Taking it Down a Notch
Over the last two decades, almost 80 percent of the country’s largest law firms have moved to a two-tier partnership, largely in hopes of boosting profits per partner. But a new study challenges this conventional wisdom.
Indiana University law professor William Henderson concludes in the study that the most profitable large law firms in America have a single partnership tier rather than separate tracks for equity and nonequity partners.
To arrive at this finding, Henderson developed a mathematical formula that quantified six factors as predictors of profitability, including leverage and prestige. He then plugged in data gleaned over 10 years from American Lawyer magazine’s lists of the top 200 law firms (known as the “Am Law 200”) and other sources of law firm data.
His analysis showed that firms with the highest rankings in the prestige category also boasted higher profits per partner. And the most common partnership structure found among the firms with the highest rankings for prestige and, therefore, profits per partner? Single-tier.
Henderson suggests the reason may be that firms with stellar reputations have a more lucrative client base, enabling them to attract talented associates who compete in a “rigorous promotion to partnership tournament.”
His study does note the allure of the two-tier model. The structure may keep star lawyers from defecting by consolidating the money and power in a select group, Henderson hypothesizes.
But his study shows the drawbacks: Lawyers in two-tier firms bill less and have fewer high profile matters and more price-sensitive clients. And these firms could lose star partners if clients with price-insensitive business are loyal to the individual lawyers rather than their firms.
Oftentimes, these two-tier firms become lifestyle firms where lawyers can safely stay in the second tier with little fear of repercussions, he says. “There is great differentiation in the marketplace. Some firms have a greater endowment of clients and legal talent than others. So with different cards to play, firms play them differently.”
There are, however, some sticking points with single-tier systems. To fuel profits, these firms must maintain a high level of prestige—something that doesn’t come easily, Henderson says.
Not So Fast, Say Critics
San Francisco-based law firm management consultant Blane Prescott of Hildebrandt International believes Henderson’s conclusions are too simplistic, partly because figures from some of the most elite firms skew the results.
Though Henderson says his calculations controlled for the “New York City factor,” Prescott says it’s like comparing apples with oranges when broad conclusions are drawn from data that includes the most elite firms.
“Only if a law firm is extraordinarily diligent about who they allow to be a partner, like the elite New York firms, is [his theory] possible. Then they let someone be a partner if they have four others to do the work they bring in and have $4 million in business. Is that realistic for someone in Missouri? No.”
Rick Cosgrove, chief executive partner of the Chicago based Am Law 200 firm Chapman and Cutler, also disagrees with Henderson. A two-tier structure helps create prestige and the profits that stem from such status because it provides flexibility to attract the top legal talent, he says. “The challenge is to get the best people highly motivated.”
All agree, however, that two-tier partnerships need to be carefully managed. Says Prescott: “A lot of firms have used the second tier as a dumping ground. They fill it with mediocre people or people who do not project quality. A two-tier structure is never a good structure to accommodate quality issues. And yet it happens.”