The members of any collective—whether citizens of a country or em ployees of a company—have essentially two possible responses when they perceive that the collective is stagnating or declining in quality. They can "voice" their concerns in the hope that the leadership will adapt and change. Or, depending upon their options, they can "exit." That was the key analytical insight of the influential treatise Exit, Voice, and Loyalty, published in 1970 by economist Albert O. Hirschman. The willingness of members to voice or exit is influenced by how much loyalty they have to the collective. If there is a large reservoir of goodwill, the leadership has more latitude to learn from its mistakes, enabling voice to play its proper role.
Hirschman’s insights can be applied to law firms, and in particular to the decisions of partners to leave one firm and join another. Since 2000, more than 30,000 partners in the big-firm sector have moved from one organization to another. At the typical Am Law 200 law firm, some 4.6 percent of the partnership laterals in each year while 3.0 percent laterals out, though the rates vary widely by firm and by year.
At first glance these lateral moves look like unambiguous examples of "exit"—a partner sees greener pastures elsewhere and moves on. But voice also plays an important role in many of these moves. Firms go out of business in part because productive partners lose faith in the enterprise and head for the doors. (See, for example, Dewey & LeBoeuf, Howrey, Heller Ehrman, and many others.) To avoid this fate, law firm leaders tend to heed the voice of the firms’ biggest producers. And at many firms, those voices tell them to make more money, the sooner the better. One way to achieve higher profits is to push out less productive or profitable partners and replace them with more promising lawyers from competitor law firms.
This may sound both simple and logical, but when the majority of large corporate law firms pursue this strategy, managers can find it impossible to distinguish between laterals who are being pushed out and those who will contribute more than they take out. A recent ALM LexisNexis survey of managing partners sheds light on this conundrum. In the survey, 96 percent of managing partners said they expected to grow through lateral partner hiring over the next two years, yet only 28 percent reported that lateral hiring had been a highly effective strategy in the past.
If virtually all large law firms pursue an aggressive lateral strategy, how many can realistically expect to increase profitability relative to their peers?
In our review of the data, we find no statistical relationship between an aggressive lateral strategy and higher profits per partner. Indeed, the most profitable firms tend to have the lowest rates of lateral hiring—roughly 1 percent per year. Yet, outside this elite group, the lateral churn is substantial, with a growing proportion of The Am Law 200 wading into the lateral market. In 2000, 70 percent of The Am Law 200 hired at least one lateral partner. By 2011, the percentage had increased to 89 percent. Departures follow the same pattern.
If the lateral market is a game that most firms have to play, but very few can win, the best strategy may be the one that produces the lowest risk of failure. Success may be simply avoiding the fate of more than a dozen Am Law 200 firms that have collapsed in recent years as partners lost faith in the enterprise and headed for the exits. Since we can’t win, we play not to lose.
Since 2000, The American Lawyer has compiled data on lateral partner movements from press releases, news reports, and monitoring of law firm websites. It also double-checks the accuracy of the data with the firms themselves. The American Lawyer ‘s data on each lateral move includes the partner’s name, her practice group, the organization she left and the one she joined, the city where each organization is based, and her titles at the old and new organizations. For this article, we matched Am Law 200 financial data by year with each lateral’s new and previous firms.
Although they may not be 100 percent complete, the data is certainly comprehensive. They include 2,020 lateral moves in 2000, a figure that ramps up to 3,620 in 2007. The lateral partner market seemingly crashed in 2009 (only 1,990 moves), though the pace of lateral movement picked up again in 2011 (2,560 moves). In general, the trend is toward more lateral movement.
Although most of the movements involve national or international law firms, 95 percent of lateral partner hires into Am Law 200 law firms do not involve movement between geographic markets. In short the battle for talent is fiercely local. Although New York City accounts for the largest proportion of lateral moves (5,150 moves in, 5,040 out during the 12-year study period), the Washington, D.C./Northern Virginia market has the highest churn rate: 15 percent of all lateral moves over 12 years, a figure nearly 20 percent higher than its proportional share of lawyers.
In recent years, however, non–U.S. offices have also become a hotbed of lateral movement. In 2002, less than 9 percent of lateral moves (190) occurred in international offices. A decade later, 22 percent of the lateral partner activity (565 moves) occurred abroad. In 2011, London was the third most active lateral market (194 lateral moves), trailing only Washington, D.C./Northern Virginia (385) and New York City (360).
Historically, lateral movement has generally taken the form of partners moving "upstream" to larger and more profitable firms. In 2000, 84 percent of all partner-level moves involved either a lawyer moving to an Am Law 200 firm from a smaller, nonranked firm, or from an Am Law 200 firm to a competitor with higher revenues per lawyer (RPL). At the same time, the long-term trend line reveals a steady decrease in the proportion of upstream moves and a steady increase in the proportion of partners moving "downstream." Indeed, the trend toward downstream moves was less a seismic consequence of the 2009 recession than part of a steady, decadelong shift in the market for lateral partners.
