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Why law associates work so hard
I have learned a new mechanism to explain the organization of knowledge-based, client-intensive partnerships:
From the property rights perspective, large law firms are poorly suited to sustaining employment relationships because they have no enforceable means of controlling the firm’s key knowledge asset—client relationships. The up-or-out partnership systems that have evolved over time in these firms offer an awkward but workable resolution to this problem. By restricting partnership size to maximize surplus per partner and by making senior attorneys residual claimants, law firms limit the opportunity for sub-groups of partners to grab and leave with the firm's clients. This action, however, creates additional demand for inexperienced associates who serve as (imperfect) substitutes for their more experienced counterparts. The result is that more associates are hired than can be promoted into a stable partnership. Those associates who do not succeed outgoing partners will be dismissed before they acquire sufficient client knowledge to themselves pose a threat of grabbing and leaving. That law firms find it worthwhile to commit to the costly practice of firing qualified attorneys in order to retain control over client relationships points to the general importance of control over assets in more conventional employment relationships.
The property rights model, in contrast to other explanations, can explain the coincidence of up-or-out promotion rules and partnerships in large law firms. At the root of our model is the claim that law firms cannot rely upon legal mechanisms to establish control over client relationships. We demonstrate that this is, in fact, the case under U.S. law. In addition, the property rights model suggests two propositions that are supported by the available historical, institutional and econometric evidence: (1) up-or-out appeared first in large corporate law firms who specialized in delivering large scale, complex legal services to valuable, long-term clients, and (2) large law firms practice a style of law that limits contact between associates and clients. Finally, the property rights model can account for the otherwise anomalous absence of up-or-out personnel policies in government agencies and large corporate litigation departments [TC: I like this latter point].
Here is the paper. Here is another version with abstract.
Posted by Tyler Cowen on October 20, 2006 at 06:35 AM in Law | Permalink
Comments
For the question of why associates work hard, there old '96 paper is quite compelling. Essentially firms select for the kind of employees that work hard.
On the up-or-out in professions in which outcome contingent contracts are hard to write, reputation can play a pivotal role and that can lead to up-or-out forms. At least such is argued by
http://pages.stern.nyu.edu/%7Ehbar-isa/hbirepnteams.pdf
Here is the abstract:
Agents work for their own reputations when young but for their firms when old. An individual with an established reputation cannot credibly commit to exerting effort when working alone. However, by hiring and working with juniors of uncertain reputation, seniors will have incentives to exert effort. Incentives for young agents arise from a concern for their own reputation (and the opportunity to take over the firm) but older agents work for the reputation of their firms (and the opportunity to sell out to juniors). An important theoretical contribution is an example of a mechanism that endogenously introduces type uncertainty.
Posted by: anon at Oct 20, 2006 9:07:02 AM
I look forward to reading the entire article, but I would add that the incentive structure in a large law firm works on the same pyschological principles as the ones which create a pyramid scheme.
Perhaps the FTC should be investigating for deceptive advertising?
Posted by: michael webster at Oct 20, 2006 9:07:12 AM
The military, of course, practices up-or-out personnel policies. This is not explained by the property rights model.
Posted by: Lars Smith at Oct 20, 2006 9:07:44 AM
My experience is with management consulting rather than law, but I suspect that that similar principles apply.
Even a well-established first-tier firm doesn't actually have a lump of locked-in clients to divvy up. Rather, the firm depends on its seniors to continuously capture/renew/nurture client relationships. The main driver of the firm's revenue is its portfolio of these seniors.
The firm can recruit bright people, but it can't tell at the outset which few of them can actually command clients' loyalty. So it hires talented people in quantity and then progressively filters them to find the keepers. The rest are let go, to make room for more raw talent to filter. Thus, up or out.
Conversely, a senior who feels ill-used can take his/her client-attracting talents to another firm. So the seniors must each reap the economic and governance benefits of their talents. Thus these firms take on a partnership form.
My favorite analogy for the latter are the senior faculty at a major research university. They control the key resource and they'll go elsewhere if not catered to [as Larry Summers presumably understands now].
Posted by: pireader at Oct 20, 2006 9:28:29 AM
Do you know of a model that explains up or out in academia?
Posted by: Bill Gardner at Oct 20, 2006 11:05:06 AM
Lars Smith is right about the US military, except that the up or out
policy applies to officers, not to enlisted. So an explanation will
have to explain that difference.
Posted by: Bob Harding at Oct 20, 2006 11:36:47 AM
Lorne Carmichael has a nice model of tenure in academia. The story is that the dean cannot assess who is likely to make for a good economist - other economists are in the best position to judge that but are unlikely to be honest in doing so if they feel the person in question is a rivel. Tenure should lead to better decisions therefore.
Posted by: anon at Oct 20, 2006 11:54:13 AM
On a related note - a couple of excellent papers on knowledge-based and professional services organization theory are:
* David Teece's Industrial and Corporate Change (2003) article titled "Expert talent and the design of (professional services) firms"
* Todd Zenger & Bill Hesterly's Organization Science (1997) article titled "The disaggregation of organizations: Selective intervention, high-powered incentives, and molecular units"
* Nicolai Foss' Organization Science (2003) article titled "Selective intervention and internal hybrids: Interpreting and learning from the rise of the oticon spaghetti organization"
Posted by: teppo at Oct 20, 2006 4:22:55 PM
The key here is that the authors are not just explaining up-or-out promotions but the combination of up-or-out promotions and the small size of most legal partnerships. Investment banks, consulting firms, and academic departments may use up-or-out incentives to enhance their own reputations, making sure the organization is managed by the best of the best and to free up space for those more likely to have real potential.
Investment banks and consulting firms weed out a lot of analysts in the first few years but poaching of clients can and does happen all the time in large firms. Paying exponentially growing salaries to large numbers of senior employees is the way some firms cope. As for academic departments, they will usually only hire someone if they think there is a good chance that the candidate will get tenure in a few years. If a professor works hard but leaves in a few years, that doesn't help the department's reputation very much.
Posted by: Mark at Oct 20, 2006 5:47:16 PM
I'm curious how this might apply to the military world. I guess this model isn't applicable to the military because the military is a much larger organization than a typical law firm?
In the military I can think of several things that accumulate as a career progresses and help the retired officers career in the defense industry:
1) Clearances. These are very valuable and are effective barrier to entries to competition.
2) Client relationships. Being a defense industry executive and having trusted personal relationships with current military decision makers would be very valuable.
...
I've actually been a part of defense consulting companies that did split off from larger companies and, effectively, stole some business. In both cases the company was designed to take advantage of minority (which includes women) set-asides, so a relatively inexperienced woman was made the figurehead while a couple guys with deep defense contacts were the real driving force.
In both cases the business model was to use the defense contracts as a very stable revenue source (the set-aside being a good barrier to competition) while trying to build a private sector IT consultancy.
Posted by: mike at Oct 20, 2006 8:04:21 PM
Herr Cowen,
I haven't read the paper. Does it mention where the fired assocites end up?
Posted by: Chaiman Mao at Oct 20, 2006 11:03:37 PM
Actually, I wasn't thinking about professors so much as how this resembles the weeding out process many grad programs use. (Not officially, of course...)
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