Going Two-Tier? Not So Fast

Thinking of going to a two-tier (equity and non-equity) partnership?  Or of increasing the non-equity ranks if (like 80% of the AmLaw 100) you're already two-tier?

I'm here to counsel extreme skepticism.  And I'm tempted to be even more absolutist:  Don't do it.

At least, that is, if the economics of the situation govern your decision.  Because—let me hasten to add—there are many perfectly praiseworthy and legitimate non-economic reasons to do so, including:

• Being able to retain valuable practitioners and producers—good citizens, if you will—who just don't quite cut it when it comes to joining the equity ranks.
• Providing an alternative career path, attractive in and of itself, for those who would prefer to avoid the ceaseless pressure of high billable hours and high expectations for business development that come with the equity partner pay grade.
• Creating a niche where practitioners with a peculiar, intrinsically valuable but somewhat arcane, specialty can be placed so as to remain available as needed.

And there's actually a fourth reason to introduce a non-equity tier which does not harm and may demonstrably benefit your firm's economics, as long as you're disciplined about it (as firms such as Kirkland & Ellis are):

• Introducing a non-equity, time-limited, period of, say, five years, between being a senior associate and a full equity junior partner, with these conditions:
  • To all appearances to the outside world, the non-equity partners appear to be, simply, partners;
  • They have access to all of the business development tools any partner would have;
  • They have a finite period of time to demonstrate—or not—that, armed with these competitive assets, they can indeed generate business;
  • Internally, they have the opportunity to demonstrate their leadership, team-building, and project management skills (with all of the implied authority that comes from being a "partner"); but lastly
  • Ascension to the ranks of non-equity does not entitle people to an indefinite stay conditioned only on good behavior:  Rather, it starts a second shot-clock running, during the pendency of which they must demonstrate the qualities expected of a full equity partner, or else be excused.
  • Oh, and if you think this is inhumane or too "tough" on general principles, I remind you to think of it from the perspective of the non-equity partner who's about to be shown the door:  Would you rather be job-seeking as a "partner" at Kirkland & Ellis or as a 9th-year associate at Davis Polk?

Now, why am I so skeptical about the supposed beneficent economics of non-equities?  Haven't we all been told for the past 20+ years, by consultants who shall remain nameless, that introducing a non-equity tier can improve your performance by boosting leverage and allowing you to retain proven and productive talent? 

Would the world were so simple.

As it turns out, what comes with introducing a non-equity tier is a subtly changed dynamic in the incentive set facing your talent.  Firms with a single-tier partnership attract the true Type A's:  Those of us who have never finished anywhere but at the top of a class and have no intention of starting to do otherwise.  But the two-tier firms hold out a veiled alternative:  If you keep your nose clean and work (reasonably but not insanely) hard, you might find yourself taking home (say)  $400,000 per year, adjusted for inflation, for the duration.   And you won't have to kill yourself in either billable hours or business generation.

I guarantee you plenty of people walking outside your windows right now would jump at that offer.

And my hunch is that, over time, that changes, ever so slightly, the composition of the people who put your firm into their consideration set.

But don't take my word for it.

Let's look at the numbers.  Fortunately, the just-released 2008 AmLaw 100 give us plenty of numbers, and I've been analyzing them off and on for the last few days.    Let's start with some correlation coefficients.

 (Correlation coefficients, for those of you who skipped statistics, are a mathematical measure of the strength and direction [positive or negative] of a relationship between two variables.   To use simple examples, red hair is correlated with green eyes; being of Asian extraction is negatively correlated with blond hair; and for people from birth to about age 16, age is highly correlated with height and weight.    Correlation coefficients can range in value from +1.0 to -1.0 and, in general, a correlation coefficient of +1.0 implies perfect correlation (being a resident of New York City correlates perfectly with being a resident of New York State); 0.0 implies no discernible relationship; and -1.0 implies no correlation whatsoever—or, in other words, that the presence of one connotes the absence of the other.   Correlation does not, please note, imply causation.) 

So here we have a few numbers.  Many of the figures are available in the AmLaw 100 directly as reported whereas others I calculated.  For example, what I call the "Non-Equity Partner Ratio" is simply (the total number of non-equity partners) divided by (the total number of equity partners).  For a single-tier firm, it's therefore 0 and for a firm with more non-equity than equity partners it exceeds 100%.

• Correlation between Non-Equity Partner Ratio and Revenue per Lawyer:  -0.4254
• Correlation between Non-Equity Partner Ratio and Profit Margin:  -0.7102
• And lastly, Correlation between Non-Equity Partner Ratio and Profits per Partner:  -0.4189

In other words, the higher your firm's proportion of non-equity partners, the lower your:

• Revenue per lawyer
• Profit margin, and
• Profits per Partner.

Here's another way of looking at it.  We know that Revenue per Lawyer and PPP are highly correlated (+0.8923 by my calculations), so I segmented the AmLaw 100 into five cohorts according to the proportion of Non-Equity Partners:

What's going on here?

I've already mentioned my theory that it makes your firm more attractive to those who aren't at the absolute top of the alpha-competitive distribution, but there are also concrete reasons to think that non-equity partners are: (a) getting more numerous, not less; and (b) constitute the most expensive tranche of leverage you have onboard.

This chart shows the breakdown, from 2000 to 2006, of all lawyers in AmLaw firms who are not equity partners.  The large red bars are of course associates and the two small grey bars are, per the survey's methodology (don't ask me!) "other non-equity lawyer" (darker grey) and "non-equity partners" (lighter grey).  The moral is very clear:  Associates are a shrinking component of the ranks of lawyers that give you leverage.  The problem with this is that associates are the cheapest form of leverage, and non-equity partners the most expensive form.

But wait, it gets worse.

Not only are non-equity lawyers the most expensive, they're the least hard-working.  Take a look:

On both charts ("higher" and "lower" profit firms) the two cohorts of lawyers that bill the fewest hours per year are "income partner" and "other non-equity lawyer."  Associates, not surprisingly, bill the most (the 3rd bar on each chart) and equity partners come in a close second (the 1st bars).  To summarize, then:  (1) There are more non-equity lawyers, as a proportion of headcount, than ever; (2) they're the most expensive cohort other than equity partners; and (3) they're the least productive.

So I ask you:  Are you still thinking of going two-tier, or going "more so" if you already are? 

There may be meet and right reasons to do so for the sake of specific individuals, for the sake of  your firm's "culture," or to preserve domestic tranquility, but if you're doing it because people who ought to know better have told you it will help your leverage, increase revenues, boost profitability, and help you retain highly productive people, I have just one question for you:

Can we talk?

A "Bubble" in PPP?

A loyal reader, partner in an AmLaw 25, writes, under the topic "Could we be developing a 'bubble' in law firm PPP:"

Bruce:  I'd be interested in getting your thoughts on the above question.

If you define a market "bubble," as a period when the expressed value of an asset (stocks or housing) exceeds the true market value of that asset, there seems to be an argument that there may be a bubble in the "share price" of law firms (represented by the Amlaw 100 anyway). That "share price," as that term has been used by some law firm leaders, is the profits per equity partner.

By my rough calculation, based on Amlaw 100 data, profits for AMLAW 100 firms has increased at a cumulative annual growth rate of over 11% for the years from 1999 to 2006. Although increased legal work may partially explain this growth, it appears more likely that law firms have increased their profits by pulling a few key levers: Increasing hours per lawyer, increasing leverage, and increasing rates. In fact, during that period, PEP grew almost 9% amongst the Amlaw 100 (the difference from gross profits to be explained in a minute). By contrast, the Dow increased only 1.2% during this period. Whereas during the bubble-building period of 1995 to 2000, it grew at 16% annually.

As has been widely discussed in the legal press, law firms' ability to continue pulling those levers is largely coming to an end. Most lawyers are working as hard as feasible. Clients are increasingly pushing back on rate increases (I just attended a session with in-house counsel where they noted that law firms should not expect to increase rates this year). While law firms attempt to increase their leverage, clients are increasingly resisting having their work done by associates. All of this means that 10% plus profit growth is not likely to continue.

