disadvantaged,” they are more “selfish, entitled, and scornful.” It’s well known, for instance, that drivers of expensive cars are far more reckless on the road.

These social forces play out in studies of the workplace, too. In 2008, a team of economists sent an email to thousands of employees at three state universities in California. The message included a link to a local newspaper that had built a database that allowed readers to look up the annual salaries of more than 300,000 state employees. A few days later, the economists sent a follow-up email with a few short questions. One of them was: “All in all, how satisfied are you with your job?” Unsurprisingly, when workers discovered that they were “paid below the median for their unit and occupation,” this had a negative impact on their job satisfaction. But when workers learned that they made more than the median, this realization gave them no pleasure. As a group, they reported no boost in satisfaction.

In short, inequality makes no one happy. Not those at the bottom. And not those on the top. The implication is that it would be healthier — psychologically, at least — if everyone was in the dark when it came to the compensation of their colleagues.

In big-firm partnership models, however, transparency is a central feature. This puts compensation committees in a fiendishly difficult situation: they have to issue decisions that their fellow partners will trust and respect, despite the fact that the human mind is prone to look upon any sign of inequality with either resentment or apathy. Is that even possible?

AT OSLER, HOSKIN & HARCOURT LLP, THE COMPENSATION COMMITTEE HAS ABOUT 10 MEMBERS. One of them is the managing partner; the rest are partners that the executive committee appoints. This band of power brokers meets every two years to determine the percentage of the overall profit that each partner will earn until the next review.

It is an intense undertaking. At the outset of the process, the committee collects reams of data. It tabulates every partner’s billings, client origination and collections. But it also factors in non-statistical contributions. “You might have a partner who spends a great deal of time on a management committee or serves as practice-group chair,” says Doug Bryce, the firm’s national managing partner. “We need to reward that, so people take on these roles.”

The final stage of this process takes place in a hotel conference room. “We sequester ourselves for a week,” says Bryce. “It’s a bit like the conclave of cardinals. We set up laptops and wire into the firm’s system. There is a never-ending cycle of food and drink that gets brought in around the clock for five days.”

Inside that room, everyone works toward the same goal: no partner should look at the committee’s final report and feel as if, compared with a colleague, she has been totally screwed. “The fact that everyone knows what everyone makes is fundamental to understanding how the process works,” says Bryce. “It’s fair to say that lawyers are human beings. And human beings are social animals. We care a lot about relativities. So getting those relativities right is at the core of the exercise.”

LawyersStill, the committee can’t pull its punches. “Our career generally offers very healthy incomes,” says Bryce. “That means partners have to continue to perform. We have high standards. And if people are not able to sustain a sufficiently high level of performance, then they will go down the list.”

This makes sitting on the committee a tense and emotional job. “There’s a fair amount of joking that goes on about the negative aspects of the role — in particular, the flak you will take from your colleagues and friends,” says Bryce. “And that joking has some truth in it. It can be a real burden. We don’t ask people to sit on it lightly.”

WHAT’S IT LIKE TO BE INSIDE A FIRM ON THE DAY THAT THE PARTNER COMPENSATION LIST IS RELEASED? “There’s tension in the air that you could cut with a knife,” says one lawyer, who’s been a partner at two large Bay Street firms. “No one gets any work done all day. So most firms release the list on a Friday. If they released the numbers on a Monday, no one would do any work all week.”

As the partnership combs through the data, there will, at some point, be disappointment. “One year, I heard the partner in the office next to mine start to rant and rave,” recalls another lawyer, who has been a partner at three large firms. “He comes over and starts screaming, ‘I was screwed! Look at what they’re paying everybody else!’” This particular partner, by the way, had been content with his income before he saw his place on the hierarchy. It was only when he measured himself against his colleagues that he burned with resentment. “I always tried to tell people not to take the money too seriously. I mean, let’s face it: even the lowest-paid partner at a big Bay Street firm is doing better than 95 percent of the country. No one can have any sympathy for us based on our compensation.”

It would be neither accurate nor fair to suggest that, on compensation day, every firm devolves into argument and anger. But it does happen. “When the results of the compensation review came out in February, there would be screaming fights and tears in the hallways,” says Regina, who currently practises at a small firm, but, for close to a decade, worked at a mid-sized Bay Street firm. “It was out in the open.”

The wounds took a long time to heal. “For about a month, the partners were actively miserable,” says Regina, who asked that we not use her real name. “It was such a pervasive, dark atmosphere.”

