Why Hockey Players Wear Helmets & Associates Bill 2,200 Hours/Year

Actually, this post is less about hockey players and associates than it is about how the top firms are all able to mysteriously agree on the "going rate" ($125,000 for first year's) without colluding, and on the dynamics behind the scenes when that rate abruptly jump-shifts to a new equilibrium.

The wonderful Robert Frank has the hockey-player story.  (Frank has been a professor of economics at Cornell since 1972, and co-authored Principles of Microeconomics with our Fed Chief heir apparent, Ben Bernanke; if you ever see his byline, you owe it to yourself to read at least the first paragraph and see if he doesn't draw you in.)

Frank recounts the hockey-player mystery as analyzed by Thomas Schelling, just-announced Nobel Prize winner.  In 1978, Schelling asked why, since all hockey players left to their own devices will prefer to play without a helmet, in secret ballots they nevertheless vote strongly in favor of mandatory helmets.  In other words, why do individual preferences diverge from group preferences? Putting it differently, if as a group players think the rule is a great idea, then why don't the players just don the helmets on their own absent the rule?

The answer takes us into territory where the Invisible Hand breaks down.  Any individual (rational, utility-maximizing) player believes he can play marginally better without a helmet—seeing and hearing more acutely.  The IH would therefore posit that all aggressive players would discard their helmets for the perceived competitive advantage:  A slightly higher chance of winning is valued more than the increased safety a helmet provides.  But of course, once no one is wearing a helmet, no one has a relative advantage in the game—and all that has been accomplished is to raise the risk level for all.  Thus secret ballots mandate helmets.

Similar "beyond the Invisible Hand" logic applies when it comes to associates' workloads.  If everyone else is leaving the office at 5:00 (i.e., wearing helmets), I can stand out from the crowd by working 'til 8:00.  Once everyone is working 'til 8:00 (doffing their helmets), my competitive advantage disappears and the only result is 2,200 hours/year minimum for all.  As Frank says pithily, "The invisible hand assumes that reward depends only on absolute performance. The fact is that life is graded on the curve."

Now turn to the flip-side of associate hours:  The "going rate."  Legal Week is covering the possible eruption of a salary war in the UK (more precisely, a one-time salary spike), where Allen & Overy recently fired a salvo by hiking starting salaries, and all are holding their collective breath to see whether others will follow suit.

"Haven't we been here before?!" you are asking:  Indeed we have; the profitability of many US firms took a lasting hit after the dot-com-driven spike from $100,000 for $125,000 in 2000.  So this time around, we know better, right?  Maybe not.  This is the dilemma:

• Law firms have very few controllable (variable) costs. 
• Of their fixed costs, compensation is far and away the largest piece of the pie; real estate is next, and essentially everything else is immaterial.
• But the war for talent is one that, on pain of resigning the firm to second-rate status, simply must be won at any cost.
• When associates are in short supply, as they evidently are now in the UK, guess who gains the upper hand at the imaginary bargaining table?

A brief digression on "in short supply:"  In a tautological way, demand and supply are always equal, in the sense that the number of associates who start at City firms (supply) is identical to the number who are hired (demand).  Observations about "tight" or "short" supply refer not to this static arithmetic truism but to the underlying changes in the marketplace:  Here, the fact that corporate, M&A, private equity, and funds work are all ramping up and four years ago in the downturn many UK associates were shown the door.

So is there any alternative but for City firms to follow A&O's lead?  Isn't the inevitable handwriting on the wall?

I invite you to participate in the following thought experiment:  Permit yourself to ask if there might not be something other than $$ (or ££ or €€) to entice associates to come, and then to stay, at your firm?  After all, in the Maslow hierarchy, money can satisfy physiological and safety needs, but not belonging, esteem, or self-actualization needs. 

Realistically, any City (or AmLaw 200) lawyer expects to work hard and concomitantly to be paid well.   But how many hold out any prayer, much less expectation, of enjoying a feeling of belonging, of, dare we say, loyalty to their firm?  (We're discussing associates, but experience with lateral partner moves confirms the indisputable value loyalty has in the marketplace:  No partner will move for, say, a 10% bump-up, in a stratosphere where 10% could be real money.   Loyalty is the counterweight.)

Absent any sense of belonging, we have highly paid but miserable people; with a sense of belonging, we might aspire to well-paid but happy people.  This would require a firm and consistent commitment to recruiting people not just with the right technical skills but those with the right cultural and behavioral profiles.  (Or, to paraphrase Legal Week, we would need to break the syndrome of "hire for the technical, fire for the behavioral.")  I stress "consistent:"  Creating a:

• palpable,
• meaningful,
• credible

firm identity that differentiates you from your peers takes both vision and hard work. 

