Our text for today, Dear Reader, coming from The American Lawyer, is as follows:
"There’s nothing like a fund-raiser at a private school in Manhattan to define your social station. Time was, lawyers were near the top of the heap. Investment bankers and other finance types have long eclipsed them, but the difference used to be one of degree. Then came private equity investors and hedge-funders, and lawyers nose-dived on the socioeconomic ladder. ‘Face it, we have no status,’ says an Am Law 100 partner of the pecking order at his sons’ private school. ‘We go to these school functions, and this well-heeled group looks right through you. They won’t give you the time of day. You’re just one step ahead of the doorman.’"
Now, it may seem crocodile tears to commiserate with someone making "only" somewhere north of $1-million/year and not, say, $2.5-million and up. And to be sure there is no richer stage for the conspicuous display of excessive wealth than at Manhattan private school auctions.
But if we’ve learned anything from the past 30 years of psycho-social experiments addressing income inequality, it’s that perceived deprivation never has anything to do with absolute deprivation: It’s all relative. (Similarly, there’s remarkable consistency across nearly all income levels when people are asked, "How much more would you have to make to feel better off?" The answer? An almost invariant 15—20% more, whether you’re making $15,000/year or $750,000/year.)
Still, the psychology and the economics of feeling under-appreciated are more complex than whether the leading digit on your 7-figure income is a "1" or a "2" or even how many digits your income comprises. The goal of this column is to explore some of that complexity, and some of the drastically mixed feelings swirling around the whole subject of lawyer compensation.
Associate compensation
Let’s begin, as it were, at the beginning, with associate compensation. On few other subjects has so much maddeningly off-topic ink been spilled. Let us line up the primary offenders.
"How can a first-year possibly be worth [$125,000/$145,000/$160,000/$180,000]?"
This typically arises from comparing first-year’s to other worthy professions and careers and concluding that, for example, since librarians only make $40,000/year and first-year’s are not four times more beneficial for the polity than librarians, something is out of whack. But markets don’t work that way; there is no such thing as a market for a hybrid librarian/first-year, just as there is no market for a librarian who bills out their services at $375/hour. In other words, the "comparing-professions" argument stumbles out of the gate in confusing the presumed social benefits conferred by a slice of the labor market with what society at large ought to be willing to pay those who have chosen a career there. Cruel, or inevitable, as it may be, markets, again, don’t work that way. The elements that go into the pricing of a first-year are far more complex, and involve at a minimum:
The return (a/k/a profit) the firm hopes to earn on the associate’s labor over their tenure at the firm. This, of course, will often be a negative number in the case of any individual associate, but had darned well better be a positive number in aggregate (and it will be).
The competitive marketplace for graduates (a) of top law schools (b) at the top of their classes. Here it’s instructive to point out what might sloppily be thought of as a mismatch between supply and demand, as evidenced by the following chart.
This shows the total lawyer headcount of the NLJ 250 over the past 30 years or so (the green line) vs. the number of graduates of US ABA-accredited law schools (the red line) and first-year enrollment in those schools (the blue line). It’s self-evident that firms must be recruiting from more law schools and/or recruiting more deeply from each class of graduates, as the number of NLJ 250 lawyers has gone from about 25,000 in 1980 to over 125,000 today (a 500% increase) while the number JD/LLB’s awarded has gone from just under 40,000 to just over 40,000 in the same period, for perhaps a 15% increase). The number of graduates in the top quarter of their class from the top ten schools has essentially been static.
So that indicates a supply/demand "mismatch," right? No: Supply and demand always match. What varies is price. Next time you see a headline along the lines of "Inadequate Oil Supplies Foreseen," don’t believe it. You may not like the price, but oil will be supplied.
That the price of first-years, then, has gone up, should surprise no one.
Associates’ Compensation is Only Fair Given: (a) That They’d Gone Without a Raise for Awhile; and/or (b) The Burden of Law School Loans
Nonsense, and nonsense. Reason (a) has been, as they say in the military, "overtaken by events." It was a "reason" you used to hear only after the famous Gunderson-Dettmer "dot-com bump" of 2000 to $125,000 for first-year’s had been in effect for some time. Raises recently have been coming along at a nice clip, with some event predicting $200,000 is within our sights. (The story comments on Williams & Connolly’s recent raise to $180,000 for first-years in Washington—although W&C studiously avoids paying bonuses, so the comparison is not quite apples-to-apples. Ward Bower, among others, says that it "indicates to me that top firms in New York are going to turn around and not only match it but beat it.")
