pay equity when retaining rainmakersMuch of the media coverage following the emergence of the COVID-19 pandemic focused on its widespread unemployment effects across an array of industries and occupations.  In response to these labor market shocks, some firms decided to wait for revenue normalization before re-employing workers who may have been laid off, or increasing the hours of those whose schedules may have been reduced. Other firms enacted structural changes in the makeup of existing staff, such as substituting part-time employees for full-time, or putting groups of employees on indefinite “work from home”-status.

This paper considers another response to COVID-related revenue drops, wherein firms attempted to increase revenue flows before the pandemic receded–specifically, by acquiring “rainmakers,” or “high revenue individuals” (HRIs), from competitive firms. Even as current firm revenues may be negatively impacted, the acquiring firm could expect a boost in near-term future revenue with the arrival of new business brought to the firm by one or more rainmakers.

The Economic Problem:  Firms Cannot “Own” Their MVPs

Movement of HRIs from one firm to another, of course, is not unusual in situations wherein an employee can capture increased earnings by changing firms and bringing an existing book of business to the new firm. To labor economists, the central question is this: “How can firms sustain employment relationships when they have no enforceable means of controlling a firm’s key knowledge asset–client relationships? (Rebitzer and Taylor)” In their recent NBER Working Paper, Rebitzer and Taylor (WP 12583) explore alternate strategies firms employ to prevent “grabbing and leaving with clients”. [1]  The authors find strategies are context-specific and depend on the extent to which firms can monitor or limit the relationships between professionals and clients. The authors discuss large law firms that have historically tended to adopt an “up or out” system– where “experienced attorneys are promoted to partnership or dismissed from the firm at the point that critical client relationships form.  In case of certain consultancies, non-compete agreements are utilized. Stock options are often used by Technology firms to prevent the exit of their key “knowledge” workers.

The COVID-19 situation fostered an environment in which competitive firms offered larger-than-usual incentives to induce intra-firm movement. In doing so, firms hoped to capitalize on the dual opportunity of acquiring long-term employees, and at the same time, substantially raising short-term revenue. An article in the legal press documented increases in rainmaker hiring efforts as a response to the pandemic. The article cited Jeffrey Lowe, a majority partner at Major, Lindsey & Africa, as observing opportunistic law firms during the pandemic putting forth “a concerted effort to lure ‘higher priority’ prospects, particularly partners or groups that can bring large books of business” during the virus epidemic.” [2]

Using a “Stick and Carrot” Approach to HRIs

In response to this continuing trend of competitive bidding for HRIs, we recommend that a “stick and carrot” approach be considered in every firm with high revenue individuals, to ensure that such employees are offered the correct incentives to stay put.  These tools were already important before COVID-induced labor market shocks, but are critical in the current climate. To start, firms must evaluate whether each of their individual HRIs are likely to be viewed as “targets” by competitive firms, all else constant.

We argue that HRIs are likely to possess relatively more of two different kinds of human capital, or skill sets: (1) more efficacy in maintaining and expanding current client business, and (2) more focus on successfully acquiring new business clients. As a result, incentives required to keep individual HRIs will differ.  This is true in both a legal framework, and from a compensation approach.

An Example of Differently-Valued HRIs

Think of two advertising sales executives who are responsible for maintaining and expanding a substantial client base that generates revenue for the firm.  “Agent A” has a large book of business developed over several years, primarily by providing excellent services and expanding business to areas of her clients’ subsidiary companies.  “Agent B,” by contrast, also has a large book of business, but clients were added primarily by introducing advertising services to new industry clients and forming new business relationships.

The key difference between the two executives is that in the case of Agent A, the “reputation” rests with the firm, while in case of agent B, it rests with the agent herself.  Each agent, to an outside competitor, would appear to be an attractive new-hire addition, provided that each can bring some, or all, of their business to the new company. For the existing employer, it is important as a first step to identify the differences between their agents that are relevant to client relationships. Appropriate steps to retain each agent should then be considered accordingly, and account for legal and economic challenges, especially in light of the COVID-19 pandemic’s impact on labor markets.

