PERVERSE INCENTIVES AND UNINTENDED CONSEQUENCES

BIG FIRM RANKINGS

Big Firm practice changed forever in 1985, when AMLAW first published law firm financials, introducing transparency on previously private information. These publications caused firms to compete for higher ranks based on metrics that morphed the goals of the profession away from a service related industry into a profit-focused behemoth built upon a model leveraging a higher number of associates per partner and increasing minimum billable hours and rates. The following perverse incentives developed out of the ranking metrics, negatively effecting both the client in terms of costs and the attorney's quality of life and overall job satisfaction.

(1) The incentive to over-bill and leverage transactions beyond necessity to increase 'Profits Per Partner.' 

In 1984, equity partners at top Big Law firms took home $289,000 in average profits ($650,000 adjusted to 2016 dollars); today, partners at the top 100 firms average more than $1.5 million per year.

(2)  Increase firm size to demonstrate success and breadth of proficiency - plus increase leverage.

A misleading metric of quality in the present day, as Big Firms are bottom-heavy​ with junior associates ill-equipped to add value to transactions, require step-by-step guidance of senior attorneys, resulting in longer turn-around times and larger bills.

 

This distortion is most true in corporate sections due to the fact that law schools predominately builds skill sets more suited for litigators (case law analysis, legal research and citation methods, writing structured memos, motions and briefs) and lack training aimed at equipping graduates with the skills necessary to function as business lawyers, comprehend a business transaction, draft transactional documents or assess optimal corporate structures.  As a result, a newly minted corporate associate may arrive the first day at work with an elite academic pedigree, but their practical education has just begun. Ironically, corporate associates at large firms are commonly assigned higher billing rates than their classmates in other sections due to market demands and the institutional clients supported by their section and the result meaning that it's the client that pays for their training and education.

(1)

The Tradition of "Home Grown" Lawyers

This tradition of law firm investment in training newly minted lawyers, even at a high cost to both the clients and the firm, became an acceptable 'norm' and was more palatable (and rational) under the initial Cravath lock-step philosophy of training home-grown corporate associates who stayed on as partners.     Clients could justify the expense as an investment in the future relationships with the firm as these associates would be their "go to" attorneys of the future.  The genius of the Cravath system was the interlocking incentives that made the model sustainable:  every person involved in the process--associates, partners, clients-was made better off.  In the case of associates who were not destine for partnership, almost without exception, the relations between the Cravath partners and associates who have left the office to compete professionally have remained friendly, and often intimate, as the culture within the firm cultivated such loyalty.

One such Cravath alumni was Charles Reich, a Yale law professor who gained fame for the influential book, The Greening of America (1971).  In a letter to a friend's daughter, who was beginning her career at Cravath, which was subsequently published in The American Lawyer in December 2007, Reich's relates impressions on his time spent as a Cravath associate: 

In the Cravath of 1952, I felt no pressure whatever concerning billable hours. ...  The only pressure was to complete an assignment on time. ...  We were all told that while few associates could expect to remain permanently at the firm itself, we could all count on well-paid future employment at one of the many corporate legal offices or regional law firms that had ongoing relationships with Cravath. The message was: Excellent work is expected, but the pressure is off. Associates were safely and comfortably on the inside for life.  Inclusion was more important than competition.

However, the trend toward lateral hiring at the partner level slowly decreased the probability that such home-grown trainees would ever become career attorneys at their firm of origin- and the culture began to change within big firms like Cravath.  Thus began a myopic, 'immediate gratification,' view at both the associate and partner level which prioritized current earnings over the long-term vision of the original Cravath model aimed at cultivating the current human capital existing within the firm community.

(2)

1965:

(3) A drastic spike in expected billable hours increased pressure on associates to log more billable time, decreasing job satisfaction and increasing the phenomenon of padding hours.

2016:

1980:

1958:

This tradition of law firm investment in training newly minted lawyers, at a high cost to both the clients and the firm, became an acceptable 'norm' and was more palatable (and rational) under the philosophy that trained home-grown associates expected to stayed on as partners.     Clients could justify the expense as an investment in the future relationships with the firm as these associates would be their "go to" attorneys of the future. The genius of the Cravath system was the interlocking incentives that made the model sustainable:  every person involved in the process--associates, partners, clients-was made better off.  In the case of associates who were not destine for partnership, almost without exception, the relations between the Cravath partners and associates who have left the office to compete professionally have remained friendly, and often intimate, as the culture within the firm cultivated such loyalty.

