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Putting justice aside, tipping the scales of compensation and leverage can have a significant effect on the makeup and morale of a law firm. Some of the managing partners that spoke with The Legalhave very different views on how to manage those issues and others. Compensation As lateral-moving partners jump across the legal landscape like kids playing hopscotch, firms are fighting to maintain an institutional client base. The solution has become a shift in compensation strategies from seniority to meritocracy. And for some firms, that might mean an increase in the compensation index, a measurement by The American Lawyerthat looks at the ratio of what the highest paid partner earns compared to the compensation of the lowest paid partner, regardless of partner tiers. “With so many firms compensating on a merit-based system, you’re just going to have a larger swing,” Thorp Reed & Armstrong Managing Partner Douglas E. Gilbert said. It used to be that from the time attorneys were in law school there was a sense among them that it was good to be treated like the rest of the group, Attorney Career Catalysts founder Frank D’Amore said. Competition wasn’t as fierce and compensation was based more on seniority, he said. Times have changed over the past 10 to 15 years and the ratio of compensation among partners may continue to increase, D’Amore said. “There’s a greater need to take care of people who are productive right now because there is a fear that they might leave,” he said. Duane Morris’ method of compensation hasn’t changed, chairman Sheldon Bonovitz said, but since he has been at the helm of the firm, its compensation has been “more real-time merit based.” Compensation is done without regard to office or practice area profitability, but based on the individual contributions of the attorney, he said. Buchanan Ingersoll & Rooney Chief Executive Officer Thomas L. VanKirk said that it is important to make sure the ratio does “not get too high out of whack,” but said his firm does not have a cap on compensation. The firm’s compensation index is about 4.5-to-1, he said. A common compensation index generally lingers between 8-to-1 and 10-to-1, Altman Weil consultant Ward Bower said. Cozen O’Connor showed a compensation index of 37-to-1 for 2005, up from 26-to-1 in 2004. Because it is a first-generation law firm, Bower said it is important that the founders be paid accordingly. “If you take me and Pat O’Connor out of the mix, your talking about a ratio of somewhere between 3- or 4-to-1,” chairman Stephen A. Cozen said. He said that he and O’Connor didn’t like the old partnership methodology that if an attorney originated a client he or she got credit for revenue that another attorney generated from the client. “We operate as a meritocracy,” he said, adding that could mean that a shareholder might make less than a member of the firm. Drinker Biddle & Reath managing partner Andrew C. Kassner said the problem with having a high compensation index is that partner morale might suffer. The higher the index, the more it seems the firm is supporting an “eat what you kill environment,” he said. How money is given out also can vary from firm to firm, Gilbert said. Many firms, he said, distribute the bulk of their money at certain times of the year and then give a few bonus checks at the end of the year. His firm prefers to disburse cash continuously and in even installments, he said. The goal for Thorp Reed, he said, was to retain about 35 percent of its gross revenue to be distributed as compensation. Leverage Those firm leaders who spoke to The Legalseem to agree that leverage has a direct tie to the profitability of a firm, but they disagree on whether it should be measured by practice area or firmwide. Most people tend to view leverage as the ratio of associates to partners, but Bower said it is really the ratio of profit contributors to profit shareholders. The non-equity partner tier would therefore be included on the contributor side of the ratio, he said. Bower and D’Amore said leverage is practice area specific. Litigation and some corporate mergers and acquisitions work require a higher ratio of about 3-to-1 or 4-to-1, D’Amore said. A highly specialized tax practice might not be leveraged at all as just that one partner handles a matter, both Bower and D’Amore said. While VanKirk agreed that certain practice areas need lower leverage, he said it “solely has to be on a firmwide basis that you measure it.” Buchanan Ingersoll has a leverage of about 4.5-to-1, VanKirk said, and he wants it to be higher. “Firms that get up to 5-to-1 have higher profits per partner,” he said. Bonovitz said he does not view leverage as practice area specific. About 25 percent of Duane Morris’ attorneys are equity partners and Bonovitz said the firm expects each of its equity partners to create enough work to keep at least one or two associates busy. Cozen said leverage is important to the profitability of a firm, but high leverage is not necessary. It ultimately comes down to what is best for the client, he said. While many firms have a higher leverage for litigation matters, Cozen said his firm is handling a billion dollar insurance litigation case with one partner, two associates and a paralegal. “We try to use the minimum number of quality