LOCATION, LOCATION, LOCATION?

In “Greed Atop the Pyramids,” I observed that the internal spread between the top and the bottom within large firm equity partnerships has grown dramatically in recent years. No one feels sorry for those at the low end, but the compensation for many top partners has reached staggering heights. My title suggested an explanation.

K&L Gates Chairman Peter Kalis — whom I’ve never met — has offered another reason: It’s not greed; it’s geography. His photograph appeared with The Wall Street Journal article on Jamie Wareham, “The $5 Million Dollar Man.” According to the Journal, at K&L Gates “top partners earn up to nine times as much as other partners. Pay spreads widen as firms become more geographically diverse, operating in cities with varying costs of living, said Peter Kalis, chairman of K&L Gates. The firm’s pay spread rose from about 5-to-1 to as much as 9-to-1 in the past decade as it expanded. ‘Houses cost less in Pittsburgh than they do in London,’ Mr. Kalis said.”

Let’s consider that proposition. It’s certainly true that London is more expensive than New York, and New York is more expensive than Pittsburgh. It’s also true that some firms consider cost-of-living differences when setting compensation; some apply formulaic across-the-board geographical adjustments. But the issue involves the top of a widening range, not the relative cost of comparable talent across offices.

Here’s how to test the hypothesis that geography accounts for this relatively new phenomenon: Are all of a firm’s top equity partners located in the city of the firm’s most expensive office? I doubt it. Or try it from the other side: Are any of the biggest paydays going to partners working in less expensive cities? Almost certainly.

I don’t know how much Kalis makes, but he might even be a useful example. His K&L Gates website biography page shows a commendable involvement in a number of Pittsburgh-area civic organizations. In addition to his Pittsburgh office, the page also lists a New York phone number, but his only bar admission is Pennsylvania. He’s certainly not headquartered in the most expensive cities where K&L Gates has offices — Tokyo, Moscow, Hong Kong, Singapore, Beijing, London, or Paris. My hunch is that, as Chairman and Global Managing Partner, he’s not at the low end of his firm’s equity partner compensation range, either. So why the superficially appealing but ultimately unpersuasive “houses are cheaper in Pittsburgh” line to explain away a pervasive big law trend?

Perhaps it’s because reality is sometimes harsh and unflattering. Citing a former pay consultant for law firms, the Journal article noted, “A majority of big law firms have begun reducing the compensation level of 10% to 30% of their partners each year, partly to free up more money to award top producers.”

I don’t know if that has happened at K&L Gates, but other law firm management consultants have suggested that the need to attract and retain rainmakers in a volatile market has widened the top-to-bottom equity partner range in many firms:

“Before the recession, [the top-to-bottom equity partner compensation ratio] was typically five-to-one in many firms. Very often today, we’re seeing that spread at 10-to-1, even 12-to-1.”

Finally, the Journal article itself provides additional evidence that something other than geography is at work: “A small number of elite firms, such as Simpson Thacher & Bartlett LLP and Cravath, Swaine & Moore LLP, still hew to narrower compensation bands, ranging from 3-to-1 to 4-to-1, typically paying the most to those with the longest service….”

Cravath has a London office. Simpson Thacher has offices in Beijing, Hong Kong, London, Los Angeles, New York, Palo Alto, Sao Paolo, Tokyo, and Washington, DC. Yet they have avoided the surging top-to-bottom equity partnership pay gaps that Kalis attributes to geography.

To understand what has really happened recently inside big firms — and why — read The Partnership.

There is, indeed, greed atop the pyramids — even in Pittsburgh.

8 thoughts on “LOCATION, LOCATION, LOCATION?

  1. “A majority of big law firms have begun reducing the compensation level of 10% to 30% of their partners each year, partly to free up more money to award top producers.”

    primarily by converting equity to nonequity partners

    wasn’t K&E the first to use non-equity partners in a big way, leading the way down the path you (more by the tone of your article than its argument) criticize?