WHEN MICHAEL MADE PARTNER AT A MID-SIZED BAY STREET FIRM, A FEW YEARS AGO, HE WAS OPTIMISTIC. The executive committee explained to him that, under the firm’s compensation model, the partners who landed new clients would earn more than those who stockpiled billable hours. “I thought, Great!” recalls Michael, who asked that we not use his real name. “I believe in that kind of model. You need to reward client development. If you don’t have more work coming in the door, the firm will disintegrate over time.”

In his first year as a partner, Michael structured his practice around that model. “I did a lot of client origination,” he says. “That meant that I did a lot less of the actual day-to-day work. I would push that work down to associates.” He was doing everything right. At least, that’s what he thought.

But at the end of his first compensation review, he had a rude awakening. In practice, the firm rewarded its service partners more than its rainmakers. Michael pored over the data and calculated that, if a partner billed $1-million worth of work, she would earn far more than the partner who generated that business in the first place. The income disparity would range from $60,000 to $100,000. “I kept banging my head against the wall,” says Michael. “I would go to the managing partner and the compensation committee and ask, ‘Why are you rewarding people more for billing than for client development? This is not what is laid out in our partnership agreement.’ I never received a satisfactory answer.”

He had his own theory, though. “Our compensation committee was composed almost entirely of people who sat at their desks, did a lot of work and focused on billing,” says Michael. “They were using their discretionary authority to ignore the compensation model as written and, instead, reward partners in a way that reflected their own skill set.”

The upper brass never interfered, a decision that Michael actually understood. For management to step in and overrule the compensation committee would have amounted to a political coup. It could have torn at the fabric of the partnership.

It also would have infuriated the high-billing partners who had grown accustomed to making so much money. “You can’t suddenly knock down their salaries by 200 grand,” says Michael. “They would be furious. It would also force the firm to admit that it hadn’t followed its own rules for years. That’s pretty embarrassing.”

About a year ago, Michael ran out of patience and left the firm. “It wasn’t the money,” he says. “I mean, I’m making a bit more now, but it was more important for me to work at a firm that would stick to its stated compensation principles.”

Michael’s experience reveals one of the core advantages of an open compensation model. Yes, transparency can breed resentment and cause psychological pain. But it allowed Michael to leave a firm that treated him unfairly.

In a closed system, compensation committees would be able to exercise their discretionary power with impunity. Doug Bryce of Osler, for his part, argues that transparency increases the likelihood that the process will be fair. “We know that every decision we make will be tested,” he says. “That definitely introduces a very healthy discipline to the process.”

COMPENSATION IS A POTENT MANAGEMENT TOOL. If a firm wants its partners to behave in a certain way, money is an effective incentive. And, indeed, many big-firm compensation models claim to recognize so-called “soft” contributions that don’t directly generate revenue: mentorship of junior associates, collaboration with colleagues, participation on diversity committees. And so on.

But do these activities truly yield a financial reward? “Here’s what I have found at most firms,” says Tim Corcoran, a New York-based legal-management consultant who has helped several Canadian firms revamp their compensation models. “Management believes it is rewarding lofty ideals like collaboration and community spirit, but, when you look at the data, that just isn’t the case.” If a partner decides to docket fewer billable hours and, instead, use that time to mentor an associate, her income will drop. It’s that simple.

Norm Bacal, the former managing partner of the now-defunct Heenan Blaikie LLP, is of the same mind. “It doesn’t really matter if you’re a great mentor or you care about teamwork,” says Bacal, who, since the implosion of his firm five years ago, has become a candid voice on the topic of law-firm management. “If you dig into the numbers, you’ll find that most of the money goes to the partners who bring in the most business or who have the highest collections.” As Bacal explains, it’s difficult for a compensation committee to put an obvious dollar figure on non-billable work. “You can say that you believe in mentorship all you want,” he says, “but it just doesn’t get rewarded as much as it ought to.”

This is a shame. To increase long-term profitability, all businesses need to cultivate junior talent.

But there might be a solution. “I think a firm should say, ‘If you sit on the student committee, or spend a certain number of hours doing mentorship, you’re going to get 25 Gs,’” says Georges Dubé, a partner at McMillan LLP. “It should be a flat-fee bonus, not part of some complex formula.”

He admits that no firm could adopt such a policy immediately. “You would need to educate the partners and give them the runway,” he says. “But you could signal that there is going to be a change in culture and announce that this will be in place within five years.” He thinks firms could make a persuasive case to their partners. “You have to attract and retain great talent. It’s so important to the long-term health of the business.”

