MOTIVATION OF NEW ZEALAND LAWYERS A CLOSE EXAMINATION OF THE ‘THIRD-THIRD-THIRD’ PRINCIPLE.

Jonny Mirkin, 2011

CONTENTS

Introduction: Third-Third-Third Principle ............................................................................................................... 3

Problems with the TTT Principle ............................................................................................................................. 4

Performance Systems ..................................................................................................................................... 4

Charge-out Rates ............................................................................................................................................ 4

Impact of Legal Aid ......................................................................................................................................... 5

Non recoverable fees ...................................................................................................................................... 5

Unattainable budgets ..................................................................................................................................... 6

Stolen fees – the problems with file sharing .................................................................................................. 6

The junior lawyer ............................................................................................................................................ 7

The firm’s ability to provide quality work ....................................................................................................... 7

Billing practices of the firm ............................................................................................................................. 8

Geography and Nature of the Firm................................................................................................................. 8

Conclusion & Recommendations ............................................................................................................................ 9

INTRODUCTION: THIRD-THIRD-THIRD PRINCIPLE One of the most significant changes in reward management in the last 20 years has

been the extension of performance-related pay beyond the shop floor to white-

collar and professional staff, who traditionally were paid straightforward salaries.1

It has become common in New Zealand law firms to introduce a performance

related pay scheme known as the “third-third-third principle” (TTT Principle). In this

report I strip off the accepted front of such a scheme and identify who it really

favours and whether it provides adequate motivation to staff solicitors.

Many firms today are tying their solicitors’ performance directly to their salaries. By

sharing the risk with the employees, the firms are in turn offering a chance to earn

more bottom line pay. Legal firms have adopted a payment by results (PBR) system

called ‘piecework’. Typically pure piecework schemes are rare, yet they are common

in Zealand firms.

Under the TTT principle, the firm takes the output of the solicitor, in billable hours,

retains one third as profit for the firm (partners or principle), applies one third

towards overheads and direct costs for the work and then pays the final third to the

lawyer as remuneration. This is illustrated in figure 1 below. It follows logically that

the lawyer now has incentive to bill as much as possible in the year to maximise his

income. If a lawyer puts through $120,000 in fees they might expect a $40,000

salary whereas if they are able to bill $150,000 then their salary could increase to

$50,000.

Figure 1: Break-down under TTT Principle

1 I. Henderson (2008). “Human Resource Management for MBA Students.”

$

1/3

Profit to firm

1/3

Contribution to Overheads

1/3

Payment to empoyee as salary/bonus

PROBLEMS WITH THE TTT PRINCIPLE The TTT principle often fails to take into account variables that effect an employee’s

ability to benefit from such a system. Often these variables are outside of the

lawyer’s control and if they are not anticipated and dealt with, the motivation that

the scheme is supposed to provide will fail.

Rewards have to be effectively managed to secure the maximum utilisation of

human assets, and to attract, motivate and retain core employees.2

I suggest that these variables fall into 10 the general headings below. My theory is

that to ensure motivation is at its highest, a firm should first identify what variables

are in play for their staff and then secondly find appropriate ways to ensure that

motivation is not reduced as a result of those variables.

Below I will briefly outline each of the variables along with my recommendations for

how firms should address the problems associated with each variable.

PERFO R MAN CE SYST EMS

Because the purpose of the incentive bonus scheme is to encourage and reward

effort, it is necessary to have some way of linking the rate of work to the level of

output.3

Unless a firm can accurately monitor and record the performance of a lawyer, they

cannot hope to implement this scheme. With performance-related pay,

remuneration becomes more complex and expensive to administer.4 If a firm wishes

to adopt this scheme, they need to ensure the appropriate IT systems are in place to

allow a lawyer to record their time and review their work in progress (WIP). Ideally,

the lawyer should be provided with constant updates from the firm showing them

how they are performing for a given month. Modern systems allow for computer

generated WIP reports and alike which are useful tools for the lawyer.5

Recommendation:

The firms need to ensure systems are up-to-(Aitken 2007)date and accurately

recording the hours worked by the staff, the hours billed, and the recoverable fees.

