Jumping through hoops – why merit-based pay is becoming the norm at top law firms

Merit-based pay for associates is rapidly becoming the norm rather than the exception. Pui-Guan Man takes a look at the different options on offer and the challenges firms still need to overcome

Pre-recession, associate pay was a pretty simple concept at most firms. Every May firms would increase their salaries for lawyers of all levels of post-qualification experience (PQE) and every May associates would also move up to the next PQE year, effectively equating to two rises for every lawyer – one to reflect market rates and the other to reflect the individual’s experience.

There is nothing like a prolonged economic downturn to focus attention on unwanted fixed costs though, so it was only a matter of time before those paying flat rates to associates started moving in the direction of performance-related measures instead.

That partner pay has also been increasingly linked with individual performance in recent years has only added further weight to this trend. As has the fact that, in what remains a highly competitive graduate recruitment market, where one firm goes the others tend to follow.

The upshot is that appetite among firms to usher in merit-linked pay for fee earners has grown so significantly over the last 18 months or so that those who do not do it are now the exception.

Getting the ball rolling

If A&O got the ball rolling within the magic circle – when in 2006 it linked pay for senior associates with individual performance – it was Freshfields Bruckhaus Deringer that made the most decisive move, with its overhaul of both its associate career path and salary structure to avoid reference to PQE, effectively consigning associate lockstep to the archives.

While other firms, such as legacy Herbert Smith, legacy Norton Rose and Ashurst, had made their changes earlier, it was the wholesale revamp by the traditionally conservative Anglo-German firm which gathered most attention.

Freshfields certainly didn’t rush its move though, first announcing plans to change its associate career ladder and appraisal system so that they were based around ‘milestones’ rather than PQE in 2009, and only starting to appraise associates on the system in 2011, with pay moving to the new system in 2012.

The firm now divides the associate career path into four distinct milestones, with lawyers needing to fulfil specific criteria in order to move past each. Salary is banded for those within each level based on performance.

“PQE was so embedded in the sector that we needed to spend time explaining how our system would work and reassuring our people and the market before implementation,” explains the firm’s London HR director, Jill Hoseason. “We were leading the way in introducing the milestones, and at the front end of the market in terms of performance-based pay, so it was relatively unfamiliar and we wanted our people to understand it and be comfortable with it.”

The firm has subsequently been looking at rolling the scheme out internationally, as well as collaborating with HR teams at both clients and other law firms to share information about the system.

“We’ve seen a lot of other [law] firms become more interested in performance-based pay. The merit-based system is really well embedded in other sectors, and adopted by many of our clients, so, as the legal sector becomes more outward looking, then absolutely we think that other firms increasingly will follow,” adds Hoseason.

All indications suggest she is right, with merit-based pay that does not reference PQE increasingly now the norm. The trend was further demonstrated by moves in 2013 and 2014 by Clyde & Co and Bird & Bird respectively to rejig their associate career paths. Clydes formally introduced a clear career development framework to regroup its fee earners into three distinct bands as junior associates, senior associates and legal directors, while Bird & Bird tightened its existing structure by toughening promotion criteria at each level.

Braving new territory

With so many firms now having made their foray into the brave new world of performance-related compensation, the concept is much less controversial than it used to be.

After all, the logic for promoting a high performance culture by rewarding the most deserving lawyers over a traditional associate lockstep is clear. Why should two lawyers performing at vastly different levels receive the same pay simply because they happened to start their training contracts at the same time?

The difficulty for firms is that they still face the challenge of defining competencies and benchmarks and, by extension, employee expectations.

How do you judge the associate in the M&A or finance team working long hours every day of the week on some of the firm’s biggest transactions on the same level as someone equally intelligent and well-trained but working far fewer hours in a quieter practice area for example?

If firms want to reward their young stars while keeping salary costs manageable, it seems almost inevitable that merit-based compensation will end up being linked with differentiation between different practices.

It is at this point it becomes divisive, however, with Norton Rose Fulbright global people partner Andrew McEachern warning it is a risky path to take.

“As ever, some practice areas are busier than others,” he notes of the current upswing in M&A activity. “[Busier practices] might make the case that they should be able to operate in a slightly different way and that they ought to be remunerated differently for having to work longer or more unsociable hours that are less evenly spread throughout the working week.

“However, going down this route is a slippery slope because the economic cycle often results in different practice areas being busy at different times.”

The situation becomes further complicated by the fact firms are sometimes forced to pay transactional lawyers they hire into the firm post-qualification more than those grown organically.

The lack of clarity in criteria for assessment reinforces the risk of lawyers feeling the system is unfair. Not only is there a risk that some less profitable practice areas will struggle to find enough lawyers keen to come in at the junior end, but recruiters also predict a flow of more senior talent out further up the scale, especially in those practice areas with a sharp deficit between supply and demand.

As one recruiter puts it, “the better the firm, the better the standard” – and if a lawyer thinks they can move from the middle of a band at their firm to sit at the top of a band at another, chances are they will.

“There isn’t a particularly scientific mechanism for merit-based pay and how it works,” says Edwards Gibson recruiter Scott Gibson. “In a hot marketplace, it can cause confusion. Lawyers may become unhappy with how they are graded and move to another firm that will pay them more.”

There is also the question of when is the best time to introduce merit-linked pay, with some arguing it is being brought in too early at some firms. RPC, for example, scrapped fixed salary rates for newly qualified (NQ) lawyers last November, citing “the pressures clients are under to obtain value from their suppliers”. Firms such as CMS Cameron McKenna, Ashurst and Hogan Lovells also operate merit-based pay from qualification.