If non–Am Law 200 law firms are viewed as the minor league, then the emphasis on minor leaguers is dwindling or their supply is drying up. In 2000, more than 1,000 lateral movers left smaller law firms for The Am Law 200, while only 650 moved between Am Law 200 law firms. By 2011, those numbers had reversed, with 1,220 lateral moves occurring between Am Law 200 law firms, but only 680 lawyers moving into Am Law 200 firms from smaller non–Am Law 200 firms. Around 2003–04 a "free agency" approach—lawyers jumping from firm to firm within the Am Law 200 league—appears to have supplanted the "minor league" model.
Since the early 2000s, there has also been a substantial uptick in partner-level hiring from in-house legal departments and state and local governments. During this time period, the proportion of the lateral market drawn from business and government climbed from 2–4 percent in the early 2000s to 7–11 percent since 2008. Yet much of this increased movement is concentrated in the New York and D.C. offices of a handful of Am Law 50 firms, which hints that these firms may be pursuing a distinctive strategy of recruiting from corporate legal departments and the public sector.
The changing dynamics of the lateral market are also apparent in the movements by specific practice areas. We grouped the laterals into 12 distinct practice areas: antitrust; bankruptcy; corporate securities; general corporate; intellectual property; labor and employment; M&A/private equity; real estate/project finance; regulatory compliance; trusts and estates; white-collar/securities enforcement; and other specialty practice areas. By examining the RPL and profits per partner (PPP) of the firms joined, we can ascertain the relative economic pull of specific practice areas. At the top of the list are antitrust, white-collar and securities enforcement, general corporate, and M&A/private equity/emerging businesses. At the bottom is labor and employment.
Although the league tables by practice area tell us the relative market pull of a particular practice area, they don’t tell us whether a lawyer in a specific practice area is more likely to move upstream or downstream. On this latter point, it is noteworthy that in 2011—in fact, for the last several years—the average lateral move has been to a less profitable, lower–RPL firm.
This is a significant change from the early 2000s. In 2000, the average lateral move was to a firm with higher RPL, with the exceptions of moves in the practice areas of trust and estates, regulatory compliance, and real estate/project finance. By 2011, the average lateral move in almost every practice area—white-collar/securities enforcement being the exception—involved a lawyer moving to a firm with lower RPL.
Digging deeper, the story becomes even more complex. In most practice areas, lateral partners leaving firms that ranked 51 to 200 in RPL in The Am Law 200 are still moving to higher–RPL firms on average, though the size of the change in RPL has been steadily shrinking. In 2000 the average RPL of the firm left was $460,000, versus $510,000 for the firm joined, a jump of $50,000. In 2011, the differential was $695,000 versus $715,000 (+$20,000). Over the last 12 years, even as the difference between the RPL of the firm left versus the firm joined has become more compressed, the pace of lateral movement has nearly doubled (from 430 in 2000 to 770 in 2011), with the most moves occurring in 2007 (1,000) and 2008 (950). More partners are moving to firms with higher RPLs, but over time the gains they see in are becoming less marked.
In contrast, for partners leaving a firm ranked in the top 50 in RPL, the average movement in every practice group is downward. Corporate partners see the least change: On average, a lateral in general corporate practice can expect that his new firm will rank 30 rungs below his old firm in RPL. The other extreme is labor and employment, where laterals see an average drop of 89 rungs in RPL. (The only exception is white-collar/securities enforcement, which in 2011 saw no lateral movement out of a top-50 RPL firm.) The dollar differentials are equally dramatic—and have increased over time. In 2000, for a partner leaving a firm in the top 50 by RPL, the average RPL of the firm left was $675,000 versus $560,000 for the firm joined, a drop of $115,000. In 2011 this differential was $1,030,000 versus $850,000 (-$180,000). Meanwhile, outflow from top RPL firms has increased substantially. Since the mid-2000s, the number of lateral partners leaving firms ranked in the top 50 by RPL has increased more than threefold, from 100 lateral moves in 2000 to an average of 300-plus lawyers per year since 2004.
One potential explanation for the increased number of downward movements is that there is now less (financial) room at the top. Since 2007, the average RPL of the 50 firms with the highest RPL has been flat ($1,060,000 in both 2007 and 2011). The practice area data tell us that departures from these high RPL firms are not just happening in high-margin practices. Instead, the downward outflow is occurring at higher levels in every practice area.
A more likely explanation is a combination of three factors. First, some high-margin firms are pushing out their less productive partners in order to maintain their profitability. Second, some partners have concluded that the best way to hang on to their clients is to move to a firm that permits a lower rate structure. Third, some larger and more profitable firms are mispricing the compensation of some of their younger talent, whose "voice" may be getting drowned out by the established rainmakers. So a larger proportion of these younger partners are exiting the firm and trying to take some clients with them. Only moves in the second and third category offer a rival firm the opportunity to increase profits through lateral hiring—and that opportunity is speculative as best.