This will result in a transparent measure to assess performance. If firms are not able

to invest in such systems, they should not attempt this scheme unless they are able

to ensure accuracy of records.

CHAR GE-OUT RAT ES

The success of this scheme is going to be highly dependent on what charge-out rate

a particular lawyer is attributed. A lawyer billing at $200 an hour will need to bill 600

hours in a year to make a budget of $120,000 and a salary of $40,000 whereas a

lawyer only billing $150 an hour will need to work an extra 200 hours over the year

to achieve the same salary. Hence this is a vital factor to the success or failure of

2 I. Henderson (2008). “Human Resource Management for MBA Students.”

3 I. Henderson (2008). “Human Resource Management for MBA Students.”

4 I. Henderson (2008). “Human Resource Management for MBA Students.”

5 See examples of such systems at: http://open-tube.com/law-firm-and-case-

management-software-best-legal-software-to-manage-your-cases-easily

such a scheme. Budgets need to be both achievable and motivational. For example

if a lawyer is required to record 8 billable hours a day to meet a salary of $40,000,

the lawyer’s motivation may be diminished.

Typically, charge-out rates are determined on a ‘pay for skills or competence’ basis

whereby pay is based on defined, recognised blocks or modules of skills6, which is

effectively legal experience of the lawyers.

Recommendation:

Firms will need to carry out evaluations of their local markets to identify what rates

are appropriate for their solicitors. Next a conversation should take place between

the firm and the staff to discuss the rate. Once a rate is decided, they need to

decided what budget reflects a fair work-load at that rate – both in terms of realistic

milestones and realistic market pressures.

IMP ACT OF LEGAL A ID

Lawyers working on legal aid files at $105 an hour7 are faced with a problem. If a

firm is relying on a solicitor to work on a large number of legal aid files, then

budgets should account for this. If other lawyers in similar positions are working on

mostly private files, there will be an inequality in pay unless adjustments are made.

Lawyers’ lack of motivation towards legal aid files has been confirmed in a recent

study in the United Kingdom. It was found that when presented with remuneration

that did not reward the application of extra inputs, solicitors reduced their supply of

such inputs in comparison with previous practice. In contrast, where fee-for-service

continued to be in place, solicitors raised the levels of inputs supplied.8

Recommendation:

If a staff member is working on legal aid files, the firm should have systems to

measure what amount of work is at the lower rate. Once this information is on

hand, an exercise similar to that with the rates should be done to determine what

budget accurately reflects a fair workload at the lower rate. One method could be to

set a budget based on an average charge-out rate – for example if 50% is private

and 50% is legal aid, an average charge-out rate could be used for setting a budget.

If there is a possibility to spread legal aid work amongst staff equally, that would

promote a sense of equality and fairness, further enhancing the motivation of staff.

NON R ECOV ER ABLE FEES

Often fess may be unrecoverable. Whatever the reason, it is an on-going problem

for New Zealand law firms. In the situation where a bill is written-off, the question

arises to who should take the hit?

There are three different figures a firm can chose to peg the salary on: recorded

hours, billed hours, and fees recovered.

6 I. Henderson (2008). “Human Resource Management for MBA Students.”

7 http://www.lsa.govt.nz/documents/LegalAidRatesandFees.pdf

8 Fenn, P., A. Gray, et al. (2007). "Standard fees for legal aid: an empirical analysis of

incentives and contracts.(Report)." Oxford Economic Papers 59(4): 662-681.

The first reflects a lawyer’s actual recorded hours and time spent on a file, the

second is what was actually billed for that work (after any reduction or uplift of

fees), and the third of these is what the firm actually receives in cash.

Depending on the nature of the firm and the clients they service, this will vary. If the

reason for the non-payment was obvious to the lawyer before working on the file

then perhaps, it would be fair to withhold the fee from his budget. However if the

client unexpectedly entered bankruptcy for example, then it may be more

appropriate for the fee to be carried onto the lawyer’s budget.