    • The K&E non-equity/equity partner structure was in place when I started at the firm and it was there when I left more than 30 years later. When they were relevant to me, the three or four years after promotion to non-equity partner was a period of further development while the firm considered a candidate’s long-term future. Much has changed. It’s no secret that the road to equity partnership throughout big law has now become more challenging as firms have focused myopically on leverage, billings, billable hours, and other business school-type “metrics” to maximize current year equity partner profits. Too often, actual legal talent becomes a necessary but not sufficient condition for advancement. I view the recent explosion in top-to-bottom spreads within big law equity partnerships as a related phenomenon. It all starts at the top.

  2. Chris,
    I don’t think the mechanism by which they achieve the pay reduction is as significant as is the fact of the reallocation of wealth to this degree. That those who produce more, get more, is not a new idea, but the growing disparity and the presumed trend-line make for grim prospects for what will likely prove a growing % of BigLaw partners. Once an arms race like this gets triggered, it only escalates. (Think: associate salaries a few years ago.)

  3. I think there is some truth in the geography argument in that having offices in regional centers means you cannot bill the rates for those lawyers that you can in New York and DC. And I suspect that a firm manager’s compensation where the firm has multiple offices is not tied to the billing rates where he or she lives, because that compensation is not tied to billings. (Separate discussion, that.)

    But I think the better question is whether there is some point that a running out of some of the best lawyers who do the work in order to pay more for “top producers” (who are often not really knowledgeable lawyers) so dilutes the product being sold that it becomes self-defeating.

    And sometimes a partner has to ask whether, if top producer TP left with clients X, Y and Z, but the firm did not have to pay TP and his or her minions any further, would the rest of us make less money or more?

    • With respect to geography, I think the question is whether the high cost-of-living in, say, London, explains the high end of the burgeoning top-to-bottom equity partner range in global firms. In my view, the answer is no. Your points about the long-range implications and the net economic impact of a top producer’s departure are good ones. For example, will Paul Hastings partners be better off with Wareham’s move to DLA Piper? I don’t know, but depending on the economics of the situation, it’s certainly possible.

  4. I just recently found your blog and find your commentary very trenchant. My thought on the geographic argument is that its a complete red herring. As the other commenter noted, its based on billable rates. If a large firm charges the same for an associate in Pittsburgh as they do in London, they likely also pay the associate the same, and that generates the same revenue and same profit. If a partner can be billed at the same rate in each city, then they too will likely be worth the same level of pay. In other words, if a partner can generate the same number of hours and the same total revenue in their book, then the appropriate compensation should be the same whether they live in London or in a hut in the Himalayas. Of course, in reality, if the practice in Pittsburgh (or the hut) is likely regionalized, its unlikely to generate the same revenue per hour as one in New York, and thus compensation might vary. But, that trickles down: if the firm pays a NY associate and a PA one the same, then the practice that can’t support the higher rates will not do well at that firm.

    Ultimately, I think you are correct that greed among the top leads to the pressure below. If lateral X is making 5 million, then the previous #1 guy at 4 million wants to be at 5. That extra 1 comes out of someone’s hide.

  5. Like many other business trends, this is an issue that may have been slow to come to the legal industry, but it is hardly a new concept. The most logical parallel I see is that of sports free agency. The attraction of “talent” is based on compensation and playing for a team “that can win a championship”. Even the most loyal franchise players in sports will switch for a better deal. And, the teams will pay because the player possesses a rare talent which can trump the talents of players they face

    However, that is why this is probably a bubble. Is that particular lawyer that does M&A the ONLY person that can do that work? Hardly. They may be talented, but there are probably 20 people in the same city that can do the work. They may have the client base, but I would like to see a formal profitability analysis of profit margin that comes with buying such a book of business. Most firms do not do so before extended lateral offers (or, it is based on rosy projections and data supplied by the suited party).

    Like sports stars, their pay becomes not a reflection of profit or value. It is based on the comp package at which the last person was signed. You have heard the line “making him the highest paid quarterback in the league.”. This is what we are starting to see here. The next step, making room under the salary cap, is already occurring by releasing lawyers or reducing their packages and promises of a partner track. The restructuring of the firm to accommodate the superstars and placate their demand is underway. The firm is attempting to buy a championship and changing the game plan to suit the diva.

    As in sports, sometimes this works. Other times, the superstar breaks a number of personal records, but the teams trophy case is just as empty as before they arrived.

    Profitability analysis and results based compensation are what is needed to bring some sanity to this growing concern.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s