This takes me back to the "share price" -- PEP. Law firms continue to feel substantial pressure to increase that share price out of fear that if they fail to do so, they will drop in the AMLAW 100 rankings, and lose the prestige that is associated with such rankings. (Even if law firms could continue to attract star talent by increasing the range in compensation to equity partners, they still perceive themselves to be limited by the average PEP they report). Thus, to continue to increase their PEP, they are starting to de-equitize partners, and close the door to new associates and income partners from moving up the ranks. (The latest example being Jenner & Block).  In fact, if you look at the numbers from the AMLAW 100 from 2005 and 2006, you see that the number of equity partners actually declined from 2005 to 2006 (by about 0.4%). In contrast, the number of equity partners actually increased at an average annual rate of 2.7% from 1999 to 2005 (which accounts for the difference in the increase in profits (over 11%) and the increase in PEP (almost 9%)).

As the growth in gross profits starts to decline, law firms are still able to increase their PEP by reducing the number of equity partners, thereby increasing the "share price" of equity partnership. But, this increase will become increasingly unsustainable. As junior attorneys realize that the prospect of achieving equity status is less than slim (and may be non-existent), many of the motivational levers will no longer exist. After all, people do not typically invest in building a business if they do not believe they will be with that firm long term.

Corporate America has recognized this issue and attempts to reward employees with long-term incentive programs (currently options and stock grants; in prior generations this was done through pensions). By taking away the long-term incentive that comes with ownership, the "true" value of a firm starts to decline, even while the "perceived" value of a firm increases. As we have seen from the bubbles in the stock markets and the housing markets, when there is such a disconnect, there can be long and painful restructurings. Unfortunately, those who suffer the most in such bubbles are those who "bought in" at the height of the bubble -- investors who bought stock in 2000, homeowners who bought homes in 2005. Those who get out at the peak will reap the profits.

For law firms, the "new entrants" are junior partners and senior associates who are investing substantially in the hopes of joining the equity ranks and reaping the rewards. The older investors -- those who are running the firms and probably on law firm management committees, are the ones who are reaping the rewards. When it becomes apparent that law firms can no longer afford the high PEP they are reporting, it will be the younger lawyers who will bear the burden.

As with other bubbles, this is a self-reinforcing process -- as the PEP for firms increase from one year to the next, the pressure on all other firms to increase PEP by that amount increases. Law firms that fail to keep up their peers perceive themselves to be at risk of entering a downward spiral -- their perceived stature declines, they are no longer able to attract top talent; absent that top talent, they are not able to keep growing revenues, and profits decline, resulting in further declines to PEP. Thus, all market participants have a substantial incentive to continue to increase PEP, even if it is illusory.  No firm can rationally "opt out." 

The same is seen in other bubble markets.  In the last days before the sub-prime bubble burst, the competition between companies led most banks to make business decisions (aggressively chasing deals with lower and lower underwriting standards) that were rational only on the theory that everyone else was doing it (otherwise known as "irrational exuberance" in 1999).  When no one wants to buy the credit any more, the model fails and all the businesses fall together. In the legal market, that process will be slower because the transfer of ownership is slower -- the "buyers" are the associates and students coming up through the ranks.  But, as the best of those lawyers recognize the lessoned value of law firm partnership, they will pursue alternative careers (investment banking, private equity, government, etc.). 

Eventually, the law firm talent pool declines significantly, reducing the value that law firms provide to their clients.  The crash may not be quick, and may take years before it becomes apparent, but it may still come, and may take a very long time (perhaps a generation) to rebuild the law firms as institutions.

There's much here.

I'd like to break it down into three components: The near term, the long term, and the structural issues.

Near term: Without question, we're in for a cyclical downturn in the growth of PPP, and, for some firms, an absolute decline. Double-digit increases in almost any measure in almost any business for a period of nearly a decade are bound to come to an end. Bull markets always do, hard as it seems to believe during the jolly times.

That's not to say firms can't take measures to mitigate the downward pressure:

• Redeploy lawyers in troubled practice areas to healthier ones;
• Use the opportunity of "shared pain" with your key clients to get closer to them;
• Adroitly stand by while the normal waves of attrition take their toll;
• Build or at least safeguard capacity in selected practice areas that you anticipate will emerge strongly from the downturn;
• And always, always, keep a sharp eye on costs--although, truth be told, you don't have much material flexibility here. You're not moving your offices to Brooklyn and you're not paying less than market for partners and associates.

Is this, then, a real problem near term?

I think not. Your lawyers understand what's going on in the economy and in their practice areas. They know when things are slow, when the new matter pipeline seems sluggish, when clients are avoiding phone calls and emails about paying. There's no reason to panic and, if you're comfortable with your long-term strategy and see no reason to change, sit tight.  Indeed, I have predicted that as we emerge from this tunnel, new requirements in structured finance and other practice areas that have been hard hit will entail demand for more, not less, lawyering of the new products.    In other words, this too shall pass.

Long term: Here the outlook is decidedly more mixed.

Our faithful correspondent has several well-taken points, which I'd like to reiterate:

• On the billable hour model, revenue = (rates) x (hours) x (realization)
• Add in a dimension for profitability, namely (^leverage)
• And you realize that each of these four measures has some intrinsic ceiling or maximum on it:
  • Rates: $1,000/hour? £1,000/hour?
  • Hours: 2,400? 3,000?
  • Realization: >100%?
  • And leverage: At some point, associates (particularly Gen X/Y) will say that the eye of the needle they're being expected to pass through is laughably small.

And yet the PPP "arms race" has no such intrinsic ceiling.  $2-million/year?   $4-million?  Even these amounts are modest compared to the compensation that investment bankers, hedge fund managers, and private equity jockeys are earning, as they rub shoulders in the same neighborhoods and sit at the same conference tables as AmLaw 100 partners.  The desperate measures firms will go to to compete in these leagues are evidenced by resort to the Death Star of de-equitizing partners. 

Our correspondent is also quite correct to point out that no firm can (unilaterally) opt out of this PPP arms race—at least not unless they are prepared to risk the equivalent of a run on the talent bank, with all its suicidal implications.  So is the only "rational" outcome going to be the wholesale disillusionment and disenfranchisement of a generation of associates, who will opt out of the entire Ponzi scheme and leave the AmLaw 100 in droves?

As inexorable as that outcome may sound, I have a higher degree of faith in the flexibility of firms—all firms in the economy, that is, not just AmLaw firms—to reform their ways when threatened with the prospect of a catastrophic collapse in the way they're used to doing business.  Which brings us to:

Structural Issues:

All of these factors—the inherent limits of rates, hours, realization, and leverage; truly serious pushback from clients on fees; the difficulty of getting Gen X and Gen Y to serve as cannon fodder for the pyramid (an attitude which is surely more rational and enlightened than that of the Baby Boom generation, by the way)—lead me to predict that firms will find ways to change the 90-year-old Cravath Model.  They will change it because they will have to, to survive.

What might this mean?   For starters, I would be delighted to predict yet again the ultimate demise of the billable hour, knowing that I would be in distinguished, and consistently wrong, company—but that's a subject for another day.  My pet theory on this, by the way, is that its demise will come when law firms find it in their own self-interest.  More specifically, when law firms discover they might actually be able to charge fees based on "value to client" rather than "cost of production," but I can't say I'm holding my breath. 

How else might firms change?

The bimodal associate/partner, up-or-out career path is, of course, already showing tremendous signs of stress and a variety of experimental tinkerings are well under way:  Non-equity partners, most famously and most numerously, but also staff and contract attorneys, job-sharing, and the first baby steps towards career "time-outs" to provide the opportunity for such radical pursuits as starting a family.

At least as fundamentally, I believe the core processes by which law firms manage cases and deals must and will change.  Mention "project management" to an average lawyer and you draw a blank, yet cases and deals are, at core, projects which must be managed.  There is typically a critical path of activities, there are assets and resources to be deployed against the tasks to be done (each, yes, with a price), and there are more and less profitable and efficient ways to structure the project.  Even if lawyers never learn these skills, why couldn't firms engage practice group managers to perform this function?

• Project management, .
• Combined with our ever more powerful knowledge management systems,
• And with all expected to briefly go back at the conclusion of a matter for an exercise in "lessons learned,"

Will enable firms to substantially enhance their economic performance even while weaning themselves away from the familiar ways of doing business.

