The decision at Shearman & Sterling to de-equitize some partners is making headlines. It fits into a broader trend of Am Law 200 firms becoming increasingly reliant on salaried partners. ALM Intelligence analysis reveals, since FY10, the compound annual growth rate (CAGR) in number of non-equity partners (defined as those who receive more than half their compensation on a fixed-income basis) has eclipsed that of equity partners within every level of the Am Law 200 (Figure 1).

While the percentage of firms with single tier partnership structures versus those with two-tier structures has remained relatively static in recent years, in terms of raw headcount, the growth in non-equity partners has far exceeded those in the equity class. In FY15, there were 21,089 non-equity partners and 29,523 equity partners across the entire Am Law 200, compared to 17,726 non-equity partners and 28,712 equity partners in FY10. The disparity in growth is most apparent with firms in the second hundred of the Am Law rankings. Since FY10, they have seen negative growth in equity partners while increasing their non-equity ranks between 2% to 3%.

NEP Compensation_Figure 1

But what does it mean for the bottom line?

Though non-equity partners are now a fixture in Big Law, little attention is given to non-equity partner compensation. Among firms with two-tier partnerships (defined for this exercise as firms with 10 or more non-equity partners), the growth of average compensation per equity partner has surpassed that of average compensation per non-equity partner in three of the four Am Law tiers (Figure 2). Moreover, within the Am Law 50 and Am Law 101-150, growth in average compensation per non-equity partner has doubled that of average compensation for salaried partner.

NEP Compensation_Figure 2

While every young income partner aspires to move into the equity class, are there firms where a non-equity partner can still make a healthy living? Figure 3 below ranks the top 10 firms by average compensation per non-equity partner in FY15.

NEP Compensation_Figure 3

Higher salaries for non-equity partners hit the firm bottom line, while equity partners are paid out of firm profits. Figure 4 below demonstrates that a top 10 ranking in non-equity partner compensation does not necessarily translate to a top ranking for equity partner compensation. Though probably not a stunning revelation, this illustrates how the financial interests of equity partners may not be aligned with their colleagues in the non-equity class.

NEP Compensation_Figure 4

Only Quinn Emanuel is able to strike a near perfect balance. Number one in non-equity partner compensation, Quinn Emanuel ranks second by equity partner compensation and is the only firm within the top 10 for each partnership group. An additional three of the top firms by non-equity compensation reside in the top 20 for equity partner compensation, while O’Melveny & Myers has the most extreme disconnect between average compensation for its non-equity and equity partners. It ranks number eight on the salaried partner list, but number 47 by equity partners.

What does this mean for Shearman & Sterling’s de-equitization plan?

It may not translate to increased profits per equity partner. On the one hand, moving lawyers out of the equity class reduces the denominator, that is, the number of individuals that share in firm profits. But, on the other, as non-equity partners, their salaries will come at the expense of the firm’s net income. This presents the same issue as the recent trend to increase associate salaries.

New costs, whether through associate pay raises or salaries to de-equitized partners, need to be covered by new revenue or else profits will take hit. How will a firm like Shearman & Sterling, which is reportedly making this decision in a bid to boost profitability, recoup those costs? Maybe there will be no new costs to recoup, or the costs will be short lived. For those impacted by de-equitization, their time as an income partner at Shearman & Sterling may be an interim step, a purgatory between their old life as an equity partner with the firm and salvation through a lateral move.

ALM Intelligence Notes:

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