When the legal industry looks back at its history,
June 6, 2016, may register as just another day in law firm decision-making. Or, it could be the day dozens of firms’ futures changed for the worse, irreparably.
On that day about one year ago, the streamlined, esteemed and exceedingly rich Wall Street firm Cravath, Swaine & Moore announced raises for its associates, effective July 1, 2016. First-year and second-year associates would get $20,000 more than before, taking home salaries of $180,000 and $190,000, respectively. Third- and fourth-year associates would see their annual paychecks grow by $25,000, while fifth- and sixth-year associates got a $30,000 bump. Seventh- and eighth-year associates—years after these debt-laden lawyers won the legal industry’s equivalents of golden tickets after they graduated from law schools at the height of the Great Recession—would make $300,000 and $315,000, respectively, before bonuses—a $35,000 increase for them.
Cravath was still smarting from a high-profile lateral loss. Partner Scott Barshay, a celebrity in the New York transactions world who’d worked on deals worth almost $300 billion in 2015 alone, had moved to a competitor, Paul, Weiss, Rifkind, Wharton & Garrison, in April. Yet Cravath was half way through a year of astonishing profitability, ultimately growing its profits by 18 percent, to $4.195 million in 2016.
Industry watchers had been waiting for one of the New York legal market leaders to slide its associates pay scale higher. The last industrywide lockstep scale increase was Simpson Thacher & Bartlett’s move to a $160,000 starting salary a decade earlier. Would firms now well past the instability of the financial crisis move to a starting salary of $180,000, $200,000 or more, many wondered. And when?
The summer of 2016 was as good a time as any for a big, prosperous New York law firm to reassert itself. At many of the country’s elite firms, in competition with Silicon Valley and Wall Street for young talent, an increase made sense. A $160,000 paycheck in 2008 was worth $184,000 in 2017 dollars, according to the Consumer Price Index’s inflation data. Cravath stepped up.
At first, Cravath’s move inspired predictable imitators. Other players in the small club of firms with profits per partner of $3 million-plus followed its lead within 48 hours, including Paul Weiss; Davis Polk & Wardwell; Kirkland & Ellis; Skadden, Arps, Slate, Meagher & Flom; Sullivan & Cromwell and Simpson Thacher.
But within seven days, Cravath’s snowball had turned into an avalanche. Firms that were far less profitable matched the behemoths, lifting associates in Washington, D.C., Los Angeles, Houston and elsewhere up to the New York level.
By the end of June, 101 firms had announced a match to the $180,000 starting salary, according to a real-time tally of announcements by the blog Above the Law. Some firms did not increase their pay for older associates quite as high as the Cravath rates, though. Other firms only raised in certain cities, or made increases that did not reach the $180,000 level for first-years. Meanwhile, a few firms moved above $180,000. In the months that followed, another two dozen or so large firms announced increased associate salaries.
“This is an important investment in the firm and our future,” Michael Ray, the managing director of the midsized intellectual property firm Sterne, Kessler, Goldstein & Fox in D.C., wrote to associates, after some had clamored for a raise. Even with Sterne Kessler outside The Am Law 200 and active in a narrow range of practices, the firm said it matched so it could compete for talent and “to provide fair compensation.”
“It’s a wave we couldn’t stop,” Ray says now, reflecting on the salary increases at his firm.
Even with this rationale, many felt the announcements didn’t make sense. One law firm consultant with Altman Weil Inc. calls the increases “irrational.” Another consultant in New York, who declines to speak negatively about his clients, puts it this way: “To me, it was amazing the speed with which firms met that [new salary level]. I’m shocked that they all did. They can’t all be competing with Cravath, and yet they all went.”
Many of the firms that matched Cravath’s rate look nothing like Cravath. Some firms’ profits per partner is a quarter or less of what Cravath partners make in a year. Others do far less work for the banking clients that make New York City firms so rich. Some merely yearn to be taken seriously in New York, like middle schoolers hovering for a seat at the popular cafeteria table. Few firms, even among The Am Law 100, compete with Cravath for business or the same top law school graduates. This June, The American Lawyer asked 50 Am Law 200 firms to talk about their own $180,000 salary match decisions and the effect on their businesses. Not one obliged.
