Three Ways to Save Big Firms
Marc S. Galanter and William D. HendersonThe American Lawyer
December 08, 2008
In an essay published last year in the Stanford Law School alumni magazine, Dean Larry Kramer noted the many challenges facing large-firm lawyers, including soaring billable hour expectations, clients' resistance to footing the bill for associate training, unprecedented associate attrition, the explosion of lateral hiring, and a diminished sense of firm culture and community.
Kramer then asks, "Does anyone actually want this? The lawyers, managing partners, and general counsel I meet are deeply concerned about what's happening. Yet they feel unable to stop it, powerless to resist the stifling market forces that drive their decisions."
From our perch in the ivory tower, we have been wondering about these same issues. Has the large corporate law firm, long an icon of superb craft and enviable amenity, and an influential model for much of the profession, undergone a major structural transformation? After careful review of data covering several decades (derived from American Lawyer research and other sources), we think the answer is yes.
Properly characterizing this change, however, is a tricky business. Over the last two decades, many commentators, including many large-firm lawyers, have decried a rising tide of greed that has seemingly engulfed the profession. This standard narrative inevitably gives previous generations too much credit. Money is and was a powerful motivator, but craft satisfaction, leisure and repose are also seductive -- most of us want generous helpings of each.
Yet, over the last three decades, a confluence of factors has forced corporate lawyers to choose between satisfaction and serenity on the one hand and the material rewards of elite corporate law partnership.
In contrast to an earlier era, partnership in a large corporate law firm is no longer an implicit contract that endures throughout one's productive years. Today, a partner's only security against de-equitization or forced retirement is his book of business or other indicator of indispensability. A majority -- even a supermajority -- of partners may prefer a more humane, sharing ethos, but such an arrangement can be undone by a few powerful partners who decide to vote with their feet. Friendship and shared history is weak glue for a 300-person partnership spread over a dozen branch offices. The academic literature refers to this as a "collective action" problem, a topic to which we will return.
The Wall Street firms of the postwar decades owed their market power to deep institutional ties with major clients. The modern in-house legal department, which makes possible price and lawyer shopping, did not exist in anything like its current form. With so much institutional memory residing with firm lawyers, large industrial enterprises were the ultimate "locked-in" clients. And the norms against lawyer mobility meant that the firm's lawyers were "locked in" too.
All across the United States, large corporate firms institutionalized the "Cravath system," in which the "best" students were recruited from the nation's leading law schools, and subjected to an extended (seven- to ten-year) apprenticeship during which they were trained and took on increasing responsibilities. At the end of this probationary period, those deemed the best performers were offered the prize of partnership -- a prize that included a share of profits and lifetime tenure with the firm. Unsuccessful associates could expect to be placed with a client or offered partnership in a less prominent firm. For almost 100 years, this "promotion-to-partner tournament" appeared to be a tested and stable feature of firm organization and lawyers' careers.
To maintain profits, such a firm needed to maintain a relatively constant ratio of associates-to-partners (i.e., leverage). Further, a reliable pipeline of talent requires a perception among associates that a reasonable number of them will achieve partnership and that the promotion decision will be based on performance rather than nepotism or economic expediency. Thus, the tournament structure commits the firm to regular and relentless growth.
Over the last three decades, most large law firms have modified the tournament structure in a number of ways. The typical result is a firm that bears a funhouse mirror resemblance to the inverted funnel of the classical tournament firm. We refer to this new model as the "core and mantle" firm. There is a now an inner core of equity partners swathed in an outer mantle made up of senior nonpartners under an array of titles, such as nonequity partner, of counsel, special counsel, staff attorney, senior attorney and permanent associate. In recent years, the mantle appears to be growing much faster than the core. For example, in fiscal year 2007, the number of equity partners working for Am Law 200 firms grew by 2.2 percent (26,949 to 27,550), while the nonequity partner ranks grew by 10.2 percent (13,608 to 14,995).
The core and mantle model accommodates heavy lateral traffic between competing law firms. In a complete turnabout from the mid-century "Golden Age," lateral movement between firms is now routine. According to our analysis of data assembled by American Lawyer research, between 2000 and 2005 over 13,000 lateral partners joined, left, or moved between Am Law 200 firms.
