I was asked this question the other day in relation to the compensation system for a legal partnership. Many partnerships adopt broadly similar systems but they come with lots of different nuances. One of the biggest issues is whether to make it open or closed. Can all the partners see what each other partner earns each year, or is it closed and only the individual partner and the Managing Partner and whatever group of partners make up the compensation committee know? Can you say that one system is better than another?
I have often heard that the best compensation system is the one that upsets the least number of partners. With that in mind, my preference is always to go for a closed system, the greater the number of partners, the more I favour this system. With a small number of partners you may well just decide to divide the profits up between you in a very transparent way as you each know each other very well. I do not think that level of transparency will be as clear the more partners are added.
Another complication of size will be what you want your compensation system to reward and in what way. Deciding someone’s compensation is often more of an art than a science, compensation can rarely, if ever, be reduced to a mathematical formula. A good compensation system should reward both the financial contribution and the behaviours and values a firm wishes to promote. It is relatively easy to measure financial contribution, but how do you measure a non-financial one? If a behaviour is not rewarded in some way why would anyone practice it? Divine altruism will only take you so far. That may sound cynical but I believe it to be true.
How do you reward seniority? Should you? How do you reward sales or origination? Again should you?How do you reward the many non-financial regulatory roles a legal firm must do: conflicts, legal counsel, diversity, regulatory, training and recruitment. How do you promote and reward succession planning?
I believe a good system will find a way of rewarding the financial and non-financial things that partners do. A partner will rarely be good at all things so a balance must be struck. You want people to play to their strengths and contribute to the firm goals in the best way that they can. It is for the compensation committee to look at those various inputs and weigh them up so that the end decisions are seen to be fair and equitable. That is why I believe the system should be closed.
The vast raft of information on each partner each year can only be properly analysed by a few. A simple spread sheet of how the profits were eventually divided substitutes the decisions of the few, allowing each partner to reach his or her own conclusions. It is a recipe to foster division. It says the highest earners are the best partners but does not say why. A closed system allows the partner to speak with the compensation committee and understand the award and to counter it if required. If you believe your compensation to be fair, do you need to know anything else?
Critics of my view will say that an open system keeps the compensation committee honest, if it knows its decisions will be public, it will think more carefully as to its decisions. All I would say is that the greater the delta between the knowledge of any individual partner about the contribution of each of their peers and the knowledge of the committee the greater will be the scope for division. In my experience, the larger the number of partners, the greater the differences in seniority or time with the firm, the greater that delta will be.
Equally such a system throws a weighty responsibility on the compensation committee to get it right. To look at appropriate comparators, look at the various inputs, consider the addition to profit and the workings of the firm. In my experience, if it can achieve that goal, there are likely to be very few challenges. Sometimes the challenges are simply to promote a discussion and greater understanding by the partner of the committee’s deliberations, sometimes there may be information not made available to the committee or overlooked. Remember and hold back a little fire-power in case you have made a mistake.
Good luck! It is an arduous and not very rewarding process but the future growth and development of your firm depend on it.