Andy Sandler, the chairman of Buckley Sandler, a midsized financial services firm in Washington, was willing to talk. But his firm didn’t make the salary leap.
“Where there’s wide variations among economic performance at large firms, I find it hard to understand why they’ve adopted a unified compensation system,” he says.
Sandler’s firm vowed not to raise salaries last summer. Instead the firm leans more heavily on variable bonuses to compensate associates at market rates. The Cravath increase “is going back to an approach that got lots of firms in trouble in the past,” Sandler says.
Sandler and some others predict mass layoffs could be next, as well as fewer associate hires, more law firm mergers and other signs of poor institutional health. On cue, the American Lawyer’s 2017 summer associates survey shows summer hiring down 2 percent year over year. The projected average class size for incoming associates dropped to 38.6 new lawyers from 40.4 the previous year.
“It’s almost a brilliant strategy by places like Cravath to separate the market,” says Dan Binstock, a legal recruiter with Garrison & Sisson Inc. in Washington.
Allen Parker, who was Cravath’s presiding partner last June and is now general counsel of Wells Fargo, declined to comment for this article. Cravath didn’t respond to requests for comment.
Binstock predicts that when law firms’ purse strings feel tight, cuts will happen more quickly than in the past. Instead of six bad months before a firm lays off, perhaps it will take only two or three months, Binstock says. Firms are already showing they will be faster to make those moves. In May, despite a strong 2016 financial performance, Seyfarth Shaw laid off associates and staff in response to a soft first quarter.At Dechert, the firm’s 563 associates cost an extra $5 million or $6 million last year, because of the Cravath-scale increase, Dechert chief executive officer Henry Nassau told American Lawyer earlier this year. (The firm did not respond to a request for comment for this article.) The firm’s profit margin dropped from 46 percent to 44 percent, according to Am Law 200 data. At Wilmer Cutler Pickering Hale and Dorr, the firm swallowed a $10 million added expense because of the associate salary increase, Wilmer’s co-managing partner Robert Novick says. Wilmer’s profit margin was unchanged at 44 percent, Am Law 200 data shows.
One firm chair outside of New York admitted that matching Cravath’s rate caused heartburn last year. The firm ultimately met its 2016 budget—but only after it had revised its expectations downward following the salary increases. The firm posted a decline in profits for 2016. The decline wouldn’t have been as bad without the increase, says the firm head, who wouldn’t bemoan his associates on the record.
And at a range of firms, “at the end of the year, a number of partners were disappointed with their bonuses compared to the year prior,” says recruiter Binstock of potential laterals he has spoken with, especially those from the nonequity class.
Client reaction to the associate salary increase came swiftly and harshly. Bank of America Corp. sent a wrist-slap to law firms days after the $180,000 cascade. “While we respect the firms’ judgment about what best serves their long-term competitive interests, we are aware of no market-driven basis for such an increase and do not expect to bear the costs of the firms’ decisions,” wrote global general counsel David Leitch, according to The Wall Street Journal.
Even now, corporate counsel are still smarting about the increases, says Amar Sarwal, the chief legal strategist of the Association of Corporate Counsel. “They’re disturbed that law firms don’t really understand their own business model, and it’s not sustainable,” he says. “Everyone I’ve spoken to about this particular item is aghast.”
In-house lawyers are most flummoxed that firms have given raises to first- and second-year associates, Sarwal says. Not only do those apprentice-level lawyers provide little to zero value, many clients refuse to pay for their hours.Several firms publicly assured clients they wouldn’t raise billing rates following the associate hiring announcements. The firms instead claim incremental price increases are part of doing business. Of 50 firms that provided ALM billing rate information this year and that pay $180,000 for first-year associates, 35 firms said they increased billing rates by more than 3 percent in 2016. Four out of five firms in the same group say they plan to increase billing rates by more than 3 percent this year.
So far, though, the dire predictions of job cuts and flailing partnerships haven’t materialized, though there are hints of struggles that could grow this year.
