It’s all too easy for a law firm to give a PEP figure that doesn’t show the entire picture. That’s why EPP is a better indicator of performance
One of the themes running through this year’s The Lawyer UK 200 Annual Report is transparency. As you flick through the features on the firms that preferred not to supply figures for the most turbulent of financial years, or the accounting games firms play to massage their results, this will become apparent.
The push for transparency is nothing new. For years The Lawyer has been on a mission to inject even more clarity into the figures it publishes. So in 2005 we introduced a new measure, listed in the tables in this year’s report but not highlighted with its own specific feature – there simply wasn’t room.
As all critics of the market worth their salt know, firms can manipulate the average profit per equity partner (PEP) figure they reveal fairly easily.
Until 2005 the PEP figures we published did not take into account the monies paid to salaried partners or other classes of equity, such as junior, fixed-share or mezzanine.
By excluding the remuneration paid to this often considerable number of partners, PEP would be inflated. There is nothing particularly sleight of hand – or even underhand – about this. Salaried partners, after all, are not owners of the business, they are employees, and as such are not as exposed to the risks of running a business – as seen last year.
But to their clients at least law firms make no distinction between different classes of partner, while gaining great PR from a high-flying PEP result. Or they did in previous years when PEP was sky rocketing.
“Non-equity partners are a great leverage tool when markets are buoyant, but a heavy cost when markets are subdued, as many firms found to their cost last year,” says Tony Williams of consultancy Jomati.
So the earnings per partner (EPP) figure we introduced in 2005 factors the money paid to other classes of partner back into the total, reducing the PEP and arguably giving a truer representation of a firm’s real average profit.
Our methodology is simple. We ask firms to provide us with two figures to reflect average profit – a PEP figure and a total remuneration figure for all partners. When the latter figure is divided by the total number of partners you get the EPP. (Incidentally, if you subtract the net profit from the total remuneration and divide that figure by the number of non-equity partners, you get the average pay for salaried and other classes of partner – head hurting yet?)
All that is then left to do is compare our PEP table with the EPP table. Staying at the top is Slaughter and May, which according to our estimates managed another record year largely off the back of its work at the heart of credit crunch-related deals. (In another nod to full disclosure this year, for the first time we identify in the table which firms’ figures we have estimated and which have been provided.)
Slaughters has only six non-equity partners, all in the firm’s three small overseas offices. According to our estimates these partners are paid an average of £700,000, adding £4.2m to the firm’s net profit of £281.25m. Divide the sum by the firm’s total 131 partners and the estimated PEP of £2.25m drops slightly to £2.18m.
Contrast that with the difference between the two figures at a firm with a more tightly held equity. Take Allen & Overy, where only 372 of the firm’s 490 partners are full equity. There the PEP is £1.09m, while EPP stands at £880,000.
Or Simmons & Simmons, where 134 full equity partners out of a total of 232 drops the PEP figure from £520,000 to £384,000.
Or arguably the daddy of them all, DLA Piper, where the £645,000 PEP falls by 45.6 per cent to an EPP of £351,000 when its 31.6 per cent equity partnership is factored in. Here in particular the EPP measure highlights the difference in remuneration between what, on the face of it at least, are all equal partners.
But of course there is more to it than that.
“Partners are kidding themselves if they just look at PEP without considering the leverage model, the partner capital requirements and the speed of distributions,” insists Williams. “Far more important than manipulated averages is what a lawyer of similar quality and performance earns in a comparable firm.”
As always, it is the full picture that counts.
For more on this, see The Lawyer UK 200 Annual Report 2009, out with this issue
(To view larger versions, please click on the images)