Recommendation:

The Partners or Principle of a firm enter into ownership because, in most instances,

they wish to pursue a higher return based on a higher level of risk and responsibility.

Part of that risk included bad debts and unpaid fees. Employers should sit down

early with their employees and negotiate what level of risk the employees want to

take on. The higher the level of risk , the higher the salary one would expect.

UNAT TAIN ABLE BUDGETS

Current legislation prevents commissions being paid if it results in an employee

being paid less than minimum wage.9 In law firms the tradition is to agree on a

budget for a set salary which does not change even if performance drops below that

figure. The firm want this figure as low as possible (to avoid over-payment for low

performance) and the employee as high as possible (for higher guaranteed income).

The problem here overlaps with charge-out rates. If an employee is forced into a

lower charge-out rate with a high budget, then it is highly unlikely they will ever

achieve a bonus. Therefore motivation to exceed the budget will be diminished and

ineffective. A firm should be cautious when setting a budget to ensure it is fair and

achievable.

Recommendation:

Budgets needs to be set at a level where they can be reached by the staff. This is

why the earlier steps of setting clear budgets is so important. The motivation of the

budget is so that anything above the budget target – the employee shares the extra

profit, thus adding to their base salary. If the bonus is within a realistic reach,

employees should feel more motivated to exceed their targets. If the targets are too

high and unrealistic they will not serve their task of motivation and in fact may

dampen the lawyer’s morale.

STOLEN FEES – T HE PR OBLEMS WIT H FI LE SHARING

When there is more than one fee-author working on a particular file, the problem

often arises over how the fee should be split. Both authors have something to gain

from a higher portion and debate can ensue over how it should be divided. This is

more common where there is a supervisor relationship in which the supervisor or

partner takes the fees and applies only a small portion back to the lawyer doing the

work.

9 See: Minimum Wages Act 1983 and Employment Relations Act 2000

Recommendation:

This is essentially an exercise that needs to be taken by the firm. Clear boundaries

should be put in place so that lawyers working on files together have clear systems

in place for how files are to be shared. By having fee-author meetings on a regular

basis, the lawyers should have good opportunities to raise any concerns about how

bills are to be split. Another possibility would be to have a default system where,

unless there is prior agreement to the contrary, bills are automatically split

according to the time spent by each author on the file. This is common place in

some firms already.

THE JUNIO R LAWY ER

The junior lawyer is particularly vulnerable for all the reasons above. They have no

existing client relationships, legal experience or ability to produce high fees.

Traditionally a firm will make a loss or break-even on a junior lawyer in the first

year. It is particularly important for a new lawyer to be aware of how the TTT

principle works and how it should benefit them more as time progresses.

Recommendation:

The nature of the industry means that junior lawyers are always going to have less

bargaining position and lower remuneration packages. However, it is important that

these junior lawyers feel valued in their work. There is currently a large problem

with retention rates of young layers and one possible solution is to treat them fairly

from day one. In my experience, there is a lack of career discussion within a firm

and this needs to be addressed. By opening communication early with the young

lawyer – particularly before beginning work, the lawyer is able to feel involved with

the plan and valuable even if the pay does not reflect it.

THE FIR M ’S ABI LIT Y TO P ROVIDE Q UALI TY WO R K

A lawyer is placed under added pressure when there is not enough work for them.

This is usually outside of the lawyer’s control. As a result of the dropped work, often

a lawyer’s budget will be negatively impacted.

This can be particularly de-motivational when a lawyer exceeds budget for a period

of time, only to have the bonus eaten away over another period where work dries

up. This is where negotiation is important and monthly or quarterly bonuses can be

explored to give short term goals for the lawyers which are less susceptible to this

problem.

Recommendation:

This will also be a constant threat to any lawyer working inside a firm. Like the

unrecoverable fees, this would be another area where discussions could take place

between the firm and the staff to see what level of risk they are willing to assume.

The detriment of having reduced work could be compensated by the bonuses that

come with brining new work into the firm off the lawyer’s own back.