Citi Private Bank, which tracks law firm finances by quarter, reported in February that some firms’ operating expense management helped to blunt the salary increases last year. This one-time fix may have softened the immediate blow, but it’s unclear if it will be effective again.
Firms have ways of paying for unexpected expenses outside of hiking their prices. Lawyers can increase the number of hours they bill or write off fewer billed hours with discounts (also known as increasing realization rates). Or firmscan reduce their business’ overhead costs apart from personnel, such as by finding savings in real estate, technology and benefits. Firms can also maintain their profitability by reducing the number of equity partners who get a share—a phenomenon that has contributed to growing nonequity classes at firms over the past several years.
Not every firm that cut costs to hike salaries used the same methods. When Amerian Lawyer asked Reed Smith’s chairman Alexander Thomas why the firm, whose PPP of $1.11 million is below the Am Law 100 average, matched the $180,000 salary scale, Thomas responded that the partnership saw it as important. “There’s 1,000 different answers about how the firm is paying for that,” Thomas said in February.
The National Association for Law Placement Inc., which regularly tallies pay rates, found that firms often give premium salaries to only some of their associates. The first-year median salary nationwide as of January was $135,000, the same as in 2015, NALP found. That may be because large firms that raised salaries in markets like New York and D.C. did not extend the raises to their offices in other cities.
Earlier this year, American Lawyer asked Angela Styles, the chair of Crowell & Moring, how she planned to pay for the increase. Her firm, which is heavily reliant on D.C. regulatory and litigation work, has narrowly increased its profit margin since the recession. Styles explained her firm found ways to cut the number of associates on the new pay scale without layoffs—by making full-time associate positions into de facto part-time jobs.
Young lawyers at Crowell who wanted the full-time rate of $180,000 now have to increase the number of hours they billed annually, from 1,900 to 2,000. If they don’t meet the new standard, they get partial pay. So associates who work the same amount as they did last year could stay on the old pay scale, too.
If the partners they work for don’t assign them enough work for the new requirements, associates would need to find new practices or change firms to stay with the market rates.
“I don’t understand why any firm would do this. There’s more to life than billing 2,400 hours a year reviewing documents,” one law firm partner in Washington says, after he lateraled partly because of disgust about his prior firm’s decision to increase associate pay along with yearly billing metrics.
Despite the bluster, there’s no sign firms have reached an inflection point.
“There are so many things we consult on from an economic standpoint. This isn’t one of them,” Tom Clay, a law firm consultant with Altman Weil, said this spring. “This will not be an economic event.” Firms aren’t “wasting away,” he added. Partners “still have their home in the ocean and the mountains.”
Some in the industry expect yet another associate salary scale increase, arriving just like the last one, first from the New York firms and mimicked by firms across the country. A $200,000 starting rate is likely.
“Every time this happens, there hasn’t been a calamity or a collapse or an epiphany on behalf of lateral partners,” Clay said. So where might the breaking point be?
“I thought it was $150,000, but obviously that wasn’t true,” he says. “The breaking point is when one of the people who traditionally do it [does again], and the others say, ‘I’m not going to raise mine.’”
Any real impact on the financial health of firms may not come to light until they report their 2017 results. Or perhaps these hikes will be absorbed as just another expense—which might only make another salary bump more likely. Consultant Hugh Simons, a former chief operating officer at Ropes & Gray, predicted earlier this year that more salary increases would “wreak havoc at firms in the middle echelons of profitability.”
At least for now, a horizon on associate pay isn’t clear. Demand in the legal industry grew in the first three months of this year, with revenue up almost 5 percent year over year, according to Citi Private Bank. The bank also reported “greater confidence” among law firm leaders for the second half of 2017. More than half of firm managers expect legal industry growth of 2 percent or more in both revenue and net income, the bank said in July.
Citi tucked one surprising detail into its last report, which forecasts the next six months. The class of lawyer that firm leaders expect to expand the most: full-time associates.
“They would stop if it’s caused them economic pain,” Clay says of firm decision-makers. “This is an itch. Pain gets them to do something, and the pain isn’t there.”
ALM Intelligence research manager Daniel Masopust contributed to this report.