We see further evidence of a sig nificant market shift when we analyze the data based on law firm gross revenue. Between 2000 and 2005, the typical lateral partner was moving from a firm with lower gross revenue to one with higher gross revenues. Between 2006 and 2008, the trend lines cross one another. Since 2009, the typical lateral partner has moved to a firm with lower gross revenue. This is a sea change.
In The Am Law 200, there is a strong but imperfect correlation between gross revenues and profits per partner. Yet the highest-grossing firms tend to have the largest and most dispersed networks of branch offices and thus relatively high overhead costs per lawyer. As one law firm consultant put it, the largest law firms tend to have "diseconomies of scale." On the one hand, it is logical that a global geographic platform fits the needs of the world’s multinational corporations. On the other hand, this large geographic platform requires higher billing rates, which makes it more difficult for firm partners to compete against regional law firms for the large volume of work that is not national or international in scope. And some of that relatively routine local and regional work is needed to keep the lights on. As a result, the global law firm is not necessarily the most profitable.
To make this more concrete, consider the four law firms that had more than $2 billion in gross revenues in 2011: Baker & McKenzie; DLA Piper; Skadden, Arps, Slate, Meagher & Flom; and Latham & Watkins. Among these four, DLA had the largest number of branch offices (76), followed by Baker & McKenzie (68), Latham (31), and Skadden (24). Yet in terms of profits per partner, none of these firms made the top 10 in 2011, and only Skadden and Latham were among the top 20.
The tension among size, overhead, target clientele, and billing rates may be one reason why a significant number of lawyers at the top-grossing law firms are exiting the big leagues and opting for smaller, more regional law firms. In turn, the firms dip into the lateral market to replace them. Not surprisingly, the highest inflows and outflows of lateral partners tend to be at firms with the large international platforms, often in excess of 6 percent outflow and 10 percent inflow of the total partnership in a given year.
It is not news to large law firm managers that there is significant stress in the market for corporate legal services. Revenues for the last several years have been flat or growing only slowly, and clients enjoy significant pricing power. In this tough economic climate, big producers expect to be rewarded for their contributions. As law firms try to keep pace with rainmakers’ compensation expectations and mitigate the risk that they might depart for a rival firm, the spread in law firms between the highest- and lowest-paid partners is widening.
This pay disparity is particularly acute for nonequity partners. According to a recent report by Major, Lindsey & Africa and ALM, the average pay of large firm equity partners increased from $811,000 in 2010 to $896,000 in 2012. In contrast, during this same period, the compensation of nonequity partners has actually declined slightly, from $336,000 to $335,000.
Allocating more income to top producers may be an effective strategy for holding the firm together in the short term, but it is not necessarily a formula for growing more rainmakers or building an organization that is capable of taking market share away from rivals and institutionalizing clients. To return to Hirschman’s framework, many law firm managers are likely listening to the voices of their key rainmakers in order to forestall their exit. But in the process, they may be drawing down their store of loyalty among younger lawyers, thus making them more likely to depart. This is an extremely tight vise for management, as they often lack sufficient latitude and leverage to pursue a longer-term strategy. Their only survival tools—if they have or can acquire them—are world-class leadership and decision making.
Our prior research reveals that large, profitable firms are the least likely to fail ["Rise and Fall," June 2012]. Among the top 40 largest firms listed in the first annual Am Law 100 in 1986, only Finley, Kumble, Wagner, Heine, Underberg, Manley, Myerson & Casey (number one in gross revenues) and the firm that resulted from the combination of Dewey Ballantine and LeBoeuf, Lamb, Greene & MacRae (tied for number 33) are no longer in existence. Both succumbed to the star system, overcommitting themselves to heavy-hitting lateral partners. In contrast, among the 60 remaining, lower-ranked firms in the first Am Law 100, 10 have collapsed. Yet, in terms of revenue and profitability, the 10 firms that failed looked strikingly similar to 18 firms that merged and survived.
Thus, the payoff of aggressive lateral hiring may not be higher profits, but additional revenues and more high-quality lawyers. Although the departure of key practice groups might put a 300-lawyer firm into a tailspin, the departure of a comparably sized group in a 1,500-lawyer firm is akin to an early warning system that provides management with an opportunity to right the ship. The scale of a 1,500-lawyer firm also enables it to make a credible pitch for work that requires a truly global reach.
So the irresistible lesson here is that while bigger may not be better, it is probably safer, at least from the perspective of law firm managers. With an average lateral inflow of 4.6 percent of the partnership each year, and an outflow of 3.0 percent, lateral hiring does have a statistically meaningfully relationship with higher revenues and hence market share. That may be good enough to survive until a more compelling strategy comes along.
William Henderson is a professor at Indiana University Maurer School of Law and Director of the Center on the Global Legal Profession. Christopher Zorn is the Liberal Arts Research Professor of Political Science, Professor of Sociology and Crime, Law, and Justice, and Affiliate Professor of Law at Pennsylvania State University. Both are principals with Lawyer Metrics, LLC.