However the firm organises this, there needs to be a compromise between the

lawyer’s bonus for hard work and the need of the firm to make a profit. By

introducing a quarterly bonus – employees are less exposed to the market risks and

are able to receive guaranteed rewards for their hard work across busy periods.

There is an element of risk here to the employer so again early communication and

negotiation is going to be key.

B ILLIN G P RACTI CES OF THE FI R M

If a firm has chosen to compete solely on price in a local market then there will be

high fee-reductions for work. A lawyer may work 5 hours on a house purchase only

to find they can only bill the client $200. A common example is the firm who offers

clients a free will. The lawyer doing this work often suffers at the hands of these

policies. In comparison, some firms allow and in fact encourage uplifts of fees to

which employees benefit from the policies.

Firms need to be clear how they will compensate staff for reduced work. Firms

should limit this kind of work and spread it evenly across all staff to maintain

fairness and a good level of motivation for the employees.

Recommendation:

A firm should always be looking at ways to increase revenue for its services. If bills

are constantly being discounted, it perhaps offers an opportunity for the firm to

self-evaluate why that is the case. Employees need to know that their hard work will

be rewarded in some manner, so a reduction is a serious blow to their esteem.

If the firm wants to reduce a bill, it is supposedly for some strategic benefit to the

firm – not a result of lack of quality of the lawyer’s work. For that reason, like the

recoverability of fees it should be a cost that goes with owning the firm. If the firm

insists on reducing some fees without remuneration, then they must at least allow

the lawyer to increase their fees when appropriate to balance out the exercise.

GEO GRAPHY AN D NAT URE O F T HE F I R M

Finally the remuneration will need to be dependent on the firm itself. A study of

Indiana Law graduates showed that job satisfaction was not necessarily linked to

salary as the author’s hypothesised. Noting that both income and job satisfaction

were desirable, they hypothesized that those lawyers in the types of practice with

higher average income were trading job satisfaction for higher income, while those

in the types of practice with lower average income were trading income for higher

job satisfaction.10

The results were inconclusive and it was found that both salary

and job satisfaction were important and generally employees would not be happy to

sacrifice one for the other. There is an important lesson here for firms – that to truly

motivate an employee there needs to be a balance of both job satisfaction and pay.

Firms particularly in cities are also more vulnerable to lose junior lawyers to rural

firms. An Australian study looked at motivating factors for lawyers who moved to

rural firms (the majority of which were junior lawyers). The chief among these

reasons were the nature of the work and professional development opportunities

10

Stake, J. E., K. G. Dau-Schmidt, et al. (2007). "Income and Career Satisfaction in the Legal Profession: Survey Data from Indiana Law School Graduates." Journal of Empirical Legal Studies 4(4): 939-981.

offered, the opportunity to save money, lifestyle, including social and community

networks and distance from ‘home’.11

Given the various benefits for moving to a rural firm, city based firms particularly

need to ensure they strike the right motivation for their junior lawyers to ensure

retention.

Recommendation:

Whatever the size of the firm, there needs to be transparency and open

communication between the staff and the firm. The TTT principle is used to

motivate staff, so firms need to keep in mind the principles already discussed above.

Realistic budgets and fair workloads need to be set, no matter the location or size of

the business. If an employee is constantly underperforming compared to their

budget, the firm needs to evaluate whether that is due to performance or the

nature of the budget and the work being asked of the lawyer. If it is not a matter of

performance, then the budget and workload should be adapted so that it accurately

reflects a fair load.

CONCLUSION & RECOMMENDATIONS Given the above, it seems that the risks for the employee significantly outweigh

those for the firm. The presence of any of the variables above will impact on the

motivation levels of an employee. The default benefit is with the firm and it is only if

some negotiation is made to deal with these variables that the employee begins to

benefit from the scheme.

A firm should undertake an evaluation of staff to see what variables are in play. The

firm then needs to look at how it can accommodate those to ensure that the

employee remains motivated.

If the firm balance things right, they should hopefully end up with happy, motivated

staff that will stay with the firm for years to come.

11

S. Forell, M. Cain and A. Gray (2010). “Recruitment and retention of lawyers in regional, rural and remote New South Wales.”