Strategic Overhaul: Rethinking Law Firm Compensation Amid the Talent War

Exogenous shocks that can alter entire market systems and industries are occurring with increasing frequency. Geopolitical instability, unprecedented strains on national systems, and rapid technological advancements in AI, automation, and machine learning are transforming our world. Regardless of one’s stance on these issues, one thing is certain: the period we are now entering is very different to the future we may have envisioned.

Consequently, the way we conduct business needs to be reevaluated. We need to engage in important conversations—not just about market positioning or firm operations, but about long-term sustainability. The issue is no longer whether disruption will occur, but how its impact will shape our firms. While it is essential to adapt and integrate new strategies for the future, we must also preserve those of the effective practices that have been the foundation of our success for years.

What is needed is a new methodology for considering, questioning, and redesigning systems. While this may seem like a resource-heavy, and time-intensive task, if managed well, it can unlock unrealised potential within your firm. Ideas and actions should be judged by their practical effects and benefits for the firm, its partners, and its broader workforce.

We need to assess whether current compensation models will remain effective in a disrupted market. Are we likely to see a segmented sector, with traditional firms facing off against emergent competitors? What will this mean for compensation in traditional firms? If a firm fails to adapt its compensation model, will it fail to change quickly enough to meet market disruptions? If partners are incentivised to continue existing practices without variation, how can we motivate them to adapt to a changing market?

Financial incentives are a fundamental aspect of a firm’s operations, significantly influencing compensation and impacting performance management and company culture. Whether it’s incentivising employees, attracting and retaining talent, or implementing penalties, compensation plays a critical role. In a knowledge-based sector, where a firm’s strength lies in its people, effective compensation strategies are essential for long-term success. When executed well, especially during disruptive times, these strategies can lead to increased innovation, improved client service, and stronger competitive positioning. Conversely, poor or stagnant compensation practices can have serious negative consequences. In this paper, we will examine compensation and why it may need re-evaluation.

Broad Issues with the Financial Model

Law firms face several broad issues with their commercial and compensation models, which impact their operations, profitability, and culture. One primary concern is the intense focus on profitability—which may seem counterintuitive. However, the short-term pursuit of year-on-year profits can lead to operational myopia. In recent years, the legal industry has experienced rising billing rates alongside increasing costs associated with attracting and retaining the right talent, both seen as key elements in the pursuit of increased short-term profit. According to the PwC Law Firm Survey Report 2023, Top 10 firms experienced significant increases in costs: property costs rose by 11%, IT costs by 16%, and marketing costs by 44%.

In the legal industry, firms often prioritise relentless year-on-year profit growth, focusing intensely on operationalisation at the expense of strategy. They implement rigorous processes and performance metrics to optimise efficiency and achieve short-term financial goals. While such ruthless operationalisation can yield impressive immediate results, it can obscure deeper strategic challenges – and potential disconnect between client priorities and the firm’s emphasis on profitability.

While it is true that top firms have been recording record returns—54 firms posted gross revenue of $1 billion or more in 2023, 4 more than in 2022, with 21 firms posting more than $2 billion, and 90 firms reporting gains in gross revenue—the focus on profitability often comes at the expense of longer-term strategy. The argument that focusing on profit is a successful strategy, supported by record returns, may seem compelling. These firms may appear successful based on annual profits, yet this success often masks a lack of genuine strategic planning. They may fail to anticipate market disruptions, innovate, or adapt to long-term changes in the legal landscape. Without a robust strategy, these firms are ill-prepared for future challenges and may struggle to maintain their competitive edge over time.

Statistics can sometimes act as a smokescreen, hiding the real issues. They provide an easy way for firms to claim they are ‘succeeding in their pursuit of revenue.’ Underpinning this is the concept of billable hours, which is crucial in law firms, where lawyers are often expected to bill between 1,800 and 2,200 hours annually. Achieving these billable hours typically requires working significantly more—often 20-30% more—to account for non-billable tasks such as administrative work, firm management, pro bono work, diversity initiatives, meetings, and continuing legal and business education.

This intense focus on individual billings may discourage partners from dedicating time to these crucial non-billable activities. Overemphasising billable hours creates a narrow focus that can detract from the broader responsibilities and values contributing to a law firm’s holistic success and sustainable culture.

True strategy in the finance and compensation involves identifying and tackling the most significant challenges an organisation faces, creating a coherent plan that leverages its strengths, and setting a direction that positions it advantageously in the market. This stands in stark contrast to operationalisation, which entails translating these strategic objectives into concrete actions, processes, and tasks that drive day-to-day operations.