Ultimately, our correspondent describes a future of unsustainable trends where, on the current model, the AmLaw firms hit a figurative brick wall.  I believe we'll take decisive evasive action sooner.  The demand for high-end legal services by the Fortune 500 and the FTSE 100 is not diminishing with globalization; it is increasing.  The ongoing re-engineering of structured finance will not yield deals with fewer covenants, warranties, representations, and contingencies; it will yield deals with more of all of those, and probably some new features yet to be invented.  Increasing cross-border and transnational economic activity requires lawyering of everything from immigration visas to  multi-billion dollar project finance.

Mom and pop law firms cannot serve these needs; only the AmLaw 100, the UK 50, and their like, can.  The scope of the future demand is, to my mind, utterly beyond question. Law firms with the scale and capability to match will step up to the plate.  If our correspondent's envisioned future plays out, there may be different players on that future roster of sophisticated firms, but players there will be.  After all, as Herbert Stein, chairman of the Council of Economic Advisers under Nixon and Ford, said of unsustainable trends:  "They tend to stop."

Update, 6 May 2008.

A 3L at an Ivy League law school writes (emphasis supplied):

"Hi Bruce,

"As a graduating 3L, I thought I’d offer a couple observations on your piece about PPP.

"My main observation is that the trend towards diminished interest in becoming partner is growing more pronounced.  In my class, I’m not sure I know a single person who would say that their goal was to become a partner.  I know people who want to leave Big Law for all sorts of in house, investment banking, government, public interest, and other field.  I know people who want to work for a few years, and then leave practice to raise a family.  I am not sure I know anyone who wants to be a partner.  This seems odd, because the rewards for rising to that level have never been higher.  I suspect that this view is partly a result of the diminishing chances at making partner.  Many students view it as so unlikely that it’s not a goal worth aiming for.

"I also am not sure that this is likely to change anytime soon.  The bread and butter of Big Law looks, at least from my vantage point, to be work that requires considerable leverage.  In a big case, or a big deal, there is a lot of junior and mid level associate work then there is partner level work.  For an extreme example, consider the recent Bear Sterns deal with JP Morgan.  The merger agreement itself is not very long, and surely the main points were the subject of careful attention from the most senior lawyers representing the parties.  Meanwhile, there was an enormous amount of diligence to do, and the number of hours involved in reviewing all that almost certainly dwarfed the time spent on negotiation and drafting of the merger agreement.

"To successfully navigate this environment, which can perhaps be characterized as a high-turnover equilibrium, firms need to nurture the development of new partners.  They further need to do so without giving the impression that everyone, or even very many, of their new associates will make partner.  This has no doubt been a problem for many years at large law firms.  My impression is that it will be a bigger problem in the future, because turnover has become so rapid.  Managing the careers of young lawyers so that at least some of them grow to be partner material appears to be less of a priority than it used to be, and that is likely to hit the bottom line of firms that don’t worry about it.

"I fully expect some of my classmates to ultimately become partners.  The challenge is that partnership has become so unlikely that it’s just not the career path that anyone expects for themselves.  I suspect that the result will be good prospects abandoning the pursuit of partnership prematurely, and some who do make it stumbling into it.  (This is closely related to the equity/non-equity partnership issue you just wrote about).  Overall, I think that current law students look at their careers in a way that tends to narrow the pipeline of future partners – and does so beyond the narrowing that is inherent in the “tournament” approach that dominates.  I assume that this is not to the long term benefit of law firms. 

"Best Regards, [...]"

Can any partner in an AmLaw 100 firm read that and assume business as usual will suffice for the foreseeable future? 

"Business as usual" meaning:   The same half-hearted attempts at professional development and associate training and mentoring, the same bizarre and archaic bimodal career path, the blinkered pretense of being able to ignore the fact that the partnership tournament years coincide with prime child-raising years, and the assumption that since we lived through Parris Island it won't kill Gen X or Gen Y, and they'd just better get used to it.

If you believe changes are not afoot, I want to be able to live in the same reality distortion field you inhabit. 

The future will look different than the past, and one thing we know to a certitude about the future:  It will arrive.  The only question is who will be prepared for it.

The AmLaw 100 for 2007: "Flash Report"

The American Lawyer not only has a spiffy new website, but this afternoon @ 3pm NY time they offered their first-ever webinar, hosted by Aric Press,  offering a preview of the AmLaw 100 for 2007.   The full results will be released tonight (look for a link here on "Adam Smith, Esq.") but first, a "flash report" from the webinar.

• Total combined revenue of the AmLaw 100 in 2007 totaled $64.5-billion, up 13.6% year over year.
• Revenue per lawyer, one of my favorite statistics (and apparently one of Aric's as well) grow 6.4% to an average of $820,000.
• Lawyer headcount was up 7% to 78,000 lawyers.
• But the slowest-growing component of that headcount, equity partners, comprised barely 23% of total headcount.
• At current rates, nonequity partners will outnumber equity partners in a mere 7 years; they already do at 21 firms (and across the entire AmLaw 100 they comprise 35% of all partners).
• The ranks of equity partners grew just 2.6% last year (about 5 partners for the "average" firm), and for the past five years the growth rate has surpassed the 21-year average growth rate of 3.2% only once (in 2003)
• Moreover:
  • 37 firms actually shrank the number of equity partners last year;
  • 4 showed no change; and
  • 8 firms added only 1 or two. 
• Skadden and Latham have both broken the $ 2.0-billion revenue/year barrier.
• In terms of PPP, 19 firms are now at $2-million or above, a gain of four firms over 2006.
• Wachtell (what a shock) remained king of the PPP hill at $4.9-million.
• Average PPP for the 100 is now $1.3-million, and median PPP is $1.2-million.
  • This means, rather insultingly, that a full dozen firms with a PPP number >$1-million find themselves in the bottom half of their peer group on this metric.
• New York continues to be a special place.  The difference between RPL for historically New York-based firms vs. non-New York firms is 41% ($1.1-million RPL for NY, $780,000 for non-NY).   Note that because this is calculated using "historic headquarters," firms such as Latham and Kirkland are, statistically, "non-NY" firms, so the "real" divergence is certainly greater.
• But overall, we have been, as Aric puts it, in a golden age, with five years in a row of growth in both RPL and PPP exceeding the historic averages.  To be specific:
  • In the five years starting in 2003, RPL has grown $205,000:  It took 10 years for it to grow by the same amount before 2003.
  • And as for PPP, since 2003 it has grown $438,000:  It took fully 15 years to grow by that amount before 2003.
• Is the great run now over?  By all current indications, it seems to be.  Deal volume is sharply down and, so far at least, litigation, restructuring, and bankruptcy have not yet stepped fully up to the plate. 
• Yet simplistic year-on-year comparisons can be misleading.  So, for the first time ever that I'm aware of, The American Lawyer explicitly ranked firms over the past ten year period based on their RPL—not total revenue and not PPP.  The results?  Absolutely fascinating:
  • 41 firms more or less ended where they began on this "relative RPL" ranking.
  • Of the remaining 59:
    • 12 dissolved or were absorbed by merger;
    • 20 improved their RPL by double digits;
    • 15 saw their RPL drop by double digits:
    • 7 moved from the bottom half of the distribution to the top half; and
    • 5 slid from the top half to the bottom half.
• The biggest movers on the ten-year RPL ranking were:
  • Dechert, up 35 slots.
  • Akin Gump, + 34.
  • DLA, + 31.
  • Chadbourne, down 44 slots,
  • And each of Dewey, King & Spalding, and White & Case down 20 slots.

What else do Aric and his colleagues at TAL foresee?

In many ways, their vision is aligned with what I would predict:

• Despite the current economic challenges (including the fact that the new and improved level of associate salaries will be with us for the full  2008 fiscal year, pushing costs to a permanently high new plateau), in the long run the increasing complexity of the economy, the rise of globalization and cross-border trade, and the increasing sophistication of our clients all argue that the long-run demand for high-end legal services will be perfectly healthy.  Indeed, in his keynote at the recent Georgetown symposium on "The Future of the Global Law Firm," Ralph Baxter, CEO of Orrick, prophesied that we would need more, not fewer, lawyers in the future.  ("Too few lawyers?!") 
• And yet the gap between richer and poorer is growing ever-wider. 

Again, look for full coverage after the entire list is released tomorrow.

