Questions for your managing partner, executive committee,
and executive director:

Is your  firm as profitable as it could be?   How
does it measure up vis-a-vis its peer group?  And
what defines that "peer group," precisely?  Do
you ever wonder what you could do to improve its margins?  Structurally
or strategically, precisely what would that entail?

If you’re reasonably typical, the answers are:

  • In all honesty, probably not
  • I’d rather not comment
  • Uuuuh, instinct; we know them when we see them
  • All the time
  • If I knew, I’d change my answers to #1 and #4

The rest of what you’re about to read won’t answer
those questions, certainly not in any glib and snappy
way, but read on if you’d like to learn about some
ground-breaking empirical research into the structure
and profitability levels of the AmLaw 200.

What follows is a highly selective and distilled excerpt
of and extrapolation from a paper forthcoming in the
University of North Carolina Law Review (84 N.C. L.
Rev. __ (2006), draft version available at SSRN),
by my good friend Prof.  William Henderson of
Indiana University Law School at Bloomington. 

The paper is titled "An Empirical Analysis of
Single-Tier vs. Two-Tier Partnership in the AmLaw 200," and
among a host of other fascinating findings is the creation
of a statistical model attempting to explain the level
of Profits per Partner (the "dependent variable," in
statistics-land) based on an extremely limited number
of quantifiable factors (the "independent variables").

If you were creating such a model, what would you
nominate for your universe of independent variables?  What,
in other words, drives PPP—what is most relevant
and determinative?

Brainstorm for a moment. […]

Time’s up.

  • Leverage?  Defined strictly as [total # of
    lawyers/# of equity partners].  Yes;
    it’s in the regression analysis, although with a
    counter-intuitive and surprising caveat.
  • Average billable hours per lawyer?  Yes again.  (That
    was an easy one.)
  • Whether the firm switched to a two-tier model in
    the past decade in order to boost reported PPP?  Sorry.
  • "Prestige" of the firm, based on annual Vault and American
    Lawyer
    surveys?  Yes again.
  • Size of firm?  Bzzzz; nope.
  • How about "associate satisfaction," as
    measured annually the The American Lawyer,
    which tracks such measures as open-ness about firm
    finances, candor about prospects for partner, and
    a firm’s commitment to professional development?  Yes;
    but see my remark about leverage.
  • Percentage of lawyers who are in New York?  Yes—so
    let’s hear it for the home town.
  • Composition of practice areas?  Not in the
    equation, partly because it’s not readily quantifiable.

This leaves us with five independent variables:

  • Leverage
  • Average hours billed
  • Prestige
  • Associate satisfaction, and
  • % of lawyers in NYC

Together, these five variables explain three-quarters (74.2%)
of firms’ profitability:

So relatively "immutable" factors, at
least in the short to medium term, account
for all but 26% of the size of the average AmLaw 200
firm’s bottom line in terms of PPP; the most enlightened
or brilliant management in the world (plus our fair-
and foul-weather friend, luck) affect only one-quarter
of the average AmLaw 200 firm’s results. 

We can say more:  Being above the regression
line means your firm is outperforming expectations;
being below it, the converse.  Out of a sense
of charity, Bill did not identify any firms below the
line by name (although if you contact me directly,
we can talk…).  On the other hand, some of the
firms identified above the line enjoy particular circumstances
that explain their unusual performance.  I’ll
select a few from the top right down (I know it’s hard
to read, but I have a larger copy):

  • Cahill-Gordon:  An outsized presence in junk-bond
    issuance, plus a notoriously tight-fisted cost control
    culture.
  • Simpson-Thacher and Davis-Polk:  Unbeatable
    prestige, making them law-firm-land’s equivalent
    of "bulge bracket" investment banks.
  • Kirkland & Ellis:  The go-to brand in
    high stakes litigation, especially antitrust.  (And
    an unusually canny twist on the two-tier partnership
    model, which I’ll discuss another day.)
  • Gibson-Dunn:  Supreme Court practice.

You get the idea:  It is extremely difficult
to establish, or sustain, a position "above the line."

The good news is it’s less difficult, given enough
time and a consistent strategic approach, to move up
the line.
   To move up the line, you
dial in changes in those famous independent variables:  Leverage,
% of our lawyers in NYC, average billable hours, prestige,  and
associate satisfaction. 

For which of those do you get the biggest bang for
the buck?  Back to our friend, the regression
analysis.  The following table displays the value,
in annual profits per partner, of a one-unit increase
in each of our variables.  A few explanations
and caveats first:  Remember first and foremost
that these are values derived from the entire universe
of AmLaw 200 firms.  As they say, "your mileage
may vary." 

Second, the meaning of a "one-unit
increase" depends on which variable you’re talking
about.  A one-unit increase in the leverage ratio,
or the average number of hours billed, is fairly self-evident,
but a "one unit" increase in prestige, and in associates’
likelihood of staying for the next two years, reflect
the subjective scales on which they were measured.  For
"prestige," Vault uses a 10-point
scale.  (For example, in 2003, Cravath and Wachtell
each scored a stratospheric 8.93, Davis-Polk 8.12,
and Simpson-Thacher 7.78.)  For "likelihood of
staying," The American Lawyer used a
5-point scale.  Finally, for "% NYC/Global," Bill
simply divided the AmLaw 200 into four roughly equal
cohorts: 0%; < 10%, 10—50%, and > 50%.  Jumping
from one cohort to the next one above is our "unit"
increase. 

The envelope, please:

Variable
Single-Tier Firms
Two-Tier Firms
Leverage
$134,854
$42,637
% NYC/ Global
$413,534
$400,618
Likelihood of Staying
[not statistically significant]
-$249,057
Avg. Hours Billed
$35,534
$50,982
Prestige
$340,293
$161,787

The more you think about these numbers (at least if
you’re like me), the less surprising they are—except
for the third row.  This says, beyond a reasonable
doubt, that for two-tier firms, the more likely associates
judge they will be to stay two years, the less profitable
the firm:  And you’re
taking it in the teeth.  A one-unit increase in
associate satisfactions costs you a cool quarter of
a million dollars a year. What on earth is going
on here?

I have my own theories, which I’ll discuss, again,
another day.  Suffice for now for me to toss out
this (I hope) pregnant thought:  Paraphrasing
Tolstoy, "all single tier firms are alike; each two-tier
firm is two-tier in its own way."  Single-tier
land is a flat, homogeneous landscape.  Two-tier
land is heterogeneous geography, full of recently thrust-up
peaks and cleaved valleys. 

Related Articles

Email Delivery

Get Our Latest Articles Delivered to your inbox +
X

Sign-up for the Insider’s Email

Be the first to learn of Adam Smith, Esq. invitation-only events, surveys, and reports.





Get Our Latest Articles Delivered to Your Inbox

Like having coffee with Adam Smith, Esq. in the morning (coffee not included).

Oops, we need this information
Oops, we need this information
Oops, we need this information

Thanks and a hearty virtual handshake from the team at Adam Smith, Esq.; we’re glad you opted to hear from us.

What you can expect from us:

  • an email whenever we publish a new article;
  • respect and affection for our loyal readers. This means we’ll exercise the strictest discretion with your contact info; we will never release it outside our firm under any circumstances, not for love and not for money. And we ourselves will email you about a new article and only about a new article.

Welcome onboard! If you like what you read, tell your friends, and if you don’t, tell us.

PS: You know where to find us so we invite you to make this a two-way conversation; if you have an idea or suggestion for something you’d like us to discuss, drop it in our inbox. No promises that we’ll write about it, but we will faithfully promise to read your thoughts carefully.