I believe this is a first, but I’m about to quote an astute and
interested UK reader’s unsolicited, over-the-transom "letter
to ‘Adam Smith, Esq.’" in
its entirety. At first I thought I could edit it gracefully
for concision, but upon attempting to do so I realized the author
must have preceded me in the effort. It’s worth reading word
for word—and, so you may proceed knowing why I do this, the
primary reason is simple: I thoroughly endorse my correspondent’s
analysis.
Here
goes:
Hi Bruce,
I
have just read a posting you might like on another of the blogs
I read (The Antitrust Hotch Potch) called "Why
Law Firms Should Not Be Ranked By Profits Per Partner." It
is not clear to me, however, whom the author (Prof. Damien
Geradin) thinks they are bad for. Here are some of my thoughts
(fairly randomly).
[Editorial insert by Bruce: Go
read the "Antitrust Hotch Potch" post before proceeding or
the following won’t make much sense.]
- The
firm I work for is currently engaged in a strategy designed
to increase PEP figures, in order to improve our attractiveness
for lateral hires.
- In the
UK, the most significant ranking (The Lawyer 100) uses turnover
as the most significant metric. (They also provide additional
tables which focus on income per partner, income per fee-earner
and profits per partner — together giving a fairly
rigorous account of performance.)
- Looking
at the arguments the author ranges against PEP rankings,
I am not convinced:
- First,
they compare apples and pears. It is not clear
to me that “an M&A practice in NY or London will
be much more profitable than firms with a strong
focus on regulatory work in DC or in Brussels.” They
may have a greater volume of work, perhaps also done
by a fee-earners at a range of levels of qualification,
but a boutique may be very profitable in its own
right.
- In the
- Second, these rankings
do not say anything about the quality of the
work. Hmm. Does anyone claim that they do?
The directories that comment on the quality of
work (I am thinking here of the Legal 500 and Chambers & Partners in
the UK) never to my knowledge rank firms according
to PEP, or any other financial indicator.
- Third, profit-per-partner
based rankings distort the priorities of
lawyers. This appears to be a complaint
about how firms treat profitability, rather
than how the market views it. And surely
if “[e]ntire practice groups will be eliminated
because they no longer belong to the strategic
priorities of the firm (essentially making
more money)”, that must be good for the health
of the firm?
- Fourth, surveys show
there is a correlation between the performance
of law firms in these rankings and their
level of prestige for prospective applicants. Well,
yes and no. I have recently spent a considerable
amount of time engaged in recruitment
for my firm, and none of the prospective
lawyers we interviewed mentioned PEP
as a factor motivating them in the choices
they were making. However, as I suggested
above, PEP is clearly a relevant consideration
for partner hires, because it impacts
directly on their income. I am sure it
is not the only factor (nor do I think
Prof. Geradin would argue that it is),
but few lawyers (being wealth-maximising
individuals) would choose to reduce their
income in their desire to change firm.
- Fifth, when the profitability
of a given firm declines …
this sometimes creates panic. This
may well be true for journalists
— watch the coverage of Hammonds’
fortunes in Legal Week or The
Lawyer — but I am not sure
that we should worry unduly. A
poorly performing firm may well collapse.
One indicator of a poorly performing
firm is likely to be a decline in
PEP figures, especially if that slide
runs counter to the market generally.
If falling PEP causes partners to
leave, then surely (assuming they
know more about the firm than the
market does) that is a better indicator
of a failing firm than the PEP figures
alone.
- Finally, more profits-per-partner
not only depends on revenues,
but also on leverage. The
argument here is that clients
should be cautious when instructing
firms with a high PEP because “the
clients will often pay for the
training of young associates.” I
am not sure how this sits with
the first complaint, that M&A
firms (which rely on armies of
associates) can post a higher
PEP than the niche regulatory
practice (where one would expect
to be advised by a real expert).
In the first place, some leverage
is necessary for lawyers and
firms to develop. Secondly, the
canny client must be aware that
work is best done at the right
level. A firm that makes partners
do due diligence on a run of
the mill corporate transaction
is in as much trouble as the
one that expects a junior associate
to handle merger control negotiations
with the European Commission.
