As Salary Cuts Move to Higher-Profit Firms, What Happens Next?
Hugh A. Simons examines where firms might go now that many have taken shorter-term measures to cut compensation. Will layoffs or firm closures follow? What groups are at risk?
May 15, 2020 at 01:03 PM
4 minute read
The original version of this story was published on The American Lawyer
To date, 69 firms have announced cuts in lawyer salary (excluding changes to equity partner compensation). The cuts have advanced across the Am Law 200 as expected: they started out among firms in low profit margin buckets and then broadened to higher margin buckets and deepened within the buckets, as evidenced by the curves advancing rightward and upward over time in the below figure. The rate at which firms are cutting salaries has started to slow—11 firms in the last two weeks compared with 16 in the two weeks prior to that.
What does this suggest for what happens next? No one knows, but three thoughts. First, while the announcements of cuts have slowed, the number in the last two weeks is large enough to suggest they've not ended. Based simply on the shape of the curves on the chart, we might particularly expect more announcements from firms in the under 25% and 40-to-45% buckets.
A second thought is based on the observation that while salary cuts shore up a firm's finances, they don't fix the underlying problem: too many lawyers, specifically more lawyers than can be kept growing professionally at the required pace given the volume of work available to them. With the level of U.S. economic activity not expected to regain its Q4 2019 level until the first half of 2022, this is more than a short-term challenge. Unchecked, it creates a post-recession existential risk for firms: clients decamping to rivals to avoid being served by under-experienced associate cohorts. Hence, we should expect layoffs when lawyers return to their offices (you can't reasonably lay someone off over Zoom).
If you based an estimate of the scale of layoffs on the size of the salary cuts—these have typically been 15 to 20 percent and probably come after an assumed elimination of bonus pools (roughly 20 percent of salary)—you'd get some frightening numbers. It's comforting that the mindset when cutting salaries is that, if you're going to do it, you should go deeper than you could possibly need—you can always give the money back. That said, there's a new class of associates set to arrive (averaging 6-7 percent of lawyer headcount) and voluntary attrition has gone to zero (as it does in any recession). It will be ugly.
A third thought has to do with the prospect of firms folding. As I've argued previously, firms don't fail by having cash run out; they fail by having partners run out, and partners run out when they lose confidence in firm leadership. The leaders who have cut salaries have buttressed their firms' finances substantially in absolute terms and, importantly, relative to peers who have not made cuts. There's the risk of a tipping point developing: when few peers have cut salaries, not doing so projects strength; when most peers have cut salaries, not doing so projects weak leadership. Thus, by not cutting, firms may jeopardize their partners' confidence in leadership. There are 8, 12, and 22 firms that have not cut salaries in the Under 25%, 25-to-30%, and 30-to-35% margin buckets, respectively. If these dynamics took hold at, say, just a third of these firms then, in round numbers, we'd see 10 to 15 firms go under.
Hugh A. Simons is formerly a senior partner and executive committee member at The Boston Consulting Group and chief operating officer and policy committee member at Ropes & Gray. Early retired, he now researches and writes about the business side of law firms and does some consulting for old friends. He welcomes reader reactions at [email protected].
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