With surpassing respect to Richard, and appreciation of the sincerity and the energy (not to mention the checkbooks) of the 96% or so of AmLaw managing partners who say that lateral recruitment is a core part of their growth strategy, on reflection I will reaffirm my profound skepticism that this “frenzy” is anything more than an enormous round of musical chairs played at great expense in transactional costs and career friction.
I won’t rehearse everything I wrote in Delusions of Crowds, (14 February 2014, Adam Smith, Esq.) but here are the highights for your convenience.
In self-defense I will only add that I declared the premise that I had the burden of explaining why otherwise presumptively rational people (managing partners) would act irrationally as plainly as I possibly could, in the very title of the article.
- One of the “hooks” for my publishing the piece when I did was that Bill Henderson and Chris Zorn had just published a cover story in The American Lawyer (“Is reliance on lateral hiring destabilizing firms?”) which found “using an arsenal of multivariate statistical methods” (and nobody but nobody does it better than they do in Law Land), they “were unable to find a relationship between a lateral partner hiring strategy and higher law firm profitability.” Nailing down their conclusion is this: For the top 10% of most-active firms in the market (the 20 most active among the AmLaw 200), “the odds of them having above-average growth in profits per partner one, two or three years later is slightly worse than a coin toss”(emphasis mine).
- Their analysis also found that “the only thing laterals really moved the needle on was gross revenues”—not RPL, not PPP, not profit margin, etc.
And I added my own speculation on what psychological motivations might underlie this:
- We as human beings and as organizations find growth dynamic, exciting, vital. It’s more exciting to launch a new brand than to reconfigure an old one; to open a new office than to strengthen an existing one; to land a new client than to win a greater wallet share from an existing one; and to hire a new lateral than to cultivate home-grown talent. Having an affair is a thrill; strengthening your marriage takes actual commitment and follow-through. Managing partners and hiring partners are exempt from none of this.
- Lawyers by predilection, training, and selection are insecure. Validation as evidenced by success at an external courtship is a powerful narcotic.
Finally, I concluded that extremely selective lateral hiring could improve a firm’s gene pool, premised upon the potential recruit being able to advance your firm’s (well-articulated and rigorously executed) strategy in concrete ways explainable in short words of Anglo-Saxon derivation, then and only then would I endorse your proceeding.
But Richard’s hypothesis is both too intriguing and too powerful (go back to that counterfactual…) to end here; I need to clarify my reaction to it in one final dimension, which takes us back to the notion of market failure.
A sturdy form of market failure is that arising from asymmetric information. And isn’t that characteristic of the lateral partner recruiting market? The only parties who really know the potential lateral’s abilities, working style, client development skills, (talent for mentoring, gift for playing nicely with others, willingness to share with alacrity, etc., etc.)—not to mention the real, hard-core, irreducible book of business s/he can claim credit for—are the lateral and the lateral’s firm whose pocket you are about to pick. You, the recruiting firm, have no such privileged access to this information. And make no mistake that some of it, while not numerical or quantitative, is as material as possibly could be to the lateral’s prospects for success or failure under your roof.
Actually, a shocking number of firms take laterals’ words for it as to their actual current compensation at the incumbent firm. One managing partner told me a few weeks ago that when they started asking for K-1’s a host of hot searches went stone cold.
If there’s asymmetric information, and hence (understandably) a form of market failure, then one doesn’t have to presume that (1) managing partners are irrational or that (2) laterals cannot indeed perform effective, low-risk, and highly profitable arbitrage upon themselves by moving to a new firm.
Richard’s insight as to one of the (presumably unintended) consequences of the stunning diversity of law firm partner compensation plans is preserved intact. And my denunciation of lateral partner recruiting as a near universal solvent to address your growth challenges is, properly, amended for the exceptional case where you actually have perfect, or sufficiently perfect, information about what you’re buying.
Richard was generous enough to share his thoughts on my response, and while I promise not to extend this analytic thread past its "sell-by" date, his additional insights are too rich, I believe, not to deserve a wider audience. I hope at least some readers agree that this exchange has proven one of the more economically sophisticated perspectives on the profession.
I admire your penetrating and economically sophisticated response to my piece, Understanding the Lateral Hiring Frenzy. In unfairly short summary, you say:
· There is no evidence that lateral hiring increases per partner profits or firm profit margins, just gross revenues.
· People find growth “dynamic, exciting and vital” and that law firm managers exempt themselves from the discipline of profit maximization in pursuit of these pleasures.
· And because theories aren’t overturned by facts, only by better theory, you invoke information asymmetry, a “market failure,” as an explanation for why recruiting managing partners continually let their firms’ pockets get picked by laterals who know more about their real prospects than anyone else.
As to your main points, my thoughts take me to the breakfast cereal aisle and to the used car lot.
While it may be true that the proliferation of a dozen flavored Cheerios cereal brands (Honey Nut, Chocolate, Apple Cinnamon, etc. etc.) does not much enhance the profitability of original, plain old Cheerios, the fact is that General Mills is the better for it. Its overall revenue and profit are presumably larger (even if margins are diluted), it captures product space that others might occupy and it diversifies in the face of changing tastes. Since lawyers and Cheerios are so much alike, the analogy is obvious and needs no elaboration.
When you and I were in school the economics profession thought that market failures were everywhere. Now we’re not so sure. In any event, information asymmetry in a market doesn’t equate to market failure; it’s just something for which market participants have to discount. If not, we would have no buying or selling of used cars – the paradigm for information asymmetry. Only you, the seller, knows whether your car is a lemon; I the buyer can’t be sure. So what happens? Only that if your car is a diamond, you’ll get less for it than you deserve because I can’t know with certainty that it’s not a lemon. But transactions beneficial to all parties happen all the time. Since lawyers and used cars are so much alike, the analogy is obvious and needs no elaboration.
