Why are law firm associates paid so much?

Next week I'll be participating, with Bruce MacEwen (aka, Adam Smith, Esq) and others in the Indiana University conference on the Globalization of the Legal Profession. So it's time for me to get back to thinking about law firm economics.

Today's lesson is triggered by a WSJ op ed, which explains the recent escalation in starting pay for law firm associates (S & C raise from $125k to $145k (plus bonus). Says the author:

Corporate law firms are, essentially, giant pyramid schemes: The associates at the bottom funnel money to the partners at the top. At Sullivan & Cromwell, for example, according to the American Lawyer, the average partner earned $2.35 million last year. A young lawyer who bills 2,200 hours at $250 per hour generates $550,000 for the firm, only $145,000 of which pays his salary. The more the associates, the richer the partners . . . . Thus, law firms have a vested interest in growing the base of the pyramid.

As the base grows, the chances of making partner shrink, so the upfront pay has to rise to induce new lawyers to play. The author says lawyers are now expected to bill 400 more hours a month, and work 600 more, than a few years ago.

To justify the work, according to the article, firms

throw more lawyers on a case, and [are] more aggressive about litigating and challenging small matters that might otherwise go uncontested. . . . . firms are lawyering matters to death, and killing their associates in the process.

This general theory is consistent with Galanter & Palay, Tournament of Lawyers: The Transformation of the Big Law Firm (1991), who argue that promotion-to-partner tournaments force law firms to add more associates so they can pay partners enough to keep them interested in the tournament.

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

One reason may be inherent changes in the need for legal services.  As usual, I'm thinking SOX.

Another reason may be that the competition for legal services is limited to law firms, consisting of people licensed to practice law. In other words, corporations can't lower their costs by hiring firms that aren't law firms to do the work.

Law firms are subject to ethical rules, one of which is that the firm must be owned by people who are licensed to practice law. This has several effects, as I explain in Ethical Rules, Agency Costs, and Law Firm Structure, 84 Virginia Law Review 1707 (1998).

For example, why do we have the tournament that drives this escalation in costs?  I explain in the above article (at 1723) that the requirement that firms be labor-managed may cause them to be more thinly capitalized than they would be without this constraint. This means, in turn, that they "may be unable to fund promised bonuses and therefore must discipline shirking by promising management and financial rights combined with tenure."

I also argue (1725) that the ban on non-lawyer ownership means that a law firm's managers and owners, who necessarily are lawyers, would want to

maximize customers' use of legal services by either performing excessive amounts of legal services or under-recommending such related nonlegal services as accounting and finance. By contrast, non-lawyer managers of firms that offer nonlegal as well as legal services would have an incentive to maximize overall profits rather than the portion of profits produced by lawyers. This would reduce or eliminate lawyers' incentives not to send clients to non-law specialists.

So, to lower legal costs, and associate salaries, we need to reduce regulation, including regulation of legal services. 

But how to do that?  Global regulatory competition and competition for legal services might help.  So, off to Bloomington. . .

Comments

[Robert Schwartz]

There is an agency problem with the General Counsel of the corporate clients of these firms. In routine matters, their incentive is to bring them in house or to find other ways to save money. It increases their empires and gives them something positive to report (everything else they report is bad news). With non-routine work, their incentive is to cya. Take-overs, big law suits, if everything goes smoothly, it will be expensive and no will care that it went smoothly. If there is a problem, the GC will blame the outside lawyers, but it must be a top firm, otherwise the GC will get fired for trying to save a nickel at the wrong time.

[SteveL]

What I find absurd is that the top tier firms will pay these rates based on some perceived difference in ability among the top 10% of the class at the elite schools. What drives the obsession with graduates from Ivy schools, Stanford, Chicago etc.? Is there any evidence that these kids actually perform better? Being a great student is not the best predictor of what makes a great lawyer. I attended a good regional school, was top 15% and the big firms wouldn't touch me. Now, with my in-house high tech experience, many would snatch me up willingly.

[Loxley Bennett]

Hello, my name is Loxley Bennett. I am 13 years old and hope to become a lawyer as an adult. The only problem is that I don't know what kind of lawyer I should be! I would prefer to be a prosecutor, but they're paid nothing compared to corporate lawyers. If you have any suggestions or helpful comments, please email me at coltrane93@hotmail.com

[Ashley Young]

My name is Ashley and im a freshmman in high school. I want to be a lawyer but I dont know what types I could be. I wouldnt mind being a Criminal Justice Lawyer or a Constiutional Lawyer. Can you tell me about some fields I could Research? email me at: hypeleelee13@yahoo.com