Georgetown Conference on the Future of the Global Law Firm: First-Hand Report

I'm back from the two-day "Future of the Global Law Firm" symposium at Georgetown Law School, which was organized by Prof. Mitt Regan of Georgetown, Prof. Larry Ribstein of the University of Illinois, and myself. You may read other coverage of this elsewhere, as in attendance were Aric Press of The American Lawyer, Leigh Jones of The National Law Journal, David Lat of AboveTheLaw, and other reporters.

But herewith the "Adam Smith, Esq." report:

We had about 130 attendees, roughly one-quarter academics and legal scholars and three-quarters practitioners and senior law firm leaders, from the US, the UK, Canada, and Australia. Seven panels over the course of Thursday and Friday through lunch tackled:

• The emerging dynamics of global competition.
• Ownership and capital structure, including the possibility and the desirability of outside (that is, non-lawyer) investment in law firms.
• Ethics and professional values.
• Perspectives from corporate law and finance.
• Organizational and cultural dynamics, and
• Lessons from other professional service firms.

Among those attending were:

• Ralph Baxter, CEO of Orrick, who delivered the keynote Friday morning
• Ted Burke, CEO of Freshfields, who delivered the keynote Thursday morning
• Stuart Popham, senior partner of Clifford Chance, who spoke after dinner on Thursday
• Practitioner/panelists included:
  • Richard L. Weisman, Partner;former Managing Partner, China offices, Baker &
    McKenzie
  • Mark Kirsch, Chair of Global Litigation and Dispute Resolution, Clifford Chance
    
  • Stephen Denyer, International Development Partner, Allen & Overy
  • Andrew Grech, Managing Director, Slater & Gordon
  • Steven Mark, Legal Services Commissioner, New South Wales, Australia
  • Osama Rahman, Ministry of Justice, United Kingdom
  • Yours Truly
  • Anthony Davis, Lawyers for the Profession Practice Group, Hinshaw & CulbertsonLLP
  • Steven Krane, Chair, Law Firm Practice Group, Proskauer Rose;Chair, American Bar
    Association Standing Committee on Ethics and Professional Responsibility
  • JeffreyHaidet, Chairman, McKenna Long & Aldridge
  • William Perlstein, Co-Managing Partner, WilmerHale
  • Lee Miller, Joint Chief Executive Officer, DLA Piper
  • James Jones, Senior Vice-President, Hildebrandt International
  • Christopher Simmons, Managing Partner, Washington Metro Market,
    PricewaterhouseCoopers
  • Ward Bower, Principal, Altman Weil, Inc.
    
• Academics who presented papers included:
  • Peter Sherer, Professor, Haskayne School of Business, University of Calgary, Predicting
    the Future of Large US Corporate Law Firms: AmLaw 2025
  • Stephen Mayson, Professor, Legal Services Policy Institute, College of Law of England
    and Wales, London, Global Law Firms: A Strategy Looking for a Market?
  • Laurel Terry, Professor, Penn State Dickinson School of Law, The EU’s Professional
    Services Competition Initiative: Is the EU Very Far Behind Australia and the UK With
    Respect to Publicly Traded Law Firms?
  • Christine Parker, Professor, University of Melbourne Law School, Australia, Peering
    Over the Ethical Precipice: Incorporation, Listing, and the Ethical Responsibilities of
    Law Firms
  • Elizabeth Chambliss, Professor, New York Law School, Law Firm General Counsel: The
    Paradox of Institutional Success?
  • John Flood, Professor, University of Westminster School of Law, Future Directions in
    the UK Legal Profession: Life After the Legal Services Act 2007
  • Larry Ribstein, Professor, University of Illinois School of Law, The Law Firm as Firm
  • Gordon Smith, Professor, J. Reuben Clark Law School, Brigham Young University,
    Form, Function, and Fiduciary Law
  • Timothy Morris, Professor and Director, Clifford Chance Centre for the Management of
    Professional Service Firms, Said Business School, University of Oxford, Navigating the
    Process of Innovation in Professional Service Firms
  • William Henderson, Professor, Indiana University School of Law, Are We Selling Results
    or Resumes? The Underexplored Linkage Between Human Resource Strategies and
    Firm-Specific Capital
  • Andrew von Nordenflycht, Professor, Segal Graduate School of Business, Simon Fraser
    University, The Demise of Professional Partnership? The Emergence and Diffusion of
    Publicly-Traded Professional Service Firms
  • Roy Suddaby, Professor, University of Alberta, School of Business, Post-
    Professionalism: How Multidisciplinary Accounting Firms are Reshaping Professional
    Institutions

If I were rationed to just one word to encapsulate the conference's theme, it would be: Change.

Lawyers are notoriously poor at coping with change: Indeed, recent psychological research indicates that change is not just hard, but actually causes physical and mental discomfort. (One managing partner recounted being faced with a near insurrection among half a dozen partners when he had the temerity to relocate their Washington, DC office by all of one short city block. I must confess that that may set a new bar for resistance to change.)

Yet change is in our futures, like it or not. More than once the observation was made that from the invention of the Cravath System around the turn of the 20th Century through about 1985, the profession looked remarkably stable, but that the last 20 years have seen revolutionary changes and the next decade promises further departures at least as radical as those we've just experienced.

Among the overall trends driving change are

• Segmentatation, meaning the increasing gap between firms able to win the highest-level, most complex work for the most demanding (and price-insensitive) clients, and other firms forced to compete on the basis of price and increasingly high client expectations for service quality, responsiveness, and consistency. Once price becomes a material part of a client's selection criteria, unfortunately, firms have put one foot on an escalator that goes in only one direction. And segmentation is driving the evolution of our industry not just at the top, in AmLaw 25 land, but at every level of the industry, including regional firms, boutiques, and even "the 22 lawyer firm in Vienna, Virginia."
• Globalization. It's no longer the exceptional corporation that has substantial business abroad, it's the exceptional corporation that doesn't. This trend is not going to reverse or decelerate. 20 years ago the percentage of lawyers working at NLJ 250 firms who were in overseas offices was just a few percent. Today it's nearly 17% and grew 11% in just the last year alone.
• Consolidation. 20 years ago the AmLaw 50 accounted for about 6% of all private, for-profit law firm revenue in the US. Today they capture over 25% of that revenue.

Other themes?

Scarcely a panelist failed to mention—or concentrate on—the "war for talent" and the challenges posed to the traditional law firm career ladder by Gen Y. (Yes, the usual caveats were added about how it can be misleading to generalize about an age cohort, since individual differences always outweigh broad demographic brush-strokes, but the point is universally acknowledged nevertheless.)

A particularly painful reality on this landscape is that, for about the past 30 years, essentially 50% of law school graduates have been women, yet throughout most of that time span, the number of female partners in the AmLaw 100 has hovered at a fairly constant 15-18%. Finally, I believe, firms are going to face up to the reality that they need to take fresh approaches to the dilemma created by the fact that the prime child-bearing and family-starting years happen to coincide quite nicely with the path-to-partnership tournament years. Proposals for innovative "off-ramp" and "on-ramp" programs were floated, some potentially in conjunction with forward-looking law schools (like Georgetown) to "de-couple" those time frames.

But the overall tone of the symposium was the simultaneous thrust of excitement and challenge balanced against the uncertain and the unknown.

Would outside equity ownership be a boon or a curse?

Why exactly do law firms need capital? Aren't we labor-intensive businesses, not capital intensive (A: As currently conceived, we are. But why is the current static model necessarily the model for a dynamic future?)

What has been the history of other professional service firms that have invited outside investors?

Will outsourcing and globalization in general (permitting work to be done in the lowest-cost jurisdiction, be that IT and HR support, or paralegal or e-discovery services) supplant the model of teams of extremely high-priced and highly educated professionals operating out of Class AAA space in the center of the world's financial capitals?

Will we lose the partnership ethos? (Laura Empson of Cass Business School gave a particularly nice presentation on this at lunchtime Thursday, positing that useful ways of thinking about partnership might be as analogous to The Three Musketeers, to Henry V's famous "band of brothers" speech before the Battle of Agincourt, to a buccaneer pirate ship, or, at last, to "Gone With the Wind.")

Can the partnership ethos survive outside the legal form of a partnership? (Yes, seemed to be the consensus--albeit challenging to do so.)

