While robust profits in 2022 injected a sense of post-Covid optimism into many law firms, the ongoing escalation of costs is now putting a squeeze on profit margins. This has sparked a renewed focus on partner profitability and the perceived fairness of profit distribution. 

To help understand the key issues, I undertook a survey of law firm remuneration trends on behalf of the LawAhead Centre at IE Law School and the Law Firm Management Committee of the IBA, which has just been published by Harvard Law School. I wanted to know the extent to which law firms adopting new approaches were achieving increased profits, developing a more sustainable approach.  

More than 100 law firms took part from every corner of the world, although the trends were surprisingly uniform. In essence: underscoring the need to clearly define partner contribution and positive behaviours while establishing a trusted system for evaluating partners and distributing profits equitably. In this first article, I will outline the changes in current approaches before addressing the need for stronger governance in the second part.

1. Partner accountabilities remain the major challenge

Defining and understanding the behaviours of an ideal partner emerged as the primary challenge. The top five remuneration priorities, as revealed by the survey, revolve around redefining partner responsibilties, including both financial and non-financial criteria.

Although leaving each partner to their own separate business is much easier than aiming to give a sense of direction to a group of senior professionals, defining and understanding the behaviours of an ideal partner is still the number one challenge. 

Any firm without a strategy is at the mercy of its remuneration model – in fact individual incentives make a firmwide strategy irrelevant – leaving a vacuum when it comes to developing common approaches to client relationships or people, for example. 

The top five remuneration priorities all aim to strengthen partner accountabilities:

1. Defining partner contribution, including both financial and non-financial criteria.
2. Dealing with poor financial performance, both the cause and necessary ‘carrots and sticks’.
3. Correcting unacceptable partner behaviours, such as keeping hold of work or treating people poorly.
4. Ensuring a fair, trusted and transparent evaluation process.
5. Encouraging partner accountabilities.

2. Redefining key performance indicators (KPIs)

Over the past three years, I’ve run many workshops that asked partners which metrics were perceived as being most important to the business, and whether these would remain the same in the future. In line with the results of the IBA survey, it’s clear that firms are re-thinking what partner contribution means and updating their KPIs. 

Approaches are still led by financial KPIs, but there is a growing understanding of the importance of non-financials, even among Eat What you Kill (EWK) firms. Of those respondents who identified themselves as EWK, more than half said they are rewarding partners on the basis of both financial and non-financial criteria. From the lockstep firms that award a bonus, 37.5% award these on financials only and 62.5% on a mixture of financials and non-financial KPIs. 

A focus on purely financial metrics is unwise – finding the right balance is key – as is using the correct mixture of financial metrics. This has spectacularly misfired in the firms using the wrong financial metrics, such as billable hours and income, as opposed to financial contribution and profit margin. 

The most common categories of non-financial performance are anchored around developing your people, stronger client relations, plus management and leadership. An increasing number of firms are also now seeking to define the values required from partners.

Of course, putting this into practice is never straightforward. Despite the work invested in redefining performance indicators, financial performance is still perceived in many firms as the main driver for partner rewards. As a case-in-point, less than half of IBA survey respondents who agreed a set of positive partner behaviours have ever applied them.

3. Introduction of guardrails within performance bands

Agreeing performance indicators is one challenge but understanding how to coordinate them is another. In addition to moving away from only financial KPIs, both EWK and lockstep firms are adopting hybrid approaches.

In pure EWK, partners are vulnerable to the ups and downs of market changes, so many are adopting equity bands in response. Partners are assessed and moved up and down bands according to three-year results, thus avoiding the vulnerability of one-year market changes. 

Lockstep firms have their own particular cultural challenges. A pure lockstep works on a simple assumption that with each year, the size and profitability of a partner’s practice will increase. This may not always be the case. 

Less than half (44%) of the law firms identifying as lockstep in the survey describe their approach as “automatic progression”. Many are introducing a bonus to reward their high performers (modified lockstep) and performance gateways every few years (managed lockstep). 

As borne out by the survey, the differences between EWK and lockstep approaches is therefore narrowing significantly as the shifting landscape demands a delicate balance between professional autonomy and the collaborative responsibilities of co-owners. In part two, we will be reviewing the challenges of evaluating non-financials with the need to strengthen governance. 

Moray McLaren is co-founder of Lexington Consultants and a professor at the LawAhead Centre for the Legal Profession at IE Law School.