The good news is that, when the tough times return, as they will, you will have a reputation (a marketplace asset every bit as real as its counterpart, loyalty) that will enable you to stand apart from the firms whose recruitment and retention policy amounts to "pay them now, shoot them later."

And you don't have to get partners in all the City firms to agree to this by secret ballot; you can do it starting in your executive committee.  Then you will be playing hockey without a helmet while all around you are encumbered with their gear.

Debating Affirmative Action: Ideology or Data?

The current issue of the Stanford Law Review has an empirical analysis of the impact of affirmative action in law school admissions on black students, written by UCLA Law Professor Richard Sander, which concludes that the "costs of preferential admissions appear to substantially outweigh the benefits."  Sander's thrust is that black law students would perform better, achieve higher class ranking, and pass the bar at greater rates, were they to attend less prestigious schools.

Can you say "incendiary?"  That's why the debate hosted by Legal Affairs between Sander and my good friend and colleague Associate Professor William Henderson of Indiana University Law School/Bloomington is such an important one, and why Bill's opening point (in what is a remarkably civilized discussion) is essential to approaching the issue:

I don't think the legal academy will reach any constructive conclusions on your study until we are capable of having exchanges that are driven primarily by data rather than ideology.

Groves of Academe

Back from the truly lovely Midwest oasis of Bloomington, Indiana (approx. 40 miles south of Indianapolis), where I had the pleasure of guest-lecturing to a group of 30 or so smart, inquisitive, and polite-but-challenging 2L's and 3L's.  Bloomington, and the Indiana University campus, are full of architectural gems and monuments both, with brick sidewalks, rolling terrain, and that ineffable "college town" feel.  At a Starbucks right across the street from the law school, the crowd could almost have come from the Upper West Side (well, half the crowd, anyway).

Midwest hospitality may be what it's cracked up to be. Prof. Henderson and Lauren Robel, the Dean of the Law School, were exemplary hosts in their willingness to spend time and make me feel at home, and I can report that the IU Law School library is one of the most beautiful I've seen. Maybe it even encourages students to spend time there. Be that as it may, the Dean and the Professor are people I am proud to know now in person.

And the hospitality runs across the board: When I went to the front desk of the charming B&B I was staying at at 6 am to see if I could get advice on a running route, I got 5-10 minutes of informed, accurate, and inspired advice complemented by a highlighted map.  And a wonderful run it was.

I'll report very very briefly on what the class I taught was about:  The AmLaw 200 and various historical, geographical, financial, and cultural perspectives on same (yes, full of charts and graphs).  The final part of my presentation dwelt on the highly statistically significant (<0.01 chance of random), and highly negative, correlation between profits per partner and associate satisfaction.   Pick the "associate satisfaction" metric you want—"family friendly," "realistic billable hours expectation," "open-ness about financials," etc.—and the negative correlation is striking.  As one student pithily put it:  "Anywhere I'd want to be an associate I would definitely not want to be a partner."

Choose, indeed, your poison.

Academic Adventures

I look forward with delight to being invited to guest-lecture at Indiana University School of Law/Bloomington in Prof. William Henderson's "The Law Firm as a Business Organization" course.  I fly out there early tomorrow morning. Full report when I return late Wednesday.

The Past 50 Years in a Nutshell

"The Industrialization of the Law Firm" is the ambitious, but fair, title of a piece by A. Harrison Barnes, Esq., founder of BCG Search.  His conclusion?: 

"Today's law firm environment is, in a sense, now being controlled by Adam Smith's 'invisible hand'--for better or worse."

He leaves little doubt, I must hasten to add, that he firmly believes it has been for the worse:  The law firm environment "has become a very tormented place," loyalty has "deteriorated dramatically," and the "Greedy Associates" chat boards are emblematic of the parlous state of the profession.

First, Barnes' argument in a nutshell; then, my take.

Barnes starts by introducing an elysian "pre-industrialized" law firm, an "insular" and "predictable" place where associates joined out of law school, made partner almost without exception, and stayed until retirement.  Lateral hiring was unthinkable, lockstep compensation ruled, and bills were for the [perceived] value of services rendered.  The first stage of "industrialization" occurred from the 1950's to the 1970's, as American corporations grew and demanded correspondingly larger scale from their law firms of choice.  Firms in turn expanded by hiring more associates—but then came the realization that not all associates could make partner, lest profits per partner take a nose-dive.  From this pressure emerged the classic "Cravath model," wherein associates are paid handsomely in exchange for the tacit understanding that virtually all will fall short of partnership.  With the increase in leverage provided by more associate bodies came, as well, the billable hour as the default fee-setting mechanism.