Within the firm, lawyers work longer to make equity partner; thereafter, they work in the shadow of possible de-equitization. Thus, the key feature of the core and mantle model is perpetual competition within the law firm to achieve, enlarge and maintain one's equity status. In other words, the promotion-to-partnership tournament has been transformed into a perpetual tournament. The only finish line is retirement or death.
On one level, it is hard to deny that the lateral movement of partners is driven in part by greed and envy. We doubt, however, that the corporate lawyers of today have become appreciably more greedy or envious than their predecessors in the 1950s, 1960s or 1970s. Rather, several key economic conditions of the so-called Golden Age no longer prevail. The bite of group opinion weakens with increased size, dispersion and diversity; the power to sanction is undercut by mobility. A larger professional and public arena gives greater scope and incentive to express professional eminence in a monetary metric. As a result, large corporate law firms operate in an atmosphere of internal and external competition that has no historical antecedent.
During the first half of the twentieth century, the legal expertise required to chaperone a large corporate enterprise resided primarily with lawyers in private practice. (In-house lawyers for railroads were an early and fading exception.) Because lateral movement of lawyers was rare, clients switching outside law firms carried significant nonfinancial costs. As a result, large corporate clients tended to have long-standing relationships with specific law firms, which shielded the corporate bar from the competitive pressures experienced by most lawyers in private practice.
Yet, as U.S. corporations became more bureaucratized, mature enterprises, they increasingly regarded the growing volume of litigation and regulatory compliance as another variable cost that needed to be controlled. During the 1970s and 1980s, general counsel responded by bringing more work in-house. By the mid-1990s, the head in-house lawyers took on the title of "chief legal officer," which reflected their elevated status among corporate management. Outside firms were increasingly hired for specific engagements or matters requiring special capabilities. Long-standing institutional ties between corporate clients and law firms began to atrophy.
The contemporary market for corporate legal services bears little resemblance to the comfortable regional guilds of the 1950s, 1960s and 1970s. For example, law firms often expand geographically so that important clients have the benefit of "one-stop shopping." Yet, staffing a financially self-sufficient branch office often relies upon the recruitment of lateral partners. According to our analysis of over 14,000 lawyers who lateraled into a corporate law partnership (mostly Am Law 200) between 2000 and 2005, a stunning 96.8 percent moved between offices in the same metropolitan area. In other words, lawyers rarely relocate. As firms move into each other's backyards to better compete nationally and internationally, the competition for lateral talent plays out in a very localized way.
Geographic expansion carries cultural costs that most law firm managers have tended to underestimate. When a partnership encompasses several hundred lawyers in a dozen widely spaced offices pieced together by mergers and lateral hires, it is very difficult to sustain (much less create from whole cloth) an organizational ethos in which partners are willing to make sacrifices for the long-term welfare of the firm. Too few lawyers trust that they will be around (or kept around) to reap the larger rewards.
Many law firms may have inadvertently reached a tipping point that is triggered by innate human limitations. Drawing upon his research on primates, the British anthropologist and evolutionary biologist Robin Dunbar posited that "there is a cognitive limit to the number of individuals with whom any one person can maintain stable relationships, that this limit is a direct function of relative neocortex size, and that this in turn limits group size." For humans, the "Dunbar number" is 150. In 2007 exactly 18 law firms in The Am Law 100 had fewer than 150 partners -- and tellingly, these firms tend to fill distinctive niches and reap very high profits.
Now we return to the collective action problem: How does a geographically dispersed law firm with 300 partners and 500 associates (most of whom avidly read the Above the Law blog) negotiate a more sustainable business model? Many law firm partners would gladly trade a portion of their earnings for a shorter workweek, greater job security, more interesting work, the opportunity to mentor (or be mentored), more pro bono work or an uninterrupted vacation. But this is not a deal that can be cut with or by firm management. The economic power within the firm lies with potentially mobile rainmaking partners who are loath to subsidize the lifestyles of lower-earning colleagues whom they barely know.