“How on earth can a lawyer prove their worth at such an early stage?” questions one legal professional. “It makes far more sense to introduce it around at least two years into a lawyer’s career.”

The real test

While merit-based pay is crucial to differentiating and engaging top performers in the war for talent, how pay is actually distributed in practice is the key measure and is certainly one which prompts many to think they would be better valued elsewhere.

Partners suggest that while the gap between the top and the bottom of each band can be large, the overwhelming majority of associates fall into an adequate bracket in the middle, with very few on either extreme end of the spectrum. In the case of Slaughters, for instance, only a very small number of its ranks are likely to receive its coveted new “exceptional” grade.

A criticism often levelled at merit-based pay models is that lawyers will put too much focus on competing with each other instead of competing with rival firms, further complicating the challenge of striking the right balance to best attract and retain talent.

“The challenge with a discretionary performance-based system is where there are significant numbers of people at a certain level some of whom will inevitably feel the discretion has not been exercised fairly,” says McEachern.

“The more discretion there is, the more flexibility, but also the more potential problems in trying to moderate among a significant amount of people. This is why our bonus process is very formulaic and transparent. We’ve made it very clear what a lawyer will get when they achieve a certain level. Partner discretion is therefore very limited.”

Handle with care

In this expectation minefield then, how assessments are managed and by whom is paramount. Firms have been quick to point out that although HR teams run the process, partners and practice heads are the ones who ultimately make the decisions. Some partners though argue that the process sometimes now relies too heavily on HR and finance departments. Particularly given the time constraints partners have for such extensive benchmarking against not only the individuals’ team but the firm as a whole.

“From what I’ve seen, lawyers just don’t have the time to manage people,” says one recruiter. “I’d speculate that HR are the ones that mostly monitor and rate individuals – a dangerous thing, as it is the partners who have the knowledge of working with the individual in question, not HR. And I would wonder if this might also feed back into the idea of a higher risk of practice group differentiation.”

“We spend a lot of time trying to get it right every year,” counters McEachern. “We use a mix of HR which runs the process – gathering data and facilitating the relevant discussions – and partners, who understand the contributions of the various individuals best. If you leave it to an individual to decide it would not be as objective and likely to result in significant inconsistencies.”

“The sensible approach to assessing an associate’s development is to reflect both technical ability and business development skills,” says Badenoch & Clark recruiter Ian Holloway. “There is a huge upside to firms if they can get the assessment criteria correct.”

No turning back

The shift in approach has not been driven purely by law firms. Rather the move fits more neatly with hardening client attitudes post recession, as they grow ever more focused on tightening spend and driving tougher bargains. Quite simply they are not happy to pay a certain rate just because the lawyer in question has a certain level of PQE.

“In today’s world, clients aren’t necessarily willing to pay a standard rate across the board for a three-year qualified solicitor – it depends on whether they have the requisite level of ability and experience,” observes Holloway. “Experience levels affect transactional lawyers in particular. For example, a mid-level associate in 2014 is unlikely to have worked on the same number of deals as a mid-level associate in 2005, due to the recession.”

He adds: “It reflects the ability and value to the firm of a particular associate, rather than simply how many years they have been employed by the firm.”

In addition to winning client support there are clear management benefits to performance linked pay. Indeed some recruiters suggest that it could even be used to justify reducing fee earners’ salaries in difficult financial conditions.

“A lot of firms will tell you it’s not about cost cutting, but the timing of when the trend took off, which was mainly during the downturn, speaks for itself,” says one recruiter.

A London partner at a US firm adds: “Honestly, I think merit-based pay is driven by cost-saving as much as a firm’s determination to hang on to star associates.

“Part of hanging on to those key associates in turn depends on how profitability in general has shaped up. Associates are smart, and will be watching profit figures to assess their prospects at a firm that may turn out to be a sinking ship.”

What is clear is that merit-based pay for associates – as with partners – is a firmly established trend. It means that there is a lot more uncertainty for individuals and a lot less transparency about which firms really do offer the best packages. And as firms try to negotiate the push-and-pull tension between collaboration and competition that performance-related models inherently create, it falls to them to decide how best to administer a system which connects the value of an associate’s contribution to a firm’s overall welfare, without letting their talent slip through their fingers.

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Bonus points

Merit-based pay and performance-related bonuses are generally two very different things. However, there are signs that merit-based pay and bonus structures are being treated as more interchangeable post the widespread UK salary freeze in 2009. As short term and flexible incentives, bonuses are increasingly being deployed in the face of more modest fluctuations in base salaries.

“COOs have always set bonus pools based on affordability. It is a case of cutting the cloth to the right size,” says an HR professional at a law firm.

Considering that many firms still award bonuses that heavily factor in how many chargeable hours an individual has logged with their firm, it could be argued that firms are finding it challenging to weight both accordingly. But there has been steady improvement on this front with many firms now factoring in business development efforts for example.

“Over the course of time, a particular practice group might have a testing year financially one year whilst individuals within the group might remain very strong performers.  A good bonus structure that reflects chargeable hours but also other performance factors such as valuable non-chargeable work and overall contribution, can result in associates still being compensated for top performance. Chargeable hours alone possibly wouldn’t allow for that,” says Eversheds head of reward Jackie Buttery.

“In respect of bonus potential, firms used to make narrow assessments of performance based on chargeable hours worked.  Now firms are becoming more sophisticated and, in the last five years, firms have really sat up and paid attention to lawyer contributions to business development activities and internal knowledge transfer.”

The concept of moving away from flat rate percentage bonus models in rewarding employees is also extending beyond fee earners, with some firms either introducing or developing merit-based bonus structures for support staff as well.