The second stage of "industrialization," from the 1980's to today, saw the introduction of two-tier (equity and non-equity) partnerships—according to Barnes, largely instigated by consultants promising increased profits through increased leverage.  [Preliminary results from the Law Firm Research Project belie this promise, but that is a separate topic.--Bruce]  The toxic result of this nefarious "stratification" of the partnership was compounded by the death of lockstep compensation and the introduction of performance-based compensation.  Performance-based compensation, in turn, fueled the growth of lateral mobility, through both a "demand" and a "supply" effect:  The demand being firms' need for high-performance teams, and the supply being such teams who deemed themselves insufficiently appreciated at their current firm.  Firm mergers, as well, took wing.

Now, as noted, Barnes points with alarm and views with despair these developments.  You should not be shocked to learn that I have a different view.  My recap?

I for one know in which world I prefer to live.  That said, Barnes' lamentations about the incivilities of today's world, including most gravely the deterioration of loyalty to and by firms, are real.  But to postulate that the "Greedy Associates" boards constitute the best representation of the state of the profession today is nonsense on stilts.  Indeed, this reminds me of the (deeply uninformed) debate over "outsourcing" jobs—and yes, Barnes does not hesitate to get in a last jab on this very point.  One should not make public policy based on analysis-by-anecdote, and one should not assess the evolution of the profession during the past 50 years based on internet chat boards.

My reaction to the "industrialization" story Barnes recounts is, in fact, entirely different:  What took so long?  I suspect Adam Smith himself would have a similar view.

"Mergers 101" [Continued]

"Mergers 101" prompted some reader response curious for more detail behind my concluding observation about how the composition of the AmLaw 200 as of 2004 differed from that as of 1999.  Here are the raw numbers:

• 11 firms were acquired
• 3 dissolved
• 8 fell out of the AmLaw 200
• 9 merged and survived as a different entity
• and there were 23 new entrants between 1999 and 2004 (totaling the "54" I cited).

Fleshing this out further, one can demonstrate that there was far more "turnover" among the AmLaw 101-200 than among the first 100 firms. 

• 23 firms on the list in 1999 did not reappear in the same form or at all in 2004
• Of these, 18 were AmLaw 101-200 firms
• Of the 5 AmLaw 100 firms that did not reappear, 2 dissolved, 2 were acquired by another AmLaw 100 firm, and one was acquired by a Global 100 (non-AmLaw) firm.

Also demonstrating more volatility in the ranks of the 101-200 firms is that all 23 new entrants as of 2004 stood in the 101-200 rankings.  The highest-ranked newcomer, at #108, is Kasowitz, Benson, Torres & Friedman, which does plaintiffs work. The second-highest newcomer, at #125, will be a surprise to few:  Boies-Schiller.

This would be an opportune moment for me to post an editorial/housekeeping note about data from the Law Firm Research Project:  Although Prof. William Henderson of Indiana University Law School/Bloomington and I have worked collaboratively and jointly to assemble and develop the raw data, "Adam Smith, Esq." is my responsibility and mine alone.  As they say up-front in books, "I humbly acknowledge the gracious and essential assistance of many of my betters, but any errors or omissions that follow are strictly my own."

Thanks to all who helped motivate this supplemental info!

Mergers 101

If you read only one article this quarter about mergers, this should be it.  Not only is the author the former managing partner of Andersen Legal (until it imploded), before that he was managing partner of Clifford Chance.  Sure, he comes from a UK-centric perspective, but economic laws know no borders, and the once-removed context helps abstract from micro-reactions one might otherwise have along the lines of, "He thinks such-and-such a firm ought to merge, but I know them  better than that."

A theme you may have picked up on—if you haven't picked up on it, I need to work harder here—is that I believe that, for richer or poorer, merger activity is on the increase.  The jury is still out, at least in my mind, on the "richer or poorer" angle, but the trend is clear.   Let's take a quick tour of the obstacles to, and then the incentives for, mergers.