One such Cravath alumni was Charles Reich, a Yale law professor who gained fame for the influential book, The Greening of America (1971).  In a letter to a friend's daughter, who was beginning her career at Cravath, which was subsequently published in The American Lawyer in December 2007, Reich's relates impressions on his time spent as a Cravath associate: 

Pamphlet published by ABA suggested annual quota of 1,300 billable hours

Full time Big Firm associates expected to bill on average 1,200-1,400 hours annually

Annual minimum billable hours of Big Firm associates increases to 1,600 - 1,800

Big Firm associates expected to bill a minimum of 1,900 to 2,400 to achieve bonus

There is a direct correlation between the shift in focus away from training homegrown attorneys to maximizing the immediate profits generated from hiring large classes of junior associates in the form of increased billable hour quotas. The largest firms tend to view junior associates as fungible commodities used for less sophisticated, hour-heavy work such as document review which requires less supervision, allowing Partners to spend more time developing business.  Lateral hiring at the partner level creates a culture in which partners lack motivation to invest time training lawyers they assumed would gone in 2-4 years, leaving many junior associates without the real career skills necessary or appropriate to command the rates being charged or to advance at the firm. Likewise, as junior associates saw their improbable longevity at their dream firm and were tasked with hours summarizing contracts and other mind-numbing work, this generation of newly-minted talent was underutilized, grew disillusioned with the practice of law, lacked motivation to invest in the firm and instead focused obsessively on associate salary and bonuses evidenced in the 'Above the Law' and 'Greedy Associates' blogging culture. 

On the subject of associate compensation, a few remarkable trends have emerged which say more about the firm's corporate ethics than whether associates are overpaid. First year associates at at the highest paying AMLaw averaged a starting salary of $82,000 in 1992 (adjusted for 2016 inflation) compared to $180,000 in 2016.  The significant increase is driven not by an increase in value-added, but on what the market supports.

 

As firms are loathe to absorb any added expenditures due to the impact on Profits per Partner and corresponding rank in peer reviewed journals, the premiums get passed down to the client in the form of higher rates, or perhaps the costs are shifted such that client's bills are tagged with reallocated over head expenditures to cover the loss. What is unclear is why cost-shifting is justified or even necessary given that billable hour quotas more than cover associate salaries in multiples with ratios of profits per partner (PPP) to associate salary of 8.8 to 1 using the combined average of PPP at AMLaw 100 ($1.6 million) up to 36.6 to 1 at the firm with the highest PPP ($6.6 million at Wachtell, Lipton, Rosen & Katz in 2016).   

(4)  A rush to open offices in major cities across the globe to establish the optics of a 'global presence,' whether or not the physical space was economically rational or utilized appropriately.

Firms have been forced to self-correct this move in the last two-years with a massive amount of office closures, many of which earned no profit in the ten or more years their lights were on.  However, many firms still subscribe to the philosophy that keeping an office open in a particular city like New York or London has an "unknown profit realization" element that cannot be measured and are unwilling to drop the cache' of losing its name in the region, regardless of whether they actually service any clients locally at the office.

The Future of Big Law

The seminal piece first predicting the demise of the Big Law model as it operates today came in a 2010 essay entitled The Death of Big Law by the late Larry Ribstein  The essay predicted the shrinkage, devolution, and ultimate demise of the traditional large law firm.  At the time virtually no practicing lawyer took it seriously. The nation’s large firms were only one year removed from record revenues and profits. Several decades of relentless growth had conditioned all to expect the inevitable rebound. Similarly, legal academics did not grasp the full reach of the article - deeming the essay just another academic analysis. 

However, the events of the last six years have humbled that attitude, and given pause to the unwavering conventional wisdom that "bigger is better." Ribstien described a paradigm shift that would profoundly disrupt the economics of legal education and cast into doubt nearly a century of academic conventions. His thesis consisted of three main pillars: (1) the organizational mindset and incentive structures cause a form of "willful blindness" of large law partners to the gravity of their long-term business problems; (2) a specific rather than abstract description of the technologies and entrepreneurs are gradually eating away at the work that has traditionally belonged to Big Law; and (3) the economics of the coming “Lean Law” era would eventually force institutions to let go of old ideas and recreate new models that better fit the needs of a 21st century economy.

As with all new ideas and shifts of this magnitude, there will be a natural ebb and flow and the change is unlikely to follow a linear pattern. However, it is a shift that we believe will eventually take hold and change the practice of law for the firms that survive.  Letting go of old traditions is the primary stumbling block for an industry which believes they have no choice but to keep up with the Cravathians, but the blind leading the blind will not work in an era that relies on innovation and trying new models more appropriate for the era and the technology available.  We are not your parents' law firm - a fact we are proud of and which means we will survive the changes of the current global economy.

 

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(1) See Robert T. Swain, The Cravath System and its Predecessors 1819-1948  (Vol. I-III) (1948).  The "Cravath System" was based on an internal lock-step structure that incentivized and envisioned a junior associates longevity at the firm.  The philosophy being that long term clients "invest" in the future of the firm and part of that process requires a training period of future partners.  However, with the current model at most firms bringing in lateral partners with books of business, would-be partners are not motivated in the same way, nor is the firm. 

 

(2) See William Henderson, Part II, "How Most Law Firms Misapply the Cravath System," Legal Prof. Blog, July 29, 2008.

(3) See Ribstein, Larry E., The Death of Big Law (August 1, 2010). Wisconsin Law Review, Vol. 2010, No. 3, 2010.