Merit-based compensation will replace lock-step as firms go international, writes Jeffrey Gordon. Jeffrey Gordon is a partner at US firm Mayer Brown & Platt.
Most big-firm lawyers regard lock-step compensation, where all partners of equal seniority receive equal pay, as the most desirable compensation system for a law firm – if the firm can afford it.
Partners who are compensated in lock-step have no incentive to hoard business and every incentive to promote their partners in whose success they share equally. Free riding does not appear to be much of a problem in lock-step firms.
Lock-step compensation systems are best suited to firms that are financially successful and have relatively homogeneous partnerships. A highly productive partner in a lock-step firm must make enough money so that he does not begrudge transferring wealth to his less productive partners. This attitude is easier to maintain in a firm where the partnership is relatively small, focused, local and highly compensated.
In the US, lock-step systems tend to be maintained by a handful of successful New York firms that concentrate on big-time transactional and securities work.
These firms, by and large, have few branch offices, do little or no lateral hiring of partners, and tend to confine their practice outside the US largely to transactions in the international capital markets that can be done under New York law.
But a lock-step system is not conducive to hiring new partners or to opening up new offices. Expansion often entails entering into new practice areas that may initially be less profitable on a per-partner basis.
Also, there may be a natural reluctance to provide the protection of lock-step compensation to a lawyer who did not grow up with the firm.
Adhering to a lock-step system of compensation increases the cost of entering new markets and requires core practice partners in the main office to subsidise new ventures.
This may be acceptable if the new businesses are capable, in time, of generating profits per partner that are roughly equivalent to the profits the firm achieves at home. But an inherently less profitable new business, however, could still be a good one.
Firms with merit-based compensation systems do not have this problem.
They are able to adjust the compensation of their partners to the profitability of the practices these partners have. They can hire new partners, sometimes at compensation levels that exceed what a lock-step firm could pay. Not surprisingly, the largest firms in the US, with the greatest number of locations, have merit-based compensation.
In this context, the accelerating international expansion of leading London law firms – most of which have lock-step compensation systems – seems anomalous.
One explanation is that these firms, by focusing on corporate finance and mergers and acquisitions, may be building foreign practices that are potentially as profitable as their City practices.
Another possibility is that the inevitability of European economic union makes European expansion a strategic imperative for big City firms.
Alternatively they may simply have more vision than their US counterparts and have developed a consensus within their firms that makes partners in their core practices willing to suffer some dilution.
But these firms' ability to preserve their lock-step compensation system is probably attributable more to the absence of strong competition for their partners who are subsidising the lock-step.
Movement of partners among the top five City firms is almost non-existent.
These firms' counterparts in New York, for the most part, are not in the business of giving English law advice. Of course, other US law firms in recent years have been in the market for English partners, and there have been some notable hires.
But few US firms have been able to convince mainstream partners at important City firms that, in addition to being more fairly compensated, they will have the equivalent practice opportunities and the security they already enjoy.
This will change. As competition for productive lawyers increases, it will be more difficult to underpay them by holding them in lock-step.
Mergers of law firms will also cause the lock-step system to fracture. A firm cannot merge with a comparable firm that compensates its partners on the basis of merit without breaking the lock-step. The alternative would be to convince the top paid partners at the merit-based firm to take a pay cut, an impractical idea.
Ultimately, successful international firms will not compensate their partners purely on the basis of merit, anymore than they will be able to pay partners in lock-step.
The key to those firms' success will be a well-administered merit-based compensation system which attaches value to a partner's contribution to the common welfare of the firm.
Pure lock-step compensation may be unsustainable, but the institutional values it promotes still have to be rewarded.