Obstacles:

• In law-firm land, there are no economies of scale.  Altman-Weil certainly seems to believe this:

• Client conflicts and client demand:  These are two sides of the same coin.  Conflicts are obviously believed to militate against large scale, although I've argued elsewhere that the common wisdom about conflicts is deeply confused, indeed incoherent.  Client demand, on the other hand, is a genuine issue:  To the extent that F1000 GC's hire individual lawyers with whom they have relationships, the size and scope of the firm behind that individual is not a compelling driver.
• Partnership agreements:  Essentially all partnership agreements have super-majority requirements for approving such hugely material changes as a merger; depending on the super-ness of the majority required, a relative handful of status quo'ers could block a merger.
• Short-term earnings dilution: The immediate post-merger period (for at least a couple of years, depending primarily on lease obligations) will be expensive as redundancies in office space need to be ironed out and technology needs to be integrated.  Since firms will almost surely expense these costs as incurred (as they should!), profits-per-partner may take a short-term hit.
• Profitability disparities:  As hard as it is to achieve equilibrium in a partnership across offices and across differential partner performance, the difficulty is squared when another firm with disparate earnings patterns needs to be folded in.
• Cultural issues:  As much alike as firms may appear to the unaided eye, I guarantee that every one believes its culture is "unique" and valuable and therefore a proper subject for historic preservation.   And post-merger, whatever else the culture may be, it will be different.

Why, then, would any firms ever merge?

• To paraphrase Dr. Johnson, the imminence of one's demise concentrates the mind wonderfully.  (The verbatim quote is: "Depend upon it, sir, when a man knows he is to be hanged in a fortnight, it concentrates his mind wonderfully.")  In other words, if market conditions are becoming such that your firm's survival in its current form is untenable in the medium to long run, drastic measures may be adopted.
• Most at risk are medium-sized firms without a clearly distinctive service offering:  These are firms that my wife, the marketing executive, would say lack a "unique selling proposition"—a benefit to their clients that is (a) distinctive; (b) credible; and (c) ownable.
• Finally, there is the importance of the market for lateral's, both individuals and practice groups.  Firms perceived as lacking a critical mass will not be attractive to laterals and, adding insult to injury, desirable partners will be all the more tempted themselves to leave.

Adam Smith would have been among the first to observe that no firm has a pre-ordained right to survive.  Indeed, according to our data from the Law Firm Research Project, no fewer than 54 firms out of the AmLaw 200 in 1999 are no longer in the AmLaw 200 as of 2004 in the same form—a 27% change in just five years.  What happened to them?  Basically, they were acquired, they merged into a different form, they dissolved, or they simply dropped off the AmLaw 200.   This can happen to you.

Announcing the "Law Firm Research Project"

Starting this past summer, Associate Professor of Law William Henderson, of the Indiana University School of Law—Bloomington and I have been working behind the scenes on the "Law Firm Research Project."  Prof. Henderson teaches a course called "The Law Firm as a Business Organization," whose title alone gives away that he and I share no small array of common professional interests. (I'll be a guest lecturer for the course in November.)

What the project entails, why we started it, and what we hope that both you and we can get out of it, I can now share with you.

Most simply stated, the project is an endeavor to create a wide-ranging (I hesitate to say "thorough," much less "exhaustive") database capturing key characteristics of the AmLaw 200 firms.  Moreover, we are using every effort to capture the same data as of 2004 and back in 1999—in case any time-longitudinal trends emerge.

What kind of data?  Lots of it, to begin with:  The current version lives in an Excel spreadsheet that runs from cell A1 to cell BX224 (on the primary tab alone), and includes items ranging from the breathtakingly obvious to the more obscure:

• total firm revenue, 1999 and 2004;
• profits per partner (same);
• number of non-equity and equity partners and total lawyers;
• associate satisfaction, diversity, and pro bono measures (ranked 1—200);
• etc.

In turn, we've subdivided the firms by market league, as follows:

• International (3 firms)
• National (25 firms)
• New York City (34)
• "Major" markets (54:  essentially firms with between 1,000 and 3,000 lawyers, headquartered in Chicago, DC, LA, or SF)
• "Middle" markets (50:  with fewer than 1,000 lawyers, headquartered in Atlanta, Boston, Dallas, Houston, Philadelphia, Pittsburgh, Richmond, and Seattle)
• "Regional" markets (35:  all other smaller AmLaw 200 firms, headquartered in cities like Cincinnati, Cleveland, and Tampa).

So what?  Well, one obvious thing to do when confronted with data is to seek out correlations.  Here's one that tells a story about geographical location vs. diversity (the higher your score, the more diverse is your firm: mean scores for each segment):

• International:  158
• New York City:  138
• National:  118
• Major market:  117
• Middle market:  66
• Regional:  45

You would have surmised that based on instinct?  Good for you:  But now we've proven it.

This is the first of what will be many, many postings about the empirical gems lurking in the data.

But before I go, a word to any managing partners toying with a switch from single-tier all-equity partners to two-tier with non-equity as well:  Don't do it!

At the very least, invite me in for a long chat first.