Operationalisation without true strategy is akin to managing a ship with great efficiency but without a clear course. For law firms, prioritising immediate operational success over strategic foresight can lead to vulnerabilities that become apparent only when it is too late to address them effectively.

To extend the metaphor of the ship, focusing on short-termism in the legal industry is akin to bailing water out of a ship that may be slowly but surely taking on water through multiple small holes. While this approach may work temporarily and be deemed “successful,” it will eventually prove insufficient, leading to a potentially swift demise.

The concept of origination credits acts as a nice allegory
for the changing perceptions and thoughts on law firm compensation. Origination credits are a traditional system used to track and reward lawyers typically for securing new clients or new matters from existing clients. (This seems beneficial at first, right? Because, of course, we must reward people for a job well done.) These credits play a crucial role in compensation, promotion, and career advancement within many law firms. It is here, in its positioning as an incentive driver and catalyst for an individual’s career that we begin to see the cracks forming.

How Origination Credits Work

• Allocation: Credits are allocated based on the origin of new business. This can be straightforward when one lawyer is responsible for bringing in a client, but it can get complicated when multiple lawyers contribute.
• Tracking: Law firms track origination credits through internal systems which record the initial client engagement and subsequent business dealings.
• Disputes: Disputes over origination credits can arise, especially in cases where more than one lawyer claims credit for bringing in the client. Firms may have specific policies or committees to resolve such disputes.

Potential Challenges with Origination Credits

Mismanaged, origination credits perpetuate power imbalances within law firms, favouring senior partners and those with established client relationships, while potentially stifling collaboration, innovation, and effective succession. This in turn leads to the fostering of competition over collaboration.

Lawyers may prioritise securing personal credit for new business over working together as a team, which can harm the firm’s culture and client service. The structure and mechanisms driving the system emphasise a ‘me before you’ mindset or a notion of ‘eat or be eaten.’  This discourages the sharing of knowledge and resources among colleagues, leading to a fragmented firm or indeed even fragmented teams where individual interests overshadow collective goals. These challenges are particularly prevalent in matters or clients that span multiple jurisdictions or teams where partners do not share a sense of common financial ownership.

The origination model also risks alienating associates and creating a cohort of associates that lacks any incentive or interest in developing their own clients and business. Katherine Loanzon stated in a recent Law.com article, “It can be frustrating to see the support that associates could receive, but often don’t,” she said.  “Plus, with the way that Big Law is structured, there’s no incentive for associates to generate any new business because you don’t even get the origination credit as an associate. So even if an associate has the contacts and is able to bring clients, there’s no incentive to do so because they’re not rewarded.”

Additionally, origination credits present equity issues. Research has shown that these credits can disproportionately disadvantage certain classes of team members, exacerbating diversity and inclusion challenges within law firms. These inequities arise from historical and structural biases that limit access to high-value clients and opportunities, perpetuating a cycle of disadvantage for underrepresented groups, including women and individuals from diverse backgrounds.

Furthermore, an overemphasis on origination credits can adversely affect client relationship management. When lawyers are more focused on securing credit for bringing in new business, the quality of service provided to existing clients may suffer. This shift in focus from client service to credit acquisition can damage long-term client relationships as clients may feel neglected or undervalued.

Eat-What-You-Kill

The “eat-what-you-kill” (EWYK) model is designed to reward partners based on their individual contributions, similar in concept to origination credits, which often accompany and precede it. Proponents of EWYK argue that its competitive nature encourages increased productivity and entrepreneurship among law firm partners, incentivising them to consistently generate more work and subsequently bill more hours.

Much like origination credits, this model carries the risk of negatively impacting the firm, particularly in terms of collaboration. A “culture of competition” can create a toxic work environment where partners prioritise hoarding work over other crucial aspects of business success, such as collaboration, succession planning and development, well-being, non-billable work, and the long-term success of the firm. This model can also disrupt the fair distribution of work among associates and exacerbate existing power dynamics within the firm, making it difficult for newer or less connected associates to gain meaningful experience and visibility. Such practices can lead to increased dissatisfaction and higher turnover rates among associates who feel marginalised or undervalued.

Lockstep

Lockstep is another traditional tentpole compensation system where partner profit shares increase based on their seniority and tenure rather than individual performance. On the surface, it aims to promote collaboration since compensation is not tied to individual business generation, making partners more likely to share clients and knowledge. Additionally, it provides a clear and predictable career path for lawyers, reducing internal competition and fostering a more collegial environment.

