Associate Salaries: The Great Debate

By now a fair amount of blawgosphere ink has already been spilled on Cameron Stracher's Op-Ed in today's WSJ, "Cut My Salary, Please!" arguing, essentially, that the recent round of associate pay hikes (from $125,000 to $145,000 for first-year's) "should [leave] young associates trembling," because "their lives are about to get much worse."   Gerry Riskin writes that money will never buy the firm motivation or the associate happiness. Professor Bainbridge takes this angle:

"To make us care, Stracher has to make one of two possible moves. First, he could argue that there's something morally problematic about wealth. Second, he could argue that high associate salaries and partner draws have negative externalities for society. In his op-ed, Stracher makes the second move."

"But what about market competition? Why don't clients, especially big corporate clients with in- house counsel, compete down rates, force efficient settlements? I'm sure that Bruce has an explanation -- indeed may have given one. But here's a couple of my own ideas for starters."

One of Larry's more perceptive and telling points is that, since ethical rules in the US require that owners of law firms be licensed lawyers, the owners have an incentive to "over-recommend" consumption of legal services in lieu of other viable substitutes:

"[L]awyers, would want to maximize customers' use of legal services by either performing excessive amounts of legal services or under-recommending such related nonlegal services as accounting and finance. By contrast, non-lawyer managers of firms that offer nonlegal as well as legal services would have an incentive to maximize overall profits rather than the portion of profits produced by lawyers."

"Higher salaries have forced firms to look for new ways to increase revenues. One obvious solution is to throw more lawyers on a case, and to be more aggressive about litigating and challenging small matters that might otherwise go uncontested. [...]  Firms are lawyering matters to death, and killing their associates in the process. It didn't used to be this way."

The problem with Stracher's observation—and the way in which he misses the fundamental economic rationale that Larry fingers—is that law firms presumably always want to increase revenues, and if they could just "throw more lawyers on a case" and pay associates coolie wages, they'd be more profitable still.  There's no solid connection, in other words, between associate wages and the staffing levels clients will accept.  (Indeed, clients would tell you there's an inverse relation, at least between acceptable staffing levels and associates' hourly rates.)

And a brief correction on Stracher's comment that: "A young lawyer who bills 2,200 hours at $250 per hour generates $550,000 for the firm, only $145,000 of which pays his salary."  Actually, by the time you figure in actual realization rates on those 2,200 hours, taxes, bonuses, benefits, and indirect administrative costs ranging from Park Avenue rents and E&O insurance to the IT infrastructure, I would be shocked if the typical first-year wasn't a meaningful cash drain to the firm.

But we still haven't answered the fundamental question Stracher's piece, which is every bit as entertaining as it is economically fallacious, implicitly poses.  To wit:  "Just why are associates paid so much?"  Read on.

I'll start by turning to "efficiency-wage theory," the novel insight of which is that paying higher wages, even above-market wages, will be profitable if it makes workers disproportionately productive.  These are the plausible mechanisms whereby that might be true (and on efficiency-wage theory in general, see, e.g., N. Gregory Mankiw, Principles of Economics (Harvard University Press:  1998) at pp. 578—583):

• Higher wages reduce turnover.   Employees are more or less continuously evaluating alternative job options.   While it may seem implausible that someone would abandon a firm, clients, and colleagues for, say, a 7% bump (from $135,000 to $145,000, e.g.), if other work factors are less than ideal, that could be the tipping factor. 
  
  Moreover, consider the repercussions from the firm's perspective of not matching "the going rate:"  Immediate, and not-unjustifiable, suspicion in the marketplace that the firm is no longer First Tier.  As a former AmLaw 50 managing partner put it to me in an email today:

  "Firms are rational enterprises, even if they occasionally seem not to be. They pay the going rate because they have to. Frankly, associate compensation is one of the easiest issues a firm has to address. There aren't many choices."

• Better-paid workers have an incentive to work harder.  This works in two dimensions:  The person earning "above-market" wages knows they're likely to take a hit if they lose their job, so they are motivated not to shirk, and the firm knows that for the premium they're paying they can get dedicated workers, so they're quicker to pull the trigger on mediocre performers.
  
• Lastly, there's an indisputable link between pay and worker quality, and top-tier law firms know this very well.  To understand how this works, consider Stracher's hypothetical (and "stark raving mad," in the words of another correspondent of mine today) suggestion that firms cut associate salaries 50%—to $72,500. 
  
  The instantaneous, powerful, and irreversible consequence of this would be that all the Harvard, Yale, and Stanford Law grads, who can command far more than $72,500 at investment banks, management consultancies, and even enlightened in-house departments (GE comes to mind) would decamp en masse from BigLaw, leaving firms to pick through the ranks of the bottom half of the class at regional and local law schools.
  
  Imagine clients' reaction to that phenomenon playing itself out....

Finally, permit me to suggest a few cultural, non-economic, angles to this story.

First of all, wages are notoriously "sticky downward:"  That is to say, unless you're an about-to-be laid-off employee of bankrupt  Delphi, you will not take a cut in pay, period, full stop.  This doesn't entirely explain why the going rate is $145,000, but it explains why it will not drop now that it is $145,000.

Second, my hypothesis is that there's less than meets the eye to the fact that every leading firm bumped up the rates this year.  I've believed for some time that while firms may have been toeing the starting-salary line at $125,000, bonuses were growing; and I predict that now that a $20,000 component of bonuses has been relabeled salary, bonuses will immediately shrink.  In other words, this is probably less of a pop than it appears.

Third is what I call the "Parris Island" phenomenon:  Partners expecting 2,000 or 2,200 hours/year out of associates have no sympathy for whiners—after all, they lived through it themselves.  Emotionally and psychologically then, expecting partners to enter a realistic dialogue about cutting pay in exchange for cutting hours is a delusion.  It's your turn now, buddy.

Finally, there may be an entirely appropriate, fitting, and survivability-testing aspect to paying people a lot and asking them to work like crazy: That's exactly what partners' lives are. If you don't take to it as an associate, you won't as a partner. Firms could be cannier than we give them credit for.

So will we see the end of this in our working lifetime?  For my money, scarcely a chance.

And for yours?