Would outside ownership actually threaten ethical behavior in law firms? In this connection, three salient points were made:

• We see no evidence of publicly owned companies in other industries behaving unethically as a pattern: No airlines cutting corners on safety, no pharmaceutical companies cavalier about product tampering, and, to be sure, no one questioning Goldman Sachs' advice since their IPO.
• Could the pressure to achieve profits from passive, minority-interest outside shareholders possibly be greater than the competitive pressures to achieve maximum PPP from the press, and to retain and attract talented partners?
• And lastly, note this well: In the famous flameouts of Enron, Worldcom, et al., the "whistleblowers" with integrity were inside the corporations, not in external auditing or law firms. If anything, this data point suggests that professionals in publicly held firms do not surrender their ethical obligations at the door.

Should we be optimistic about the overall global demand for law? I believe we should. After all, don't globalizing corporations require more, not less, legal advice? (As strange as it may seem to say, could we need, in a word, more lawyers?) The "rule of law" is not, after all, self-executing.

Clients are becoming more demanding, to be sure, but it's misapprehending the situation to think it's all about fees or price; rather, it's about actually comprehending the clients' businesses. In a sense, isn't this development "back to the future," back to a day when lawyers intimately knew their clients and were institutionally close to them in ways that are unusual today? More than a few name-brand law firms, according to their managing partners, are investing more in institutionalizing the client relationship than they are in any other recent initiative, even to the point of creating a "client relationship" dimension as a third organizational dimensional matrix on top of the familiar two of practice groups and geographical footprint.

The value of human capital--the "war for talent" again--has never been higher. But it's now beyond partners and associates to non-lawyer staff and C-suite executives. Among all these groups, lawyers included, it's no longer enough to be merely technically excellent. Today's clients and today's environment call for people with high levels of "emotional intelligence" and right-brain capabilities. If this is right, we need to re-think the ideal profile of a partner (and I believe strongly that it's right).

Also, if we value human capital, what's to fear from "outsourcing?" Isn't that just another way of saving a generation of associates from the equivalent of being consigned to working in the textile mills of e-discovery? (Whenever politicians rail against NAFTA or other free trade agreements, I always wonder which voters are out there desperately hoping their children have the opportunity to grow up and go to work in a textile mill.) Perhaps young associates should be exposed to one and only one tour of duty in e-discovery, but we know for a fact that too much of that is why on average they leave after 2.5-3.0 years. Wouldn't you?

Finally, as to the future, my own belief is that assuming the Legal Services Act comes into effect as currently scheduled in the UK, the inevitable flow of money from some firms that will take advantage of outside investment (and there will be some firms) will sluice into the US. Trying to stop the flow through prohibition and regulation will only lead to feckless, disruptive, and pointless excursions into attempted micro-management of global law firms' capital structure, an effort unrealistic at its core and doomed to swift failure. If you doubt money's vibrant ability to find its own level, I have three words for you: "campaign finance reform."

At the point where bar associations here, sclerotic and paleolithic as they are, are forced to confront a new marketplace reality, they will actually have no alternative but to respond in ways that recognize and accommodate that reality, and to get over their hundred years' war against genuine competition in the profession. And, it is my devout hope, they will awaken to the need for a "level playing field" in our global economy.

On this point, the insanity of firms' being potentially subject to 51 different jurisdictional bar authorities in the United States was, without exception, roundly denounced. GE (for example) gets to choose whether it wishes to be incorporated in Connecticut, New York, California, Delaware, or somewhere else entirely. Why shouldn't Latham have the same choice?

The conversation on this topic, brief as it was, focused on acknowledging the blisteringly obvious antique anomaly of "presence-based" regulation. The only interesting note to add is that corporate clients would presumably be roundly in favor of unitary law firm bar regulation since it would at once obviate the need to hire duplicative local counsel in jurisdictions far and wide for no commercial, economic, or strategic purpose.

Do we have all the answers?

I've never been at a conference before where so many readily admitted to so few answers. But that's the way entrepreneurship and innovation proceed. Not by knowing to a fare-thee-well what all will work, by specifying it exhaustively in advance, but by experimenting. New businesses are not created by figuring out in advance every possible contingency that could go wrong and only launching then; they're created by the "ready, fire, aim," mindset. Or, as I said in a prior life as CEO of a dot-com, "mid-course corrections are my middle name."

In my own presentation, I took issue with the assumption that our industry is not capital-intensive by opining that that's static, not dynamic, thinking, constituting a great failure of imagination. And by analogy I used evolution's famous "Cambrian Explosion" (great video courtesy of WGBH here) . If you're not familiar with this, the story is simple:

• For the first 3-1/2 billion of the Earth's 4-billion years, all nature knew how to produce were single-celled organisms: Algae, fungi, protozoa, etc.
• Then, from about 530-580-million years ago, evolution came upon and exploited the miraculous invention of multi-cellular organisms.
• Every single order of Animalia that exists today was invented during the Cambrian explosion.
• There were a huge number of dead ends, wrong turns, mistaken detours, and fundamentally bad designs (creatures with five eyes)
• But there was a never-before-or-since efflorescence of innovation including such truly useful structures as eyes, ears, scent, and four limbs. (Four limbs, if you're interested in mobility, are Truly Useful. There's a reason cars have four wheels.)

Do we know where it's all going, or where, as some linear extrapolations had it, where we'll be in 2025 as an industry? Not on your life.

But could you or I imagine such a conference even as recently as three years ago? Not I.

Hope to see you three years hence at the next conference.

Updates:  29 April 2008

Two addenda which have come in since I originally published this.  The first is an article, which is self-explanatory, and the second is an incisive comment by the General Counsel of a Fortune 500.

Second, we have our astute GC's thoughts:

"Bruce -- Sounds like an interesting conference.  It's a shame that in-house counsel appear to be poorly represented – after all, we are the reason for existence of most private practice counsel (and ultimately the source of revenue to support the legal education system).  Those attending have a high degree of interest in maintenance of the current extremely profitable and robust status quo as opposed to being agents for change.  The in-house community needs legal service providers as we simply cannot in-source all our work.  As such we need our law firms to be profitable.  We can move to a world where law firms are merely suppliers or one where they are partners and accept risk and reward in exchange for value -- but in either case, change must occur.  That change must take place at the law schools which need to train and produce counselors not lawyers (i.e., more focus on practical delivery of real world legal services) and at the law firms that must change their economic model to focus on profits through cost reductions as opposed to top line revenue growth.  We simply must begin a dialogue to focus on value -- and that means achieving the business client's objectives effectively and efficiently.  Generally speaking, clients are not interested in winning cases or answering interesting questions of law -- we are interested in reaching our business objectives profitably and with a focus on compliance and stakeholder value.  If there is indeed a war for talent, I do not believe it's a war that clients are asking law firms to fight, much less are willing to pay for.”

As for the relative paucity of inhouse counsel, guilty as charged.  As one of the organizers of the conference, all I can offer in mitigation is that we wanted law firm leaders to feel free to speak openly about their appetite for change and we perhaps assumed a little too casually that the presence of a large representation of GC's would make people feel defensive or guarded.  A senior representative of the ACCA was there, however, and made some of the very points advanced by our GC friend here.

I'll continue to update this as additional commentary comes in.

Hard Economics & Associate Lockstep

No question is posed to me more frequently these days than, "What does this economic environment mean for law firms?"

To which the only sensible answer is, "It's way too soon to predict anything for sure, but each firm's own situation is sure to differ."    Indeed, it's true that we've seen layoffs at Cadwalader, Clifford Chance, Thacher Profitt, and as of yesterday Thelen Reid, as noted on the WSJ Law Blog.  Yet I've also had conversations with managing partners who tell me that the first quarter of 2008 is shaping up to be as strong as any last year.  So what's going on?

I've written about this environment before, and recently, as in:

• "Prospects for 2008"
• "Think Different.  Who, Me?"
• "Don't (Only) Sweat the Small Stuff"
• "Glass Not Half Full"
• "A Contrarian Bounce?", and
• "The Upcoming Banana?"

If I had to summarize where I stand, I'll reiterate that at this stage in the cycle I remain a "worried optimist."

But since loudly and confidently declaring one's economic predictions is essentially a mug's game (as the joke has it, "you could lay all the economists in the world end to end and they wouldn't reach a conclusion"), the real question is, What should you do?

I have a thought:  Let's re-examine associate lockstep.

Again, this is not the first time I've written about this; in "Fealty to Anachronisms," I reported last June on Howrey's ditching associate lockstep.  But it's time to revisit the issue.