Reason (b) demonstrates the sloppiest kind of economically illiterate wishful thinking. What it costs to go to law school—while admittedly, on average, probably more than those MBA’s at the hedge funds and I-banks had to spend—has precisely zero to do with one’s post-graduation salary. Whether you think of it as a "sunk cost," an admission ticket, or simply an investment—one whose future returns have yet to be determined, and which may be positive or negative—no one is going to pay you a penny more for an outrageous student loan burden than for a modest or nonexistent one.
Clients Complaining About First-Years’ Salaries
We’ve all heard general counsel and other highly educated people who ought to know better griping about the "insanity" of first-year salaries (actual quote, and I could have used far more trenchant language and kept it real).
The only intelligent response to this is, "Snap out of it!"
Indeed, I wish our profession had more law firm leaders sufficiently courageous and plain-spoken to offer precisely that uncompromising rebuttal to what is the height of irrationality. The economic mistake our good friends and clients are making is to pretend that it should matter to them what the prices are of specific factors of production that go into the end goods and services they buy. No sensible buyer cares about the cost of each, or any, specific component of what they’re contemplating purchasing; they care about value for price.
Here’s a concrete example: If I’m debating whether to buy a BMW or a Lexus, do I care what the factory-line workers get paid? For that matter, do I care what each CEO gets paid? Not unless I’m hyperventilating about some tendentious socioeconomic cause—in which case we can stipulate my purchasing decision will not be made on the merits of value for price.
So why are clients saying these things about 1st-year salaries? My only hypothesis, since it cannot be rational, is that it’s psychological: It could be a poisonous combination of jealousy and resentment that BigLaw associates do so relatively well so early in their careers, compared to those toiling in the vineyards of corporate legal departments. But whatever the explanation, it is not our problem and someone should display the common sense and modicum of judgment required to tell them so.
Income not wealth
Rare is the lawyer, partner or associate, who observes that while our profession of late provides extremely handsome incomes, firms provide no true wealth-creating opportunities compared to investment banks, private equity and hedge funds, or even good old fashioned Fortune 500’s extending stock options.
I have no explanation for why this bedrock fact goes so unremarked. It could be that all the noise about associate salaries and PPP’s drowns out the signal concerning wealth accumulation; it could be that we’re all so inured to the current state of affairs that we don’t think to comment upon it; or it could even be that the very fact of noting it seems to serve little purpose beyond salting the wound.
Yet senior partners in prominent firms have complained to me, on occasion, that the method by which almost all firms raise capital namely, enforced partner contributions of capital—jocularly referred to by one as "passing the hat among one’s friends"—is singularly unsophisticated. A seminal consequence of that lack of sophistication is that returns on contributed capital are below-market at best and zero at worst, meaning that some consider themselves lucky to get their contributions back intact (and unadjusted for inflation), much less to enjoy a competitive rate of return on equity ownership of a piece of their firm: "I might as well park $X-hundred thousand or million dollars in a mattress for 25 years, for all the good my capital contribution has done me!"
Anecdotally (but there are many many comparable anecdotes), consider the case of a fellow I know who just barely failed to make partner at a major New York City firm, only to end up years later as general counsel of a major financial services organization, with a rich stock options buffet from which to dine. Missing out on partnership may have been the best thing that ever happened to him, financially.
And my point with this would be?
I have two, actually, following repetition of the meet and right reminder that there is little call for sympathy for the economic circumstances of almost anyone employed by BigLaw these days.
Firstly, we should not don the defensive cloak quite so hastily when critics attack associate salaries or ever-escalating PPP’s. That is part of the picture, and a very nice part indeed, but only part. No one who chooses BigLaw as a career for 40 years, under the current model, will retire with accumulated wealth handed to them along the way. They will have earned whatever they have, paid full-bore ordinary income tax on it, and then and only then been able to save and invest some portion.
Secondly, we might begin to wonder whether the current model is all it’s cracked up to be. Lloyd Blankfein, CEO of Goldman Sachs, received "the largest payday ever for the head of a Wall Street firm" this year, namely about $69-million in cash, stock, and options awards. And his base salary? $600,000, or an amount entitling your firm to the quite distinct back of the pack if that’s your PPP figure. There are more ways, may I suggest, to skin the compensation cat.
On that note I conclude this holiday compensation meditation.
Are we doing what we can and should to reward the genuine achievers in our firm? Does associate lockstep still make sense? Did it ever?
Is paying out cash as ordinary income the only model we can conceive of? How strained are our imaginative faculties?
On the billable hour model, what hope is there—ever—for capital creation and wealth-building? Common wisdom about the billable hour is to the effect that lawyers and firms should love it because it’s a no-lose "cost plus" model. Is that, in fact, the most damnably short-sighted perspective possible?
And why, again, are we as a profession so reflexively defensive about our earnings? I haven’t noticed Goldman Sachs, or Mr. Blankfein, in an apologia this week.
Do we, in fact, really know where we stand on all this?
