Every spring, the eyes of attorneys at large law firms everywhere turn to The American Lawyer‘s Am Law 100 rankings, and specifically to the list’s key metric: average profits per equity partner (PPP). But if the goal is to obtain meaningful insight into a firm’s culture, financial strength, or the profitability of most of its partners, those focused on PPP are looking at the wrong ball.
Start with the Basics
For years, large law firms have been increasing their PPP by reducing their equity partner ranks. The American Lawyer reports that such cuts, when done correctly, are “a solid management technique, not financial chicanery.” But as currently being executed by some firms, it looks more like throwing furniture into the fireplace to keep the equity house warm.
Since 1985, the average leverage ratio of all attorneys to equity partners among Am Law 50 firms has doubled from 1.76 to more than 3.5. In other words, it’s now twice as difficult to become an equity partner than it was when today’s senior partners entered that club. Between 1999 and 2009, the number of nonequity partners at Am Law 100 firms grew threefold, while the number of equity partners increased by less than one-third.
Arithmetic did the rest: Average partner profits at Am Law 50 firms soared from $300,000 in 1985 ($650,000 in today’s dollars) to more than $1.7 million in 2012.
The Beat Goes On
Perhaps it’s not financial chicanery, but many firms admit that they’re still turning the screws on equity partner head count as a way to increase PPP. According to The American Lawyer’s most recent Law Firm Leaders Survey, 45 percent of respondent firms deequitized partners in 2012 and roughly the same number plan to do so in 2013.
But even when year-to-year equity head count remains flat, as it did overall for firms in 2012, that nominal result masks a destabilizing trend: the growing concentration of income and power at the top. In fact, it is undermining the validity of the PPP metric itself.
An Unpublished Metric More Important than PPP
The internal top-to-bottom spread within the equity ranks of most firms doesn’t appear in the Am Law 100 survey or anywhere else, but it should, along with information that details the number of partners earning different amounts within that range. As meaningful metrics, they carry much more weight than PPP.
Even as overall leverage ratios have increased dramatically, the internal gap within equity partnerships has skyrocketed. A few firms adhere to lockstep equity partner compensation within a narrow overall range (3 to 1 or 4 to 1). Most, though, have adopted wider spreads. K&L Gates, for example, disclosed an 8-to-1 gap, up from 6 to 1 in 2011, when it released its 2012 financial statement [PDF]. Dewey & LeBoeuf’s range reportedly exceeded 20 to 1.
This growing internal gap undermines the informational value of PPP. In any statistical analysis, an average is meaningful if the underlying sample is distributed normally—along a bell-shaped curve where the average is the peak, for instance. But the distribution of incomes within most big-firm equity partnerships bears no resemblance to such a curve.
Rules governing statistical validity have real-world implications. While a lower threshold for profit participation makes room for more equity partners, the result over time is a Dewey-style “barbell” system: a handful of rainmakers dominating one end of the barbell, with many more so-called service partners populating the other—and rarely moving very far off it.
As Edwin B. Reeser and Patrick J. McKenna wrote about Am Law 200 firms last year, “Typically, two-thirds of the equity partners earn less, and some perhaps only half, of the average PPP.” Statisticians know that in such a skewed distribution, the arithmetic average conveys little that is useful about the underlying population from which it is drawn.
Why It Matters
For firms that don’t have lockstep partner compensation, the PPP metric doesn’t reveal much at all. Consider, for example, a firm with two partners and an 8-to-1 equity partner spread. If Partner A earns $4 million and Partner B earns $500,000, average PPP is $2.25 million—a number that doesn’t describe either partner’s situation or the stability of the firm itself. But the underlying details say quite a bit about the culture of that partnership.
Firms with the courage to do so should follow the lead of K&L Gates and disclose what that firm calls its "compression ratio" and then take it a step further: reveal their internal income distributions as well. But such revelations might lead to uncomfortable conversations about why, especially during the past decade, managing partners have engineered explosive increases in internal equity partner income gaps.
A future post will consider that topic. It’s not pretty.
Steven J. Harper is an adjunct professor at Northwestern University and author of The Lawyer Bubble: A Profession in Crisis (Basic Books, April 2013), and other books. He retired as a partner at Kirkland & Ellis in 2008 after 30 years in private practice. His blog about the legal profession, The Belly of the Beast, can be found at http://thebellyofthebeast.wordpress.com/. A version of the column above was first published on The Belly of the Beast.