To begin, it helps to step back and take a deep breath before we ask probing questions about a custom we take so very much for granted—one which has been ingrained as a core element of the "Cravath System" dating back to the turn of the prior century.

But if you look at our industry's practice of compensating associates from the perspective of corporate America—or even from the perspective of the putative "man in the street"—I'm put in mind of nothing so much as the New York Times music critic reviewing an early Verdi opera with an especially preposterous plot:  "If I tried to explain to you why Ernani kills himself, we'd be here all week and at the end you wouldn't believe me anyway."

Isn't that about right?  How on earth is it that we've brainwashed ourselves to believe  associate lockstep makes sense?

I submit that in no other business does compensation turn almost solely on year of graduation or year of admission to the profession.  Are we right and the rest of the for-profit economy wrong?  If you're with me at least to this point, now is the opportunity of an economic cycle to re-examine this hoary tradition.

The moment's propitious because, regardless of one's views of the health of our revenue streams going forward, savvy attention to cost is always a virtue, and given the recent spike in associate salary "going rates," real money is at stake.  (I might add that clients appear irrationally anything but exuberant about the associate salary spike.  This may make zero sense economically but it seems to clients to make great sense psychologically.  Ignore it at your peril.)

How then might you wean your firm away from associate lockstep?  Start by taking a page from the playbook of firms, such as Howrey and notably Latham, that have done it already.  Some ideas:

• Create "bands" rather than "years," and group associates past the first or second year into perhaps three such bands of seniority.
• Within each band, which would have a minimum, median, and maximum salary range, determine the place of individual associates based on 360° assessments.
• Permit, indeed encourage, deviations from seniority; that is, after all, what this is all about.  Why not have a third-year who's a superstar earn more than a fifth-year who's hanging on by their fingernails? 
• Deviations from seniority achieve a number of salubrious objectives:
  • They tell the truth to associates about how the firm views their performance;
  • The associate's costs begin to more roughly approximate their value to clients;
  • The firm can more wisely target its scarce salary and bonus dollars to those it wants to keep, now divorced from the artificial constraints of lockstep year-by-year compensation;
  • Billing partners are liberated from the awkward conversations with clients about associates' increased rates; if a client notes that a particular associate's rate has gone up, it's not because another year has ticked over on the calendar, but rather it's because the firm has decided that associate's performance—and value to the client—has increased.

Perilous times are often the most conducive to change.  As a managing partner said to me, "Change is easiest when the house is on fire."  Don't wait for the house to be on fire. 

But explore creative alternatives to business as usual.  Your partners, and your associates, will thank you for it.

Update (24 March):

A 3L at a heavy-duty law school writes (reproduced by permission, but anonymously):

"Hi, I am currently a 3L at [...]. I very much agree that firms should move away from lockstep pay, but I do wonder whether an economic downturn would be a feasible time to do it. I will be starting at a firm in the fall, one of the "bulge bracket" NY firms that you refer to, and it occurs to me that now would not be the time to implement this there. Two of the largest and most profitable practice groups are litigation and M&A (unsurprisingly). I have been told that M&A is fairly cyclical and litigation is mildly counter-cyclical, that the partners are aware of this and that they fully expect hours to fluctuate accordingly. However, the M&A people have been working their tails off for the past few years under lockstep pay. If this program is implemented now, the M&A people will probably resent the fact that it is starting while they have to sit on their hands, rather than in the last few years where they put in superlative hours. Furthermore, lockstep pay helps to avoid causing people to fret about their reduced hours during downturns in business, whereas lockstep pay might cause competition for work that might damage the firm's atmosphere. More generally, how should firms thinking about switching to merit pay deal with fairness between different practice groups that operate according to different business cycles?"

He raises an interesting point, one I did not address in this  piece initially, which is why I wanted to append his question and my thoughts.

Which are two:  First, to the extent variable compensation under my hypothetical scheme would include a material component reflecting hours billed, our faithful correspondent is correct that timing issues and practice group cyclicality will all but ensure that someone's ox is gored during the transition from lockstep.   There are ways to solve or at least ameliorate that, of course, and were someone to actually ask me to advise on such a transition, I'm quite certain I would recommend a "glide path" during the transition that would even out any capricious inequity.  After all, everyone knows what's hot and what's not:  You just have to address it as adults.

But second, implicit in his question is the assumption that a large portion of the variability in compensation would reflect the absolute level of billable hours.  I don't know if I implied that in the original piece, but now that the predicate is laid bare, I will plead to only the most tepid endorsement of that assumption.  More precisely, I will endorse the notion that "more hours means more  $$" within the scheme I outlined only with the following understandings:

• There's an important distinction between the workload of a practice area overall and the hours billed by any individual associate.
  • It's unfair to penalize associates for a low overall level of activity in their group—if that's anyone's fault, it's the partners' (or the economy's).
  • Conversely, I believe it's not only fair but the soul of meritocratic capitalism to reward individuals for hours at the right of the bell curve within their group and to ding individuals at the left.
• But the heart of my proposal as I envision it has almost nothing to do with hours and everything to do with professional development and progress along the curve of being a high-performing practitioner.  What I care about are:
  • Pure legal excellence:   Analytic ability, attention to detail while not losing sight of the big picture, an instinct for getting to the core of a matter.
  • Writing and speaking clearly, effectively, and precisely.
  • Being able to team with colleagues within the firm, up, down, and sideways.
  • Client relationship skills—beyond dutifully reporting what clearly has to be reported—extending into the realm of potentially excellent client service overall.

A thought-provoking followup.  Thank you (and you know who you are).

Process or Passion?

A major article appears in this month's American Lawyer, penned by Ben Heineman, most famously ex-GC of GE, and David Wilkins, Harvard Law professor. Both are now deeply involved in HLS's Program on the Legal Profession, whose stated mission is "to build bridges between the academy and the profession."

The article, "The Lost Generation?", subtitled "demoralized and dispirited, big-firm associates are defecting in droves. Here's what firms, and their clients, can do about it," is one of which it might be said, "Attention must be paid." Between them, Heineman and Wilkins contribute more diverse experience of the world and more IQ points per paragraph than has graced any other article yet published this year.

First, permit me to summarize their arguments, and then I'll offer my own humble coda.

The problem, in a nutshell, is attrition. Despite increased salaries and bonuses, more (professed) attention to work/life balance and associate development, more indisputable investments in stress management, concierge services, and day-care, by years three to four anywhere from 30 to 50% and more of associates are out the door.

The reasons are well-known:

• Having paid off law school debts, they're done.
• Private equity and investment banking pay better and are sexier.
• They figure they won't make partner--and aren't sure they'd like to, based on what they see of partners' lifestyles.
• Other obvious reasons like following a spouse to a different city or deciding to become the "at home" spouse.

But then David and Ben delve deeper into the associate/partner disconnect within large firms and unearth more subtle, cultural, professional, and personal reasons for the appalling rates of attrition:

• A depressingly high ratio of drudge-work to interesting work. (As one commenter to the WSJ Law Blog piece on the article put it, "One word: e-discovery!")
• Large matters staffed by large teams where junior associates feel peripheral and marginalized.
• Partners' inability to communicate (junior partners are especially singled out for this critique).
• Utter opacity about:
  • firms' finances
  • associates' chances for partnership
  • the criteria for partnership
• Corporate clients who, as the authors put it, "are unwilling to take risks on young associates and unwilling to pay their rates, so associates may not have interesting opportunities such as doing important work, meeting with businesspeople, or traveling to depositions, hearings, or arguments." [We'll come back to this.]

And they claim that this has all changed markedly for the worse in the past 20 to 30 years. This one sentence may summarize the article:

"Big-firm associates, then, may be a lost generation: a cohort of junior lawyers whose initial professional experience is extremely unsatisfying, who are turned off by the traditional rite of passage in a large firm, and who are not developing as legal professionals in the broadest sense of that phrase."

Here they may have put their fingers on what I think could be one of the defining challenges to the profession in the near future: Climbing the mountain of finding the next generation of committed professionals. Ben and David proceed to enumerate some suggested reforms attempting to ameliorate the barriers that young associates seem to feel stand in their way. Most are conventional extrapolations of things a few firms are already doing, and perhaps the question is whether the cumulative impact of all of them would really change the proportion of associates who feel inspired.