The lockstep model has come under fire, mostly from top-performing partners who feel they are driving the business and expect to be compensated accordingly. This perceived lack of incentivisation for high-performing lawyers who bring in significant business can lead to a brain drain, as they seek higher-paying positions in rival, often larger, firms. Despite these threats, some firms have resisted calls for change, with firm leaders citing “the benefits of collaboration and client service” as counterbalances to the issues inherent in the lockstep model.

Guarantees

Guarantees are commitments to pay a certain amount to partners, often used to attract lateral hires or retain key talent. These guarantees provide a strong incentive for high-performing partners to join or stay with the firm, offering financial stability, which can be appealing in a competitive market.

However, they can be expensive for the firm, particularly if the guaranteed amount is significant, and may lead to resentment among existing partners, who feel that their loyalty and contribution are being overlooked or devalued. It is also a challenge if those arriving on these cash guarantees begin to underperform relative to their large pay packages, if the firm loses work to competitors, or the market shifts – something firms need to consider seriously with the advent of new technologies, the powerful position of Newlaw companies, and the risk of encroachment from adjacent sectors. To balance this, firms need to use cash guarantees selectively and ensure transparency with existing partners about the rationale behind these guarantees. Additionally, tying guarantees to performance metrics can help align the interests of the firm and the partner.

The best-known example of firm that mismanaged the guarantee model was global firm Dewey & Le Boeuf. Its downfall was primarily driven by unsustainable compensation guarantees promised to many its partners, some reaching as high as $10 million annually. These guarantees, intended to attract top talent, resulted in severe cash flow issues when firm revenues could not keep up with the financial obligations. The financial instability, revelations of internal mismanagement, and a sense of lack of loyalty to existing partners, led to a significant loss of confidence among the partners, prompting many to leave. The departure of key revenue-generating partners exacerbated the firm’s troubles, creating a vicious cycle of instability that led to its collapse in 2012.

Despite the relatively recent and highly publicised collapse of Dewey & LeBoeuf, the practice of offering (often opaque) guarantees has rapidly become common in many firms as the competition for rainmakers and substantial client portfolios intensifies. Firms must exercise caution and avoid selective amnesia regarding the clear risks associated with the widespread use of such guarantees.

Fixed Shares

Fixed shares refer to a compensation model where partners receive a predetermined share of the firm’s profits regardless of their individual contributions – not necessarily linked to seniority nor tenure. This model provides a straightforward and transparent compensation structure, encouraging partners to focus on the overall success of the firm rather than individual achievements. However, like lockstep, it may lead to high-performing partners feeling inadequately rewarded for their contributions – leaving the firm vulnerable to rivals’ raids.

The Talent War and Its Consequences

Given the close ties between the two, we can’t discuss law firm compensation without also addressing the burgeoning talent war. Law firms have employed increasingly aggressive tactics in this competition, including headline-grabbing “raids” by top-tier firms. The significance of these moves was recently emphasised by Krishnan Nair, Managing Editor at Law.com, who remarked, “Partner moves reflect a shift in market share, sometimes involving key clients switching allegiances, often accompanied by the migration of multiple fee earners and potentially millions of dollars in revenue transferring from one firm to another. (…) These ‘moves’ can have substantial consequences for how a firm’s partnership and remuneration are structured, how profits are distributed, how a firm is perceived by clients and competitors, and ultimately, for the firm’s broader working culture.”

More recently, and in response to such prominent poaching tactics, aggressive defence has become the natural next step in this tit-for-tat war, with firms now, for example, withholding accrued compensation from partners who choose to leave.

Kirkland & Ellis, often viewed as a titan of aggressive moves in the talent war, is an interesting lightning rod for the broader industry’s appetite. Moves such as renewing their $50,000 associate referral bonuses, as well as imposing a “penalty” for leavers, reveal what can be expected from many firms’ as possible next steps.

Not to be outdone, firms like Paul Weiss Rifkind Wharton & Garrison have moved to attract fresh talent by offering £180,000 to junior lawyers in London. This has led to steep pay packages being matched by equally financially powerful US firms with UK operations, leaving many homegrown firms in the region struggling to match the rising pay ceilings set by industry leaders. The issue here is not necessarily the competitiveness of pay within firms, as they may offer similarly high salaries across different jurisdictions. Rather, the concern lies in whether these jurisdictions can sustain such massive pay packages relative to the revenue they generate. This disparity raises questions about the long-term viability of maintaining such high salaries in regions where the financial returns may not justify them.