There is a promise of
more to come. I hope the argument is of better
quality next time…
To my mind, this exchange raises a bounty of fascinating questions—but
since I concentrated on industrial structure and market concentration
in my undergrad economics program, and since I allegedly practiced
antitrust law as a young associate, that perhaps is to be expected.
First, permit me to say that while the original (inflammatory?)
post comes from a site, new to me, styled as dealing with "Antitrust,"
I see no issue here remotely related to antitrust concerns.
loyal reader emailed me "off-blog" last week positing that if law
firm mergers were subject to antitrust scrutiny, fewer would go
through. My response was that I always assumed they were,
at least in the legal-jurisdiction sense, subject to such scrutiny,
absent a statutory exemption [of which there is none], but that
even a merger of, say, Skadden and Clifford-Chance, would bring
them to less than a 2% market share in the AmLaw 100, so anticompetitive
concerns are at this stage in the evolution of the industry a
bit premature.]
Second, many perfectly legitimate reasons exist to doubt that
PPP or PEP is the sine qua non of rankings. The
AmLaw 200 itself, a la the Fortune 500, is based on total annual
revenue. And I would argue that PPP is a number you can manipulate
readily. Reduce the number of "equity" partners, for starters,
or, for those who may have gone to school on dot-com era financing,
capitalize operating costs, switch income reporting from cash-basis
to accrual-basis, and the list goes on and on. If I have
not said so here before, I apologize, but I have long believed
that revenue per lawyer, or per partner, is far
more difficult to fudge.
Third, if PPP is so flawed, why do we put up with it? Obviously,
because it’s hugely informative and quantifiable. Lifestyle,
quality of work, diversity, commitment to pro bono, investment
in professional development, collaborative quotient of the culture,
enlightened fee structures, leadership training, clear-eyed strategic
thinking, genuine innovation in delivering professional services—these
are all qualities devoutly to be wished, and to which I hope
I have devoted amply worthy space in these pages—but they
are not quantifiable.
To me, the bottom line is that PPP tells a strong story about
a firm:
- If it’s declining vis-a-vis its peer group over a relevant
market cycle, it’s a call to "battle stations" - If it’s increasing [as above], it’s a virtuous circle giving
the firm the luxury of courting desirable laterals - And, in the long run, it’s how firms from Skadden, Davis-Polk,
and Brobeck, to GE, GM, and WorldCom, survive and continue to
thrive
Trust me, I’m keeping an eye on it.
Dear Bruce,
Thanks for your posting on my story: “Why law firms should not be ranked by profits per partner”.
Let me react to the criticism made by one of your readers:
First, they compare apples and pears. It is not clear to me that “an M&A practice in NY or London will be much more profitable than firms with a strong focus on regulatory work in DC or in Brussels.” They may have a greater volume of work, perhaps also done by a fee-earners at a range of levels of qualification, but a boutique may be very profitable in its own right.
DG: Well, I am not sure I understand the comment. If you look at the PEP-based rankings you will almost invariably find the NY firms well ahead of the DC firms. Some boutiques may be profitable, but they are not many and again most of them will be doing M&A related work in NY.
Second, these rankings do not say anything about the quality of the work. Hmm. Does anyone claim that they do? The directories that comment on the quality of work (I am thinking here of the Legal 500 and Chambers & Partners in the UK) never to my knowledge rank firms according to PEP, or any other financial indicator.
No, but they create a misleading perception that if a firm A makes more money than firm B, it is because it does better work.
Third, profit-per-partner based rankings distort the priorities of lawyers. This appears to be a complaint about how firms treat profitability, rather than how the market views it. And surely if “[e]ntire practice groups will be eliminated because they no longer belong to the strategic priorities of the firm (essentially making more money)”, that must be good for the health of the firm?
DG: No comment on this one.
Fourth, surveys show there is a correlation between the performance of law firms in these rankings and their level of prestige for prospective applicants. Well, yes and no. I have recently spent a considerable amount of time engaged in recruitment for my firm, and none of the prospective lawyers we interviewed mentioned PEP as a factor motivating them in the choices they were making. However, as I suggested above, PEP is clearly a relevant consideration for partner hires, because it impacts directly on their income. I am sure it is not the only factor (nor do I think Prof. Geradin would argue that it is), but few lawyers (being wealth-maximising individuals) would choose to reduce their income in their desire to change firm.