Their core recommendation is surely sound: Expose associates early on to real work even if they're bystanders and not participants. Only if junior associates have a sense of the drama of high-stakes litigation or deal-making will there be a prayer of their staying enough years to begin doing it themselves.

Ben and David's prescription thus includes these elements:

• Having junior associates attend key meetings, albeit "off the meter;"
• "Seconding" third or fourth-year associates to corporate clients to get a more textured sense of what companies actually do with legal advice and how lawyers fit into the overall corporate hierarchy;
• Somewhat obviously, expanding pro bono commitments;
• And equally obviously, expanding opportunities to "lend" associates to governmental agencies; but most important of all
• Really and truly demanding that partners devote time and emotional commitment to professional development, including competency benchmarks and internal career counseling.

Do we, then, have a credible response to the dilemma of ever-higher compensation and ever-higher attrition?

Almost. The authors are far too generous to corporate clients and put essentially the entire burden of associate development on law firms. Yes, I understand the financial pressures on GC's to cut costs just as their other C-suite comrades are doing, but I'll bet you that the CFO is not second-guessing junior trainees being on the outside auditor's team and the CMO is not telling the ad agency to leave the assistant account executives back at the office.

It's actually worse than that, because the same GC who (for example) instructs outside counsel not even to bother putting first-year's on the bill because their time will only be zero'ed out is going to go right back to those same firms to poach mid-level's when the inhouse department needs to staff up. Economists call this free-riding, but it doesn't take an economics background to label it for what it is: Patently hypocritical, exploitative, and plain old unfair.

Corporate America, which presumably benefits first and foremost from the services of BigLaw, needs to behave more as a business partner and less as a distant third-party willing to exploit the reality that right now there's a lot of sand in the gears when the interests of law firms and the interests of young associates try to mesh.

Nevertheless, many components of what Ben and David have laid out are, as I said, inarguable.

But even if we could get corporate America to help the situation rather than throw fuel on the fire, one other thing is missing, and that is passion for the profession: Inspiring it, cultivating it, sustaining it. These are the among the missions of law firms (and yes, clients), because it's passion and only passion for the intellectual challenges and the creative possibilities of the profession that can sustain a lifetime of engagement and performance at the highest levels. Understandably, we're more comfortable talking about processes and procedures and techniques; but let's not lose sight of what we're trying to achieve. Lifetime commitment to the practice.

Don't (Only) Sweat the Small Stuff

While we're all obsessing over the sub-prime crisis, the credit crunch in general, the housing market's retrenchment, the inability to mark to market CDO's, the devilish tendency of "liquidity" to be robust when you don't need it and nonexistent when you do, whether worldwide financial institutions' losses and writedowns will total $150-billion, $250-billion, or some other number entirely, and the implications of all of this for our firms in terms of practice groups and geographic focus, it may make sense to stand back, take a deep breath, and look at what's going on with global capital markets over the long run.

Stepping up to this particular plate is one of the most familiar suspects: McKinsey.

In their "Long term trends in the global capital markets," they offer the following perspective:

• Globally, financial assets are on a growth tear, and this should be expected to continue.
• As a consequence, financial markets are deeper than they ever have been.
• Cross-border transactions and investment links have never been stronger.
• Emerging markets are continuing to surge, outpacing GDP growth in those economies.
• New sources of capital are emerging.
• Japan continues to be challenged.
• The euro is emerging as a potential worldwide rival to the dollar, as European cross-border transactions accelerate.
• Nevertheless, the United States has unparalleled strengths, and despite all the ink being spilled over "sovereign wealth funds" and the like, the actual composition of foreign equity ownership might surprise you.

Now, to unpacking some of this wealth of data and analysis.

Growth of financial assets

Over the past 25 years, all financial assets (the value of all bank deposits, government debt securities, corporate debt securities, and equity securities) have grown strongly: From 2006 to 2007 alone, +17% from $142-trillion to $167-trillion. Bank deposits are a decreasing share. This shows the "CAGR" (compound annual growth rate) of equity securities' value over the past 10 years to be 10.4%, private debt securities 10.7%, government debt 6.8%, and bank deposits 7.8%. (It's heartening that the slowest growth has been government debt.)

Financial market growth outpacing GDP

"Financial depth" is the ratio of a country's financial assets to its GDP, and the good news it that it's been increasing consistently across all global regions. Why is this good news? More liquidity, more capital access for borrowers, better risk allocation.

In 1990, only 33 countries had financial assets whose value exceeded GDP; by 2006, 72 did. Likewise, in 1990 only 2 countries had financial assets triple their GDP; by 2007, it was 26.

Growing cross-border links

Cross-border investments are at an all-time high, making us more financially interdependent across the globe than ever before. If cross-border investments are deemed to include foreign investments of multinationals, ownership of foreign debt and equity by investors, and foreign lending and deposits, it totals $74.5-trillion at the end of 2006, or about half of all global financial assets.

Of greater interest is the changing composition of this investment. Ten years ago the US was the predominant hub. Today, while the US is still first among equals, the eurozone and the UK have built important links to emerging markets, and the Middle East is emerging as a major player on the global stage.

Here are the schematic cross-border flows, first the $31-trillion of such flows in 1999 and second the $48-trillion of such flows in 2006 (constant dollars):

Of particular note here is not just the overall growth, but trends in its composition:

• The US more than maintained its share, as did the mature economies of the UK and the Eurozone.
• In relative value, Japan lost ground.
• The strongest ties (red arrows) remained between the US and the UK and the Eurozone.
• Flows to Latin America more than doubled.
• Whereas in 1999 many of the linkages showed less than $1-trillion of movement (light blue/grey lines), by 2005 those weak links had all but disappeared.
• The emerging economies of Russia and Eastern Europe, and of "emerging Asia" roughly tripled their participation in the global economy, on this measure.
• But the most stellar performance of all came in the Middle East's increasing integration into the global financial economy, with flows more than quadrupling.  (And you were wondering why Latham just announced the simultaneous opening of three offices there, in Abu Dhabi, Dubai, and Doha?)

Emerging markets emerge

Last year, one quarter of the entire growth of global financial assets arose from emerging market economies. And they still appear to have substantial running room, accounting for only 14% of financial assets but 23% of global GDP.  And although bank deposits are still the most valuable asset class, reflecting these economies' immaturity, they accounted for 35% of all IPO value in 2006, up from 10% in 2000.  Chinese companies alone raised as much in IPO's in 2006 as did all companies in the eurozone combined.

New providers of capital

You would imagine that the world's richest countries would be the pre-eminent suppliers of global capital, but just because that's logical does not mean it's true. In fact, emerging markets are, as we all know, the largest suppliers of capital, with outbound foreign direct investment, at $139-billion in 2006, doubling from 2005 and sextupling from 2001.

But the flow is not just one-way. A total of $700-billion of inbound foreign direct investment took place in 2006, amounting to 6.4% of those countries' GDP. In other words, the developed and the developing world are linked in the capital markets as never before.

Here are the net capital flows (outflows - inflows) in constant 2006 dollars (billions) for 34 emerging markets including Brazil, China, India, the Philippines, Russia, South Korea, and Thailand (among others):

The continuing ennui of Japan

There are almost too many ways to enumerate the continuing weakness of Japan, but here are a few:

• Despite its proximity to emerging Asian economies, it accounted for just 6% of foreign funds invested there.
• Its government debt is truly enormous, amounting to 150% of GDP and one-third of all its financial assets.  Not counting that debt, its financial depth ([value of financial assets]/[value of GDP]) would essentially be at the 1990 level.  In that same period, the financial depth of the US has increased 168 percentage points and the eurozone 173.

The sources of direct investment into the emerging Asian countries in 2006 (totaling $2.2-trillion) show the US with a commanding lead at 29%, Hong Kong plus Singapore plus Taiwan at 24%, the UK at 18%, the eurozone at 14%, and Japan's slice smaller than "the rest of the world:"

The strength of the euro

While the euro's rise against the dollar is by now old news, what's less well known is that in the spring of 2007 the total value of all euros in circulation surpassed that of all US dollars in circulation for the first time—and there may be no looking back.    And while central banks and other financial institutions still hold two-thirds of their reserves in dollars, the euro's share has grown from 18% in 1999 to 25% today.  It is probably already the most popular currency for companies issuing international bonds.

The US' relative strength

But it's far too soon for Yanks to despair. 

