By now a fair amount of blawgosphere ink has already been spilled
on Cameron
Stracher‘s Op-Ed in today’s WSJ, “Cut
My Salary, Please!” arguing, essentially, that the recent
round of associate pay hikes (from $125,000 to $145,000 for first-year’s) “should
[leave] young associates trembling,” because “their lives
are about to get much worse.”   Gerry Riskin writes that
money will never buy the firm motivation or the associate happiness. Professor Bainbridge takes this angle:

“To make us care, Stracher has to make one of two possible moves. First, he could argue that there’s something morally problematic about wealth. Second, he could argue that high associate salaries and partner draws have negative externalities for society. In his op-ed, Stracher makes the second move.”

Larry Ribstein takes a more micro-economically analytical approach and
asks, with a gracious and kind reference to me:

“But what about market competition? Why don’t clients, especially
big corporate clients with in- house counsel, compete down rates, force
efficient settlements? I’m sure that Bruce has an explanation
— indeed may have given one. But here’s a couple of my own ideas for
starters.”

One of Larry’s more perceptive and telling points is that, since ethical
rules in the US require that owners of law firms be licensed
lawyers, the owners have an incentive to “over-recommend” consumption
of legal services in lieu of other viable substitutes:

“[L]awyers,
would want to
maximize customers’ use of legal services by either performing excessive
amounts of legal services or under-recommending such related nonlegal
services as accounting and finance. By contrast, non-lawyer managers
of firms that offer nonlegal as well as legal services would have an
incentive to maximize overall profits rather than the portion of profits
produced by lawyers.”

Stracher makes what at first blush looks to be a tangentially related
point, but as I read it, it’s economically flawed:

“Higher
salaries have forced firms to look for new ways to increase revenues.
One obvious solution is to throw more lawyers on a case, and to be more
aggressive about litigating and challenging small matters that might
otherwise go uncontested. […]  Firms are lawyering matters to
death, and killing their associates in the process.
It didn’t used to be this way.”

The problem with Stracher’s observation—and the way in which
he misses
the fundamental economic rationale that Larry fingers—is that
law firms presumably always want to increase
revenues, and if they could just “throw more lawyers on a case” and pay
associates coolie wages, they’d be more profitable still.  There’s
no solid connection, in other words, between associate wages and the
staffing levels clients will accept.  (Indeed, clients would tell
you there’s an inverse relation, at least between acceptable staffing
levels and associates’ hourly rates.)

And a brief correction on Stracher’s comment that: “A young lawyer
who bills 2,200 hours at $250 per hour generates $550,000 for the firm,
only $145,000 of which pays his salary.”  Actually, by the
time you figure in actual realization rates on those 2,200 hours, taxes,
bonuses, benefits, and indirect administrative costs ranging from Park
Avenue rents and E&O insurance to the IT infrastructure, I would be shocked
if the typical first-year wasn’t a meaningful cash drain to the firm.

But we still haven’t answered the fundamental question Stracher’s
piece, which is every bit as entertaining as it is economically fallacious,
implicitly poses.  To wit:  “Just why are
associates paid so much?”  Read on.

I’ll start by turning to “efficiency-wage theory,” the novel insight
of which is that paying higher wages, even above-market wages, will
be profitable if it makes workers disproportionately productive.  These
are the plausible mechanisms whereby that might be true (and on efficiency-wage
theory in general, see, e.g., N. Gregory Mankiw, Principles
of Economics (Harvard University Press:  1998) at
pp. 578—583):

• Higher wages reduce turnover.   Employees are more or
  less continuously evaluating alternative job options.   While
  it may seem implausible that someone would abandon a firm, clients,
  and colleagues for, say, a 7% bump (from $135,000 to $145,000, e.g.),
  if other work factors are less than ideal, that could be the tipping
  factor.Moreover, consider the repercussions from the firm’s
  perspective of not matching “the going rate:”  Immediate,
  and not-unjustifiable, suspicion in the marketplace that the firm
  is no longer First Tier.  As a former AmLaw 50 managing partner
  put it to me in an email today:

  “Firms are rational enterprises,
  even if they occasionally seem not to be. They pay the going rate
  because they have to. Frankly, associate compensation is one of
  the easiest issues a firm has to address. There aren’t many choices.”

• Better-paid workers have an incentive to work harder.  This
  works in two dimensions:  The person earning “above-market”
  wages knows they’re likely to take a hit if they lose their job,
  so they are motivated not to shirk, and the firm knows that for the
  premium they’re paying they can get dedicated workers, so they’re
  quicker to pull the trigger on mediocre performers.
• Lastly, there’s an indisputable link between pay and worker quality,
  and top-tier law firms know this very well.  To understand how
  this works, consider Stracher’s hypothetical (and “stark raving mad,”
  in the words of another correspondent of mine today) suggestion that
  firms cut associate salaries 50%—to $72,500.The instantaneous, powerful, and irreversible consequence of this
  would be that all the Harvard, Yale, and Stanford Law grads, who
  can command far more than $72,500 at investment banks, management
  consultancies, and even enlightened in-house departments (GE comes
  to mind) would decamp en masse from BigLaw, leaving firms
  to pick through the ranks of the bottom half of the class at regional
  and local law schools.

  Imagine clients’ reaction to that phenomenon playing itself out….

Finally, permit me to suggest a few cultural, non-economic, angles
to this story.

First of all, wages are notoriously “sticky downward:”  That
is to say, unless you’re an about-to-be laid-off employee of bankrupt  Delphi,
you will not take a cut in pay, period, full stop.  This doesn’t
entirely explain why the going rate is $145,000, but
it explains why it will not drop now that it is $145,000.

Second, my hypothesis is that there’s less than meets the eye to the
fact that every leading firm bumped up the rates this year.  I’ve
believed for some time that while firms may have been toeing the starting-salary
line at $125,000, bonuses were growing; and I predict that now that
a $20,000 component of bonuses has been relabeled salary, bonuses will
immediately shrink.  In other words, this is probably less of
a pop than it appears.

Third is what I call the “Parris Island” phenomenon:  Partners
expecting 2,000 or 2,200 hours/year out of associates have no sympathy
for whiners—after all, they lived through it themselves.  Emotionally
and psychologically then, expecting partners to enter a realistic dialogue
about cutting pay in exchange for cutting hours is a delusion.  It’s
your turn now, buddy.

Finally, there may be an entirely appropriate, fitting, and survivability-testing aspect to paying people a lot and asking them to work like crazy: That’s exactly what partners’ lives are. If you don’t take to it as an associate, you won’t as a partner. Firms could be cannier than we give them credit for.

So will we see the end of this in our working lifetime?  For
my money, scarcely a chance.

And for yours?