In the case of Agent A (whose business is centered on clients with long-term relationships to the firm), much of the value to clients is likely to have been generated by the historical relationship of the advertising firm to the end client; Agent A’s primary value is in maintaining these long-term services. Thus, if Agent A attempts to move her book of business to a competitive firm, a large portion of the value of the business’ lost revenue could be viewed by the employer as having been generated by the firm, and not Agent A as an individual.  This may provide some firms at risk of losing HRIs with legal recourse against these costly departures.

The Most Effective “Sticks”: Legal Agreements

When considering HRIs like Agent A, it is important to ask whether the agent, while employed and building her book of business, did so under a restrictive covenant meant to protect the firm from losing firm-generated revenues. While economic consultants can help identify which employees are likely to be HRIs, the most advantageous legal agreements for protecting both the firm and its employees will depend on what particular value an employee holds and how he or she acquired it.  For example, some industries have formalized patenting of company secrets that an HRI cannot “leave with,” or restrictive covenants to keep HRS from leaving a firm with company-owned data or information on clients.  We leave the choice and enforcement of such “sticks” to attorneys inside and outside of a firm with HRIs, but we recognize that some employment fields, such as the law itself, may face shifting boundaries on what “sticks” are enforceable.[3]

The Most Effective “Carrots”: Extra Compensation

Returning to Agent B in our example, we saw this employee most responsible for bringing new business to the firm–that is, clients of Agent B think of her, as opposed to the company she works for, as being the main reason for their choice of advertising agency.  Arguably, an HRI such as Agent B, upon leaving one company for another, will have a higher likelihood of moving her book of business than one like Agent A, whose business is very much linked to the company itself. For this reason, the compensation for Agent B in her existing position must reward her adequately for the type of business her book is built upon.

An economist recognizes the incremental value of Agent B’s revenue production as arising from “new business.” In short, when revenue is brought into a company based on the relative talent of the agent herself, a “new business bonus” recognizes that the company’s reputation and history with new clients are being less rewarded than the profit-producing effort of the agent herself. The payment of a new business bonus conveys to the agent that the company recognizes that his or her effort brought expanded revenues over and above what expanding existing business to longer-term clients would have gained. At the same time, in the current COVID-19 environment, a new business bonus acts as a counterbalance to the relative attractiveness of HRIs who can offer to bring a larger book of business, and in a shorter period of time, to a competitive firm.

A Warning about Compensation-Based “Carrots”

In arguing for compensation package changes that can affect multiple highly compensated employees, we recognize that rewarding some new business acquisitions more lucratively may lead to gender and/or race pay equity issues within the firm. Under some state laws, not only persons who are performing “similar” job duties to HRIs like Agent B, but also those who are performing “substantially similar” job duties (that is, those that do not involve bringing in new business) may believe they are placed at a disadvantage by the compensation changes considered above. Such considerations should not foreclose paying new business bonuses of varying sizes to different employees (rainmakers), but it requires care in setting up a system that can be legally defended.

Final Thoughts

It is always advisable to appropriately compensate employees for different demonstrated skill sets—including the ability to bring in new business clients among HRIs—so as to diminish the likelihood that HRIs will search for alternative employment. The pandemic has not changed this reality. The essential point is that not all HRIs have the same business-building skills; recognizing the full value of those bringing truly new business skills (i.e., person-specific) may require a potential re-thinking of bonus payments where rainmakers are involved.

At Welch Consulting, we specialize in economic analysis of complex labor and employment issues. If you have questions concerning the benefits and risks of implementing different pay structures during the pandemic, or simply want to ensure alignment with state or federal pay equity laws, please get in touch.

References:

[1] Rebitzer, J. & Taylor, L. (2006). When Knowledge is an Asset: Explaining the Organizational Structure of Large Law Firms. (NBER Working Paper No. 12583). National Bureau of Economic Research. https://www.nber.org/papers/w12583.

[2] Dong, Xiumei. Hiring From The Top: Firms Target Rainmakers Amid Virus. (2020, June 16). Law360. https://www.law360.com/articles/1283561/hiring-from-the-top-firms-target-rainmakers-amid-virus .

[3] Kabot, A. (2021, February 5). Law Firm Penalties On Departing Partners Just Got Riskier. Law360. https://www.law360.com/articles/1352503/law-firm-penalties-on-departing-partners-just-got-riskier .

 

The opinions expressed are those of the author(s) and do not necessarily reflect the views of our firm or its clients.