Bonuses and Law-Firm Associate Compensation

It is the time of year when some law firms pay out substantial bonuses. The bonuses may be predictable from year to year, or not, and then there may also be "special bonuses" of another $10 - $30,000, so that the overall compensation of a second year associate could end up coming in a mix that is three-fourths "salary," and one-fourth bonus. There is something of a puzzle in this, and then also the pattern of elite firms' matching one another's bonuses, as they do salaries. The associate at Firm A may receive a stated salary of 180K and then be given a bonus of 35K with an extra bonus of 15K. Meanwhile, the associate at cross-town rival B, receives the identical salary, and then the identical bonuses.

There is nothing wrong with the conventional explanations.  The bonus may be a way of showing (or trying to show) appreciation just when the associate needs an extra push to work long hours. It may be a way of keeping associates from departing during a busy season, as they wait until bonuses are paid. The bonus feature may protect the firm (or the associates from layoffs) in the event of a bad year, inasmuch as the bonus need not be paid. Less conventionally, it may (as a colleague of mine suggested today) be a way of helping young spenders hang on to some money at year's end, and indeed the marginal rate of consumption may be a bit lower out of "windfalls." And it may be a way of creating a wedge between those who are part-time or those out on parental leave, who will often not qualify for comparable bonuses. Finally, but surely there are other explanations, associates, like other experimental subjects, may respond better to random rewards than to regular ones (like a schedule of pay linked to hours worked).

The parallel behavior among forms is not difficult to understand, at least at one level. If all firms imitate, then the first mover gains only a small reputational advantage - and at some cost (to all firms). But it is likely that only a set of very profitable firms match the bonus payments. We have a market in which there are perhaps 100 firms paying top wages, and then, 50 firms paying yet higher wages through the bonus system.

Clients are said sometimes to resent or resist the high pay of associates. They are suspicious of high billing rates attached to inexperienced lawyers. It is possible that bonuses are less publicized so that clients do not express concern when that form of compensation rises. It is interesting that associates of British firms are said to be paid less than their U.S. counterparts, even though they are often billed out at higher rates. The wedge between compensation and hourly billing rates could have many sources, including higher real estate costs in London. But it suggests that the market for legal services is somewhat unlinked from the market for associates. The division of rents between firms and associates need not be the same in disparate locations.

Perhaps the most compelling explanation for the bonus structure is that it allows, or eventually will allow, differential compensation within a firm, depending on how many hours an associate wishes to work. The initial salary is high enough to signal prestige, but the firm wants associates even if they want to bill "only" 1850 or 2000 hours a year. But of course if the associate is willing, or wants, to work longer hours and bill 2200 or 2500 hours that is all the better - so long as the firm does not lose the excellent lawyers who do not want to work such hours. At some firms bonuses are proportional to hours billed, and I suspect that at other firms they will be soon. The confounding element is that some firms "ruin" the multi-tier system (higher pay for more hours, but it is acceptable to work somewhat fewer hours) by raising the base salary with great fanfare. When Firm A announces that its starting salary has gone up from 145K to 160K, Firm B might wish to say "Well, ours will remain at 145, but we will raise our bonuses so that the hard worker will do as well here as at A - but here there is the option of fewer hours." The problem is that many starting associates will prefer Firm A because the 160 salary is guaranteed even for those who do not work the extra hours. Still, it may be possible over time for Firm B to develop a reputation that it will indeed pay bonuses that enable a two-tier system which, in principle, might be desired by many potential employees.

Comments

[saul levmore]

Over in Volokh Conspiracy ( http://volokh.com/posts/1196794243.shtml ), Orin Kerr suggests that the salary/bonus allocation is a product of (1) salary as a signal of quality to uninformed associates, and (2) bonus as reward and incentive for billable hours. That's good though it does not explain why so many firms refrain from paying bonuses. We both like the idea of bonuses as reward or incentive (or reducer or resentment) but I'd still like to suggest that firms may be happy with some modest billers. The question is whether they can be supported in an equilibrium, or whether they will always be outflanked by firms that choose instead to raise base salaries in order to send a stronger "signal."

[Ted]

Rational firms in the top tier would be happy with modest billers, but I have yet to hear from a law firm partner who was happy with the 1750-hour-billing associate; surprisingly few law firm partners adequately understand the idea of marginal resources, and view the 1750-hour-biller through the cost-accounting system and think that they're losing money on the attorney once they attribute overhead costs. (I've even heard some partners claim that they lose money on second-year associates as a group.)

[qwerty]

The small variations (as low as 5K in either direction) from the mostly lockstep class bonus are neither necessary nor sufficient to create multiple tiers of productivity. A more convincing explanation is that firms want to reserve the option of lowering total compensation in tough times in a more subtle way than by reducing base salaries. This helps internal morale and recruiting.

[Michael E. Lopez]

Firms prefer the predictability of knowing when most of their associates are going to leave (January-March). This is optimal timing, because it gives the firm several months to bring their new crop of first years up to speed.

The bonuses are, I think, primarily a way to regulate the inevitable departures. Associates stick around till December to get their bonus, and then leave ASAP so that they can qualify for the largest possible pro-rated bonus at their new firm (if any).

[Transplanted Lawyer]

Further to Michael E. Lopez's point, when I worked in a large firm, I was often told that the bonuses would be computed based on a calendar year's performance, and then paid in the spring. Of course, if you'd quit in the interim, you wouldn't get paid anything since bonuses were only paid to current associates. So, people had to stick around for several months, in order to actually collect those bonuses, which meant they missed out on the prime recruiting season when they could have gotten the best salaries offered by the firm's competitors.

Bastards.

[meh, really]

It is interesting that associates of British firms are said to be paid less than their U.S. counterparts, even though they are often billed out at higher rates.
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Ugh...this is comparing apples to oranges. The legal market is different in the U.K. because the cost and structure of legal education and training is completely different. Of course the compensation structure for newly qualified and newly barred attorney will differ. I'm sure you know this (you are a dean), but opted against including it in this entry.

The big question is why?

[Jeff Donner]

2,500 "billable" hours in a year? Please.