lawyers,” he said. While leverage is a good thing for law firm economics, a high leverage cannot be used in every matter, he said. Gilbert said he thinks leverage is practice area dependent, but also has an eye on what the clients are willing to pay for. “It’s a dangerous game to be so focused on leverage that you lose sight of how you’re serving your clients,” he said. “Clients are not willing to pay for leverage.” Clients at Wolf Block Schorr & Solis-Cohen and Eckert Seamans Cherin & Mellott aren’t paying for high leverage because the firms’ leaders said their leverage is 1-to-1. “What’s not good leverage is our ratio,” Wolf Block Chairman Mark Alderman said. “Less is not more, more is more.” The firm has been at a 1-to-1 ratio for at least as long as Alderman has been there, he said, adding that it is “fiercely difficult” to change leverage. “You have to grow your way into leverage,” he said, either through a merger or by moving attorneys “from the top” and putting them “on the bottom.” Eckert Seamans Chief Executive Officer Timothy P. Ryan said his firm is in a comfort zone at 1-to-1 leverage. He said the firm quickly juggles leverage through the use of contract attorneys. One local AmLaw 200 firm that has better PPP and revenue per lawyer than many of its AmLaw 100 neighbors has the opposite of what leverage is normally seen to be. Out of the 167 lawyers listed for Reading-based Stevens & Lee on the AmLaw 200 for 2005, 103 were equity partners. The firm’s managing partner Joseph M. Harenza said several reasons contribute to the firm’s ability to succeed with the rare model. Most of the firm’s 14 offices are located outside of major markets, in part, to save on overhead, he said. The expense per lawyer at Stevens & Lee, Harenza said, is about $100,000 to $150,000 less than most firms. The firm also makes it a priority to handle mainly high-end, specialized work that is not rate sensitive, Harenza said, adding that the firm is not really handling insurance matters or similar practice areas that traditionally have lower rates. The realization rate for collecting on accounts receivable is at the higher end, he said. “If I had more associates, we’d have $1 million plus in profits per partner,” Harenza said. Hourly Rates The overhead of international expansion is causing some firms to price themselves out of certain markets, Ryan said. Hourly rates are the driving force in the industry right now, he said. “They just keep going up,” Ryan said. “There are lawyers that are looking to leave because they have nice books of business, but their clients can’t pay [the rates.]“ He said his firm has seen an increase in lateral interest because of just that scenario. Firms that are neither international/global nor boutiques, but are somewhere in the middle are the ones that have the problem of pricing themselves out of the market, Ryan said. It is firms of 100 to 300 lawyers that do not have an institutional client base that are the ones who suffer in the current market, Cozen said. “They place themselves out of the market if they try to mirror themselves after the super 25,” he said, adding that clients won’t pay those rates. Cozen O’Connor has a “large range of rates,” he said and can charge higher rates for its commercial litigation than its insurance litigation work. Duane Morris has made no secret about its intentions to grow by about 400 lawyers in the next few years. Some of that has already begun, and Bonovitz said hourly rates are no more or less of a problem than they were five to 10 years ago. He said his firm raises its rates annually. D’Amore said that over the last 10 years, firms have become much better at cost management in terms of reducing overhead. The only place, then, for firms to increase profits is through increasing revenue, he said. Because there are only so many hours in a day for an attorney to work, the logical place to look for increased revenue would be through increased rates, he said. While the “mega-firms” like Morgan Lewis & Bockius and Dechert can get away with charging high hourly rates because of their depth and breadth, some of the smaller firms might find themselves losing clients, he said. Overall, however, D’Amore said he does not see firms like Saul Ewing or Cozen O’Connor having to keep their rates stagnant. Many of the local firms are able to consistently raise their rates, he said. Some of the rate decisions will be practice and geographic area specific, but firms will look to bring each office and practice area to its maximum rate allowable by the market, he said. D’Amore said that firms could get to a point where they would lose clients if the rates get too high. As more and more firms have offices outside of their headquarters, companies are no longer only interested in using that close-to-home firm, Kassner said. Companies want firms that can handle specialized work and they are willing to pay for it, he said. He said the idea of pricing the firm out of a market is not really the analysis used anymore. The issue of rates, he said, is not based on geography but on the level of work and the type of client. In the next installment of thePartners & Profits series on Oct. 23, read about how local law firms feel about debt and set up capital contribution and pension plans. �

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