How Associate Bonuses May Highlight BigLaw’s Profit Gap
Law360, Grand Rapids (November 22, 2017, 10:09 AM EST) — In past years, many BigLaw firms have played follow-the-leader in matching associate bonuses to those set by the most profitable firms, but as law firm profit gaps grow, experts say it’s likely that bonuses at less profitable firms will remain on trend with past years even as their counterparts up the ante for a select few associates.
The growing gap in the legal industry between the few most profitable law firms and the rest of the field could manifest in the holiday bonus season, according to industry experts who say less-profitable law firms that were burned by keeping up with salary raises in 2016 will likely think twice this winter before matching highly profitable law firms like Cravath Swaine & Moore LLP, Davis Polk & Wardwell LLP and Simpson Thacher & Bartlett LLP on bonuses.
In June and July 2016, a large swath of BigLaw followed the lead of Cravath when it raised base pay for its associates to a starting salary of $180,000. And then, when bonus season rolled around, many followed the lead again as bonuses ranging from $15,000 to $100,000, depending on experience, were doled out to associates.
But some say the game of follow-the-leader will likely stop this year, should those highly profitable law firms up the ante again with even larger holiday bonuses.
“A lot of firms that followed to $180,000 did so because they felt they had no other choice from a competitive recruiting and retention standpoint,” said Dan Binstock, a partner at attorney search firm Garrison & Sisson Inc. “But bonuses may be the first way that we see a splintering where some firms say, ‘We refuse to continue to follow, because our business model is too different to justify continuing.'”
In 2016, the industry’s richest firms grew richer and many of those below the top profitability tier struggled to improve their financial position.
Data from The American Lawyer shows that, overall, while the 100 largest law firms in the U.S. grew their profits per partner by 3 percent on average from 2015 to 2016, the 10 most profitable grew their PPP by an average of 7.6 percent.
Four of them increased their PPP by 10 percent or more, including Cravath, with profits per partner rising 18 percent year-on-year to $4.2 million, Davis Polk up 14.2 percent to $3.8 million and Kirkland & Ellis rising 13.7 percent to $4.1 million; the remainder of BigLaw averaged $1.66 million in profits per partner in 2016.
Kent Zimmermann, a consultant at Zeughauser Group, agreed that a minority of the market is poised to offer increased bonuses this year as their profits rise while most law firms will likely maintain bonus levels and a few may even reduce them.
“For some firms it’s still a relatively fresh memory that they increased their base compensation materially to follow the lead of the New York and other firms that did that,” Zimmermann said. “Some firms ended up regretting the decision to do that because of how much it cost, particularly some firms that are not among the most profitable.”
That contention appears to be supported by a report released Nov. 13 by Citi Private Bank’s law firm group that looks at U.S. law firms’ financial performance during the first nine months of 2017.
Across the industry, revenue increased 3.6 percent in the first three quarters of 2017 after a 3.7 percent year-over-year increase in 2016, the report found. Meanwhile, expenses increased more in 2017 — 3.8 percent — than the year before, driven by bigger associate salaries, an indication that law firm profits may suffer in the final year-end results for 2017.
But that doesn’t mean bonuses will decline or disappear, according to Mark Jungers, co-founder of legal search firm Lippman Jungers LLC. Jungers predicts bonuses will, for the most part, remain the same as last year.
“I don’t think the salary increases from last year will drag bonuses down,” he said. “Those are now water under the bridge. Associates get paid more now, and that’s just how it is.”
How many law firms decide to hand out beefy bonuses and how many refuse to follow along all comes down to a waterfall effect and how it plays out, according to Binstock.
After Cravath raised associate salaries, he said, a lot of slightly less profitable firms matched it, which prompted those with slightly still lower profits to follow, and so on.
“There’s going to be some point where certain firms refuse to continue to follow and will make a conscious decision to stay more true to their realistic business model with the understanding that they may lose out on certain laterals, or lose a couple of associates,” Binstock said.
Rather than blindly follow the pack, some law firms will likely get creative with bonus structures in order to retain and attract associates while still maintaining profitability, according to Jamy J. Sullivan, executive director of Robert Half Legal.
“Many law firms will continue to tie bonuses to the organization’s profitability during the past year in combination with associates’ performance and their number of years with the firm,” Sullivan said. “An associate’s performance may reflect a number of factors, such as billable hours above a set threshold, achievement of business development targets, client feedback and billings, and significant project or trial outcomes.”
Firms may add a retention-related component in order to limit the overall cost of year-end bonuses while also addressing attrition, Sullivan said.
In a recent study by Robert Half Legal, close to 40 percent of lawyers interviewed expressed concern about losing top legal performers to other job opportunities, signaling that retention is high priority.
An example of a retention-related component to a bonus structure is Quinn Emanuel Urquhart & Sullivan’s decision in August to set aside 1 percent of its annual profits — an estimated $8 million based on 2016 figures — to create a bonus pool to award second- through sixth-year associates who meet certain billing targets and have demonstrated devotion to the firm by sticking with it for at least three years.
According to the National Association for Law Placement, lateral associate hiring accounted for 60 percent of lateral hiring in 2016, with an average of nine hires per office of a law firm.
The consequences of the trend aren’t cheap — some estimates peg the cost of replacing one associate at $400,000.
“The active lateral hiring market for senior-level attorneys is one factor that I believe will impact legal year-end bonus treatment this year,” Sullivan said.
By Aebra Coe
–Editing by Brian Baresch and Rebecca Flanagan.