Actually, if there is a market imperfection (not failure) residing in your opinion that counter-productive lateral hiring is widespread, it isn’t information asymmetry, it’s an agency problem—managing partners who persistently act against the interests of the partnerships they represent without getting punished for it. If lateral hiring is counter-productive and managers aren’t dethroned for doing it, something is wrong with the implicit contract between firms and managers. In conclusion, let me say that I don’t believe this story for a minute. That isn’t because lawyers are so brilliant at framing contracts. It’s that the market punishes poor managerial performance. By what process? Why by lateral mobility. Managements that by injudicious hiring cause incumbent partners’ incomes to fall lose sleep worrying that their incumbent partners will be laterally hired by more profitable firms. The discipline imposed on managements by the threat of departures is yet another benefit of the lateral hiring frenzy.
In conclusion, I think that our differences about the economics are minor ones. The real difference lies in our assumptions about the frequency and severity of bad outcomes. This is a factual matter but nobody knows the facts. You acknowledge that extremely selective lateral hiring could benefit the recruiting firm. I admit in turn that unselective, brainless lateral recruiting won’t do a law firm any good. That leaves the unknown middle ground in which law firms that are good at recruiting will thrive and fumblers will suffer. What more can we say than that?
I think Richard has graciously and cogently reconciled our two approaches and brought them into congruence.
I will close with a short speculation on the "agency problem" Richard points out and invite readers to weigh in.
I’ve often wondered about the severity of the agency problem in law firm management. There’s a theoretical case to be made that it’s less severe than in C corporations since 99.9% of the time the MP emerges from the ranks of the partners and returns to the ranks at term end, so it’s in MPs’s self interest to stay "close" to the partnership’s attitudes and risk preference profiles. It would be like having the shareholders down the hall and not abstractedly through the lens of the market and stock analysts.
Then there’s a theoretical case to be made that it’s more severe in Law Land because there is no "equity," no stock options, no future stream of earnings by which an ex-MP can benefit beyond the day he walks out the door, so make hay while the sun shines.
I invite readers’ thoughts on this.
I’ve read both lateral pieces with great interest. First off, great work to you both – Richard Rapp and Bruce.
One thing in this post struck me:
“Finally, I concluded that extremely selective lateral hiring could improve a firm’s gene pool, premised upon the potential recruit being able to advance your firm’s (well-articulated and rigorously executed) strategy in concrete ways explainable in short words of Anglo-Saxon derivation, then and only then would I endorse your proceeding.”
I’ve just finished reading the book “The Alliance”, co-authored by Reid Hoffman, the
founder of LinkedIn. Obviously, the relates to Silicon Valley employment, where your developer already has three offers by Apple, Google, etc. (Essentially, a lateral, but with stock options) but has applications to employment overall.
The book addresses how lifetime employment is a myth and that employment should be conveyed more as a “tour of duty”: Employees brought in for a specific business task for a dedicated period of time or goal achieved. This is directly relevant to Bruce’s statement.
The other co-author, Chris Yeh was interviewed and said something I’m not sure law firms would follow with partner laterals. While discussing the value of a talented abrasive individual vs. a collaborative work environment in a corporate culture, Yeh said, “The way you can tell there is a corporate culture is if there are certain extremely talented people that your refuse to hire.”
In many law firms, as long as you have a big book of business, we will hire you. Also, we’ll get you on board first and figure out what to do with you next.
References:
Review of the Alliance:
http://www.huffingtonpost.com/arianna-huffington/the-alliance-the-must-read-book-of-the-summer_b_5572590.html
Chris Yeh’s interview (The quote above comes around the 48:15 mark. This is a basketball podcast, but I find multiple equivalent scenarios between Law Firms and NBA teams.)
http://www.boxscoregeeks.com/articles/the-boxscore-geeks-show-the-alliance-with-regular-special-guest-chris-yeh
Dear Johnny:
First of all, many thanks on behalf of Richard and myself for your kind words; it turned out to be (IMHO) a fascinating interplay of ideas.
I frankly hadn’t heard about The Alliance but I’m going to read it. It speaks to the issue so many law firms are mystified by and largely grappling unsuccessfully with, the famous Millennial generation of young lawyers. A few weeks ago I enjoyed a very thoughtful conversation with the Managing Partner of a leading NYC firm who announced–most unexpectedly to me–that he “loved the Millennials, because they want what clients want:” Engagement, responsiveness, results, a sense of where every little thing they’re doing fits in the larger scheme of things.
The “tour of duty” metaphor is also spot on: I believe Millennials will utterly knock themselves out for your firm if they feel they’re getting valuable training and that your firm will keep track of them once they’ve left and continue to offer them opportunities, connections, and conceivably even additional training as “alumni.”
The day when more law firms embrace this kind of thinking may be far off, alas.
The agency problem in law firms that choose their MP from among the younger and ambitious might differ from the problem in those that choose an older partner as MP who is expected to retire shortly after serving as MP. The younger MP is motivated to protect his (it’s usually “his”) stream of future earnings that will continue after he steps down as MP and needs to preserve good relations with the other partners for when he is out of power; the older partner wants to maximize his current income while serving as MP. An older MP who acts solely from self-interest might be inclined to risk the firm’s long-term success in exchange for increasing short-term profits. It would be interesting to study failed firms and graph out the age of their MPs against the amount of debt per partner.