Consequences of Maintaining Outdated Compensation Models

If a firm fails to adapt its compensation model, it risks falling behind in a market where responsiveness and innovation are key. Traditional models, such as those relying heavily on billable hours or origination credits, may lead partners to focus on securing immediate, personal gains rather than investing in long-term, strategic growth. As highlighted earlier, systems like origination credits and the “eat-what-you-kill” model can perpetuate power imbalances and discourage teamwork, ultimately detracting from the firm’s overall performance, adaptability, and in a rapidly disrupting sector, long-term sustainability.

Driving Behavioural Change Through Incentives

To encourage partners to adapt and respond to a disrupting market, it is essential to integrate new strategies into the firm’s compensation models. These strategies should align financial incentives with behaviours that support the firm’s long-term success:

• Performance-Based Incentives: Compensation structures should include elements that reward innovation, collaboration, and contributions to the firm’s strategic goals. Metrics for client satisfaction, team achievements, and participation in firm-wide projects can drive partners to engage in activities that benefit the entire firm. To further support a shift away from traditional compensation structures, firms can consider the following innovative approaches:
• Mission-Driven Compensation: Align bonuses with the firm’s mission, values, and goals to ensure all staff members feel valued. This approach ensures that everyone is working towards common objectives, enhancing cohesion and commitment to the firm’s overarching purpose.
• Client-Centred Rewards: Link client reviews and satisfaction to bonus calculations to encourage employees to prioritise client experience. By tying compensation to client feedback, firms can ensure that the quality of service remains a top priority, fostering long-term client relationships and satisfaction.
• Flexible Compensation Models: Adopting or modifying compensation models to include lockstep elements or hybrid systems can balance individual performance with collective success. Such models help retain top talent while fostering a more inclusive and cooperative firm culture.
• Encourage Non-Lawyer Staff: Provide fair, market-value salaries and bonuses for non-partner lawyers and non-lawyer staff to boost morale and reduce turnover. Recognising the contributions of all employees, not just partners, can lead to a more motivated and stable workforce. This is even more important as we move further into a technology augmented future in which non-legal talent will become key to survival.
• Balanced Scorecard Approach: Implementing a balanced scorecard approach provides a more comprehensive view of performance, balancing financial results with other critical factors such as client feedback, professional development, and internal collaboration. This holistic assessment ensures that all aspects of a partner’s contribution are valued.
• Technology Adoption and Understanding: Incorporate incentives for learning and utilising new technologies. By encouraging partners and staff to adopt and efficiently use new technology, firms can enhance productivity, innovation, and overall value. Offering bonuses or rewards for completing technology training or for successfully implementing tech-driven projects can drive a culture of continuous improvement and adaptation.
• New Breed of Talent: Attract and retain a new breed of talent by offering incentives that align with modern career aspirations, such as flexible working arrangements (within reason), professional development opportunities, and technology integration. By recognising and rewarding the skills and contributions of tech-savvy professionals, firms can stay competitive and innovative.
• Transparency and Communication: Clear and transparent communication about the rationale behind compensation changes and how they align with the firm’s strategic goals is crucial. This transparency can mitigate resistance and foster a collective commitment to the firm’s future.

Conclusion

The challenges associated with law firm compensation are deeply rooted in the industry’s culture and traditional business models. Origination credits, while intended to reward business generation, often undermine collaboration, exacerbate equity issues, and detract from client service. The intense focus on profitability and aggressive tactics in the talent war further compound these problems, creating a highly competitive and sometimes toxic environment.

To address these issues, law firms must critically reassess and potentially overhaul their compensation models. Moving away from systems that foster internal competition and towards those that promote collaboration and equity is essential. Adopting or modifying the lockstep model to include performance-based elements could strike a balance between rewarding individual contributions and fostering a collaborative culture. Implementing transparent and equitable policies around cash guarantees and fixed shares can also help retain top talent without breeding resentment.

Moreover, firms must prioritise client satisfaction and employee well-being alongside profitability. This means creating an environment where lawyers are encouraged to focus on the quality of client relationships rather than merely the quantity of new business. Emphasising diversity and inclusion within compensation practices can help address systemic inequities and build a more inclusive firm culture.

In the face of the talent war, law firms must be strategic in their recruitment and retention efforts, ensuring that financial incentives do not overshadow the importance of a supportive and collaborative work environment. This might involve innovative approaches such as offering flexible work arrangements, investing in professional development, and fostering a sense of community within the firm.

Ultimately, the future success of law firms will depend on their ability to adapt to these challenges and create compensation models that align with the evolving values of the legal profession. By balancing financial incentives with a commitment to collaboration, diversity, and client service, law firms can build sustainable practices that attract top talent and deliver exceptional value to their clients.