DG: As a law professor, I see many of my students going to large corporate firms. Many of them tend to equate the profitability of the firm with its quality. At age 23-25, people have no idea about the legal market, but they tend to be quite impressed by the high figures they can see of some legal newsletters. They tend to forget that: (i) fewer and fewer associates make partner (in part because the pressure to maintain PEP high; (ii) it takes longer and longer to make partner (now firms have created all sorts of hybrid status, such as counsel, local partners, etc. in which an increasing number of lawyers are found); and (iii) once you are partner, there is a growing risk that you end up being de-equitized because your management has decided that the cake must be divided in a smaller number of pieces.
Fifth, when the profitability of a given firm declines … this sometimes creates panic. This may well be true for journalists — watch the coverage of Hammonds’ fortunes in Legal Week or The Lawyer — but I am not sure that we should worry unduly. A poorly performing firm may well collapse. One indicator of a poorly performing firm is likely to be a decline in PEP figures, especially if that slide runs counter to the market generally. If falling PEP causes partners to leave, then surely (assuming they know more about the firm than the market does) that is a better indicator of a failing firm than the PEP figures alone.
DG: You tend to assume that journalists have no impact on the way lawyers and clients see firms like Hammond, etc. I have worked in the past as an associate in a firm that was doing very good work, but there was not a great deal of pressure on the number of billable hours. They allowed me to work part-time there while I was starting my career as a law professor. For a couple of years, there firm’s PEP went down and that created a very negative spiral of associates becoming worried about their future, partners being unhappy by seeing their firm going down in the rankings, etc.
As to the ability of a senior lawyer to be given the opportunity to work less for less money (a perfectly reasonable trade-off), forget it. I know lawyers in the late 40s and 50s who would like to slown down, but can’t because they would be fired.
Finally, more profits-per-partner not only depends on revenues, but also on leverage. The argument here is that clients should be cautious when instructing firms with a high PEP because “the clients will often pay for the training of young associates.” I am not sure how this sits with the first complaint, that M&A firms (which rely on armies of associates) can post a higher PEP than the niche regulatory practice (where one would expect to be advised by a real expert). In the first place, some leverage is necessary for lawyers and firms to develop. Secondly, the canny client must be aware that work is best done at the right level. A firm that makes partners do due diligence on a run of the mill corporate transaction is in as much trouble as the one that expects a junior associate to handle merger control negotiations with the European Commission.
DG: This is a caricature of what I said. Speaking of antitrust, I have seen dozens of memos drafted by first or second year associates whose quality was quite awful. The partners then re-write the thing, but charges the whole amount to the client. Partners will keep themselves busy not necessarily with the work that requires the greater level of experience and knowledge, but with the work that is the most profitable/urgent [some of them also do little legal work as they have to manage their army of junior lawyers. Hence, all sorts of complex matters are left to associates who end up spending days drafting memos that will end up in the bin.
I hope this clarifies some of the assertions made in my posting.
Kind regards,
Damien Geradin
Damien,
I should apologise for commenting on your blog posting via Bruce’s blog, rather than in yours. I suppose my reason for drawing it to Bruce’s attention was that your concerns about profit-based ranking did not fit with my experience of law firm rankings in the UK, nor my understanding of those in the US.
Thank you for the clarification above. As a former academic, I share your concern that law graduates are attracted (like moths) to the firms that burn brightest, even though their interests might well be better served in a less high-profile firm. I have become more sanguine about this problem, however, as over the 35-40 years of a legal career most people end up in the right place in the end. (And one could make an argument that it is easier to move from Magic Circle firm to a less-profitable practice in the regions than vice versa.)
Your comment about the older partner who wants to slow down is interesting. I fear that the days of law firm partnerships that looked after their older members in this way have gone. One of the partners I work with is very fond of referring to the memo Martin Lipton circulated on the 25th anniversary of Wachtell, Lipton, Rosen & Katz. The model of a law firm outlined in that document is a fine one, but an unusual one now. As Bruce regularly reminds us, the successful modern law firm will be run according to the rules of management and business found in the good corporation. That doesn’t necessarily mean that the old partners should be jettisoned, but their place in the firm is no longer guaranteed. This may well be harsh, and I hope a good firm would manage those exits decently and fairly.