The US remains the most liquid and largest financial market, with nearly one-third of all assets, and the strongest absolute growth rate of any market in the world.  Also on the positive side of the ledger is that only 5% of US financial assets constitute government debt.

And we keep attracting nearly 25% of all global inflows, as the largest single destination for foreign direct investment—as well as being the largest single source of outgoing foreign direct investment.

Foreign ownership of equities

Given all the alarms raised about increasing foreign ownership of US assets, where do you suppose the US ranks in foreign-owned equity as a percentage of all outstanding equity, compared to, say, the Eurozone, the UK, and Japan?

Dead last, by a long shot.  Here are the figures, for 1990 and 2006:

At 14% foreign ownership (today), the US trails all other economic regions by far, and is just barely ahead of emerging Asian markets in its proportion of domestic control.

Where does this leave us?

At the most fundamental level, if you ever doubted globalization is here to stay, get over it. 

At the strategic and tactical levels, as you look at the ongoing market turmoil, with new reports seemingly daily of another name-brand institution taking a big writedown or another arcane corner of the credit markets getting the flu, take a deep breath and have the courage to raise your eyes above the short-term chaos towards the horizon.

• The US is not sliding into global capital markets irrelevance.
• The axis of power in Asia is shifting from Japan to China.
• The eurozone will continue to matter more than ever.
• The Mideast is emerging from its provincial, resource-heavy and passive stance to becoming a globally aware, capital-heavy and active player.
• Cross-border flows are enormous and look primed to escalate even further.

Then ask yourself what capabilities your firm has to capitalize on these trends.  If you don't like the answer, now, when the conventional wisdom seems to be advising "hunker down," may be the time to pick up some capability for less than it would have cost you a year ago.  And if you do like the answer, I'd advise pretty much the same:  Steal a march on your more timid competitors so that you're prepared to emerge from this period of stress more capable and more broadly positioned than before.

Hard to do, you're saying?  With some of your key practice areas showing severe signs of stress? 

Yes, you must address the current smoke before it becomes a fire.  But what you cannot do is to permit "sweating the small stuff" to be the enemy of building on the big stuff: Financial globalization with a vengeance.

The Story Behind the Reed Smith/Anderson Kill Story

By now it's been amply reported that 55 of Anderson Kill's 126 lawyers are leaving for Reed Smith, effective February 1.   In classically hyper-ventilating fashion, the Brits (Legal Week) reported that Reed Smith "has swooped, ...taking almost half the fee-earners."  Adding to the somewhat melodramatic coverage given the story were confused and even conflicting statements initially coming from the two firms.  For example, on law.com the two firms couldn't seem to agree on the number actually departing, with Reed Smith sticking by the figure of 55 and Anderson Kill rather obliquely calling the number departing "fluid."  Meanwhile, on the widely read WSJ Law Blog, their second story about it said:

"Law Blog colleague Amir Efrati spent a good part of today tracking down the story behind the story. The Law Blog’s conclusion: given how little the firms agree on the circumstances surrounding the failed merger, it might be just as well that they didn’t tie the knot."

I decided I'd prefer to get to the bottom of things on my own, so last weekI had a chance to catch up with Greg Jordan, Reed Smith's managing partner, and the real story is a bit more complex (and human, and nuanced) than the immediate and somewhat sexed-up reports would have had it.

First, here are some of the basic facts:

• As noted, the deal is effective 1 Feb 2008
• A total of 56 lawyers out of about 120 at Anderson-Kill are coming over to Reed Smith:  25 partners, 3 counsel, 27 associates.
• Some  of the key personnel who came over include:
  • Jeffrey Glatzer, a bankruptcy litigator, and former Anderson Kill firm-wide president and CEO
  • Lawrence Kill, an antitrust lawyer and a name partner
  • James Davis, managing partner, Chicago
  • John Ellison, managing partner,  Philadelphia
  • Steven Cooper, head of litigation, and  J. Andrew Rahl, Jr., head of bankruptcy, both members of the executive committee.

As for how the talks began—and they were merger talks at the outset—Greg reported, which is not news, that Reed Smith is always on the lookout for ways to build  key practice areas, and since insurance recovery work is an important practice, the talks with Anderson Kill were logical. 

Another aspect of the early reports was also correct:  That the merger talks ultimately broke down over conflicts.  The exact nature of the conflicts, however, is slightly different than typically implied—it was not that Reed Smith represents large swaths of the insurance industry and Anderson Kill typically sues the insurance industry—but rather that the two firms found themselves representing different interests in some large bankruptcy proceedings.  (The rules and customs of the federal bankruptcy court are, shall we say, beyond the scope of "Adam Smith,  Esq.," but suffice to note that they are a land unto themselves where, among other things, even knowing and informed  consent to waiving potential conflicts is often a non-starter.)

Things then got complicated. 

Whether or not the conflicts were irreconcilable, ultimately, it was simply too hard—quite understandably—to ask  one or both of two groups of dedicated lawyers who had worked long and hard on sizable matters to resign their client representations.  And so the merger talks broke off.

But introductions had been made and some unmistakably positive impresions formed.  Soon, some senior Anderson Kill partners came back to Reed Smith and asked if they could still merge if they could  do it with almost everyone instead of everyone.  Reed Smith's response was that since it wouldn't work as a "whole firm" merger, then it was really up to Anderson Kill to solve their partnership issues and work out any alternative they'd like to propose, but that  Reed Smith would entertain continuing discussions if they could do that and there was anything they wanted to come back with.

Ultimately, the Anderson partners did resolve their issues and Reed Smith extended offers to 57 lawyers at Anderson Kill and 56 accepted.  As Greg somewhat ruefully put it, "it ended up being a heck of a lot more complicated than a straight merger would have been."

Does Greg have any regrets as to how it played out?

"In terms of the business for both firms, going forward, absolutely not!  For us, it's one more step in our  plan of filling in  gaps in our  practice areas, helping us build out our litigation and restructuring practices, and continuing to invest in our key offices in New York, Chicago, and Philadelphia.  And as for Anderson Kill, we think, they are going to do very well going forward; they have a good group and a good plan and we wish them all the success in the world."

Absolutely no regrets?

"Well, I have to admit  the way it  was reported made us look a little predatory—that was unfortunate and unfair.  But  I guess I understand it made for a better story."

What, then, are we left to learn from this?   My read is that both firms—and, on the whole, the individuals  involved—are going to be far better off in the long run.  And I don't think this is happy talk.

One of the peculiarities of the practice of almost any individual lawyer, and one of the few abiding truths in our world, is that some people are better off having a platform behind them that provides a diver

unse practice set, high capacity when needed, and a relatively ambitious geographic footprint, and for others those characteristics are irrelevant at best and an expensive and irritating distraction at worst.

My working hypothesis about all this, then, is that the people involved understood that—intuitively and subconsciously if not analytically and with cold rigor—and made  their self-enlightened choices.

Where I come from, that's the way the market is supposed to work.

And don't we, after all, see this all the time on a smaller scale (one admittedly not lending itself to breathless leads in the press)?  Don't we see people migrating laterally from smaller boutiques, regional and specialty firms, to larger national and international platforms, and don't we  also see exactly the reverse?  This was simply a bunch of people doing both those things simultaneously.

The Ten Years' War

It's been nearly a decade since McKinsey published the seminal article, The War for Talent, but many of its abiding observations remain true today and indeed are worth revisiting. What they found ten years ago started from the implacable demographic reality that the baby boom generation was passing through the senior management pipeline and that there were far fewer bodies coming down the pike in the future.  It can be summarized thus:

"What we found should be a call to arms for corporate America. Companies are about to be engaged in a war for senior executive talent that will remain a defining characteristic of their competitive landscape for decades to come. Yet most are ill prepared, and even the best are vulnerable."

And their recommendations?

• First, make the war for talent a top priority of the entire organization, starting at the top. That means spending senior partner time interviewing not just lateral partners, but lateral associates and all associates, at regular intervals, to discover what's on their minds.
• Make sure you have a compelling answer to the question, "Why would a very talented person want to work here?"
• Recruit continuously. Not just seasonally, and not just when you think you have an opening. Constantly be on the lookout for talent. (I might add that in the current fear-of-recession marketplace, this is more true than ever; perfectly good talent may find itself on the street, or on the fence, for no good reason. Be opportunistic.)
• Put people in situations before