The structural problems that plague many large law firms are both serious and difficult to solve. Firms that improve their competitive position by increasing profits per partner only raise the bar for everyone else. What, then, is the exit strategy? We can envision several ways out; one that can be undertaken ex parte by some firms, a second requiring collective action by the guild and a third that would require legislative initiative. If these proposed solutions seem laughably ivory tower, we are emboldened by our perception that the structural problems of large corporate law firms are sufficiently severe to invite their inhabitants to engage in thinking outside their increasingly uncomfortable box.
FIRST OPTION: ABOLISH PARTNER/ASSOCIATE DISTINCTIONS
Option one is for law firms to willingly defuse the growth imperative of the promotion-to-partner tournament. Firms with a strong collegial bond among partners and senior associates (mostly firms that have not yet passed the Dunbar number) could accomplish this by converting themselves into employee-owned professional corporations, abolishing distinctions between partners and associates. This maneuver would essentially commit the firm to its present leverage. If the firm truly has a strong collegial bond, very few rainmakers will decamp.
The nontournament large firm would commit itself to a long-term strategy focusing on specific practice areas, clientele and superior service, thus giving the firm a distinctive profile and a long-term competitive advantage. Knowledge management and business process innovations would be firm-specific capital that would augment the value of firm shares. Suddenly, every lawyer in the firm would become cost-conscious because overstaffing and inefficiency would tarnish the firm's brand and bottom line.
The nontournament firm could offer the entry-level lawyer a unique high-value proposition -- lifetime employment (after an initial probationary period) doing high-end legal work for premier clients in exchange for willingness to live up to the firm's exemplary professional norms. This would entail an enhanced selection process with rigorous interviews, careful reference checks and assessments of the candidate's personality, emotional intelligence, value system and professional drive. The starting profit share would be less than $160,000, but the lower initial paycheck would be counterbalanced by wonderful training opportunities, including client contact and the chance to grow as a professional.
SECOND OPTION: NONLAWYER INVESTMENT
A second way for large law firms to regain control over their long-term destiny would be opened by modification of the ethics rules to permit nonlawyer investment, already permissible in Australia and England. Such a change could provide a firm with the capital to finance bold new initiatives -- in knowledge management, business processes, personnel selection -- that would generate long-term competitive advantages.
Such a transition would very likely spur the defection of powerful partners. But the arrival of nonlawyer capital would mitigate the outflow because rainmakers who long to be part of an outstanding organization could be guaranteed a substantial income over an extended transition. For those who left, it could be addition by subtraction, ridding the firm of what David Maister calls "warlord" partners who are more interested in optimizing their practices than in building a great law firm that serves the best interests of clients. This strategy only works, however, if the cooperative ethos of the smaller but more cohesive business can actually innovate and consistently add value at a higher level than at firms where the warlords still reign.
THIRD OPTION: LEGISLATIVE ACTION ON PARTNERS' COVENANTS NOT TO COMPETE
A third option would require legislative restoration of the enforceability of partners' covenants not to compete, enabling firms to signal their commitment to collegiality and sharing. These proposals -- and others that inventive lawyers will undoubtedly come up with -- move in a very different direction than the endemic aspiration to prosper exceedingly by attracting high end, price-insensitive work, a strategy that comports with the egos of elite lawyers but, looking at the profession as a whole, is a will-o'-the-wisp.
In his seminal "Exit, Voice and Loyalty," the economist Albert Hirschman drew an illuminating distinction between exit and voice as responses to dissatisfaction with institutions. He pointed out instances in which those institutions were decisively degraded by excessive reliance on exit. For a generation, the governance of large law firms has been enfeebled by the ascendancy of exit and the decline of loyalty. Each of the alternatives discussed above -- an elite nontournament firm, a well-financed firm with outside investors, or a firm with enhanced sharing and collegiality guaranteed by the enforceable commitment to stay -- seeks to restore the governance powers of the firm, reducing the dominion of exit, empowering partners to shape their working lives by voice, and creating the conditions for the resurgence of loyalty and professionalism.
Marc S. Galanter is an emeritus law professor at the University of Wisconsin-Madison. William D. Henderson is an associate law professor at the University of Indiana-Bloomington. A longer version of this article, "The Elastic Tournament: A Second Transformation of the Big Law Firm," appeared in Stanford Law Review earlier this year.