Such a bonus structure would also be, in the big picture, pretty cheap. “Let’s say you want to give eight partners a $25,000 bonus,” says Dubé. “You would need 100 partners to give up $2,000 of their income each year. That isn’t much. I don’t see any reason why a firm couldn’t put this in place.”

IN AN OVERHEAD SNAPSHOT OF BAY STREET, TWO LARGE FIRMS STAND OUT: TORYS LLP AND DAVIES WARD PHILLIPS AND VINEBERG LLP.  For decades, they have calculated partner compensation without numbers or statistics. This doesn’t mean that the profitability of each partner is irrelevant, but both firms determine compensation using an intense peer-review evaluation process.

Let’s start with Davies. The firm — like Osler — conducts its compensation review every second year. But there is no separate compensation committee. The management committee handles this process. “If we’re trying to run the firm, then it would be a bit weird to surrender the compensation system to another group of people,” says Shawn McReynolds, the firm’s managing partner. “We would lose one of the best tools we have to modify behaviour.”

Their process takes up an enormous amount of time. “We go around and interview every partner,” says McReynolds. “We start by showing each partner how we divided up the pie over the past two years. Then we ask: ‘How would you change it and why?’”

Naturally, some partners will bring up money, pointing out which colleagues have a rapidly growing (or shrinking) practice. There is no data, however. “We don’t keep track of billable hours,” says McReynolds. “We don’t track originations. We don’t care who signs the bill that goes out to the client. None of that matters.”

Finish LineThe absence of analytics forces partners to discuss contributions to firm culture. “If it doesn’t matter what your billable hours are, then other factors start to matter a lot more,” says McReynolds. “We want to know who is doing the unsung jobs that make the firm work. Who is training and mentoring young lawyers? Who are the thought leaders? No one records or writes these things down. But the partners notice. This is what we are trying to reward.”

Before the management committee distributes the revised compensation breakdown, it meets with every member of the partnership. “Everybody gets a conversation before they get an envelope,” says McReynolds. “I’ll say, ‘This is how we’d like to adjust your compensation and this is why.’ Some people don’t say much; other people have questions, so we have a dialogue.”

He admits that downward adjustments can be difficult to bear. “If you’ve always had the same income as your law-school classmate and then, all of a sudden, you’re making less, you will notice. And even if you know that it’s fair, it can be emotional.”

At Torys, the process is similar, but there are two key differences. First, the firm has a separate partner-review committee that oversees compensation. And second, it solicits feedback on partners through a written questionnaire. “Every lawyer and law clerk who interacts substantially with a partner is asked to rate that partner,” says Les Viner, the firm’s managing partner. The survey includes a range of questions. Such as: Does this partner care about your professional development? Does the partner manage files efficiently?

Partners also submit a statement, no more than three pages in length, that touts their own performance. It might outline recent examples of collaboration; it might also describe how the partner plans to improve.

The committee examines both the survey responses and partner statements. Then it assigns each partner “a composite score” and sorts them into bands, which correspond to a certain level of compensation.

Financial statistics — say, billings or collections — play no role in the process. “Partners contribute in many different ways,” says Viner. “There is no single formula or uniform expectation. We believe that profitability is a by-product of terrific service and culture, not a primary goal in and of itself.”

Viner takes real pride in this approach: “We think our system is a source of differentiation and competitive advantage in making our firm a great place to work and also offering top-notch service to clients.”

SO IS THAT THE ANSWER? To stop talking about numbers and, instead, adopt a peer-review model in the image of what takes place at Torys or Davies? McReynolds doesn’t think that other firms would necessarily benefit by copying the Davies model. In his view, there is no obvious, fool-proof compensation process that every firm should adopt.

His conclusion makes intuitive sense. After all, when money is involved, nothing is simple. It has the power to incentivize better behaviour, but it’s also a deeply corrupting force, both on culture and the human mind. We already know, for instance, that the top-earners in the workplace take little pleasure in their high status. We know that pay cuts can cause feelings of frustration and shame. And we know that, despite the best of intentions, it’s hard to reward non-billable work. These problems are difficult — or, rather, extremely, painfully difficult — to solve. No single firm will have the answer.

McReynolds, in fact, makes this precise point. “At the end of the day, there’s no perfect system,” he says. “You want to have a fair process. And you want to get to a fair outcome. As long as you tick those two boxes, nothing else really matters.”

This story is from our Spring 2019 Issue.

Illustrations by Pete Ryan