Why is the expense of attorneys fees inconsistent in economic terms with their overabundance?

As an economist major and also a lawyer who has worked in many different areas of my profession over the past decade and a half, let me take a look.

“Sticky” wages. Who likes to take a pay cut? No one. Historically, most companies (both in and out of the legal profession) will do anything to avoid taking a pay cut, even if it means layoffs. This has changed somewhat in recent years, particularly in highly volatile industries such as technology and finance, but the legal profession is one of the slowest to change. This leads to:

“Sticky” billing rates. Law firm billing rates only go one of two ways: up or sideways. They never go down. This is economically insane. When demand for something evaporates due to, say, the housing bust or the dot-com bust, basic principles of microeconomics tell us that the price must fall to restore equilibrium (supply = demand). When prices are sticky, that doesn’t happen, so you end up with a gap between supply and demand: overpriced lawyers sitting around doing nothing, and clients not being served because they can’t afford those rates. A classic “lose-lose” situation.

Limited discounts. Most other industries also don’t like to cut prices, in good times or bad. The thing is, if you’re selling Cisco routers and switches to enterprise clients and demand is plummeting with the economy, you can instruct your resellers to offer steeper discounts to high-volume customers. In business software and hardware stores, I’m used to seeing occasional discounts of up to 30%, 40%, even 50% to get/maintain the continued business of top customers. This is completely unheard of in the commercial law world, where the deepest discounts I have ever seen are 15-20%. Not nearly enough for a major recession. Why is that?

Obsession with prestige and ratings. Lawyers tend to be hyper-competitive personalities. This helps win cases and negotiate hard deals, but causes problems when it leads to irrational decisions. The top big commercial law firms (“Am Law 100” or “NLJ 250”) are persistently obsessed with their respective positions in the rankings, including the most common metrics (profits per partner, revenue per lawyer, year-over-year growth) as well as qualitative factors (hiring the “best ” law school graduates, recruitment of the most famous partners). how do they do it?

Money is considered a representative of prestige. A handful of century-old “white shoe” firms in New York, Boston, and DC dominated the world of commercial law, but that changed radically in the post-war years with the emergence of aggressive, entrepreneurial upstarts (often Jewish graduates of top law schools who had been marginalized by anti-Semitism in the old firms ) began to gain market share and eventually became some of the most profitable practices. Regional companies from other cities also entered the fray, renaming themselves “national” companies. How to get the most reputable rain partners? Make your business as profitable as possible to attract them. How to hire the best collaborators? Pay the highest starting salary.

Employee wages are not an efficient, free market. The top tier of large law firms is an oligopoly in each regional market. For many years until 1996, when I graduated from law school, all the big New York firms paid exactly $83,000 starting salary, all the LA firms $70,000, and so on. One of the top handful of firms would decide when it was finally time to raise employee pay (often Cravath or Skadden in New York), and once the new number was announced, every other firm that wanted to be considered “top” would quickly move in. to match. As the most profitable legal market in the country, New York led these changes for decades until…

The dot-com boom changed everything. In the late 1990s, there was a severe shortage of corporate lawyers in Silicon Valley as the amount of deal work exploded, with record IPOs, M&A and VC activity, as well as every other type of deal you can imagine. At the same time, the cost of living in the Bay Area was spiraling. The situation has been exacerbated by the exodus of lawyers (myself included) from top law firms to pursue in-house opportunities at Internet companies, lured by the potential wealth of stock options and other factors. Businesses in SF/SV, as well as LA and other non-NY markets, have decided they need to raise associate wages. It started gradually, with regional offices matching New York starting salaries ($90-$95,000) until the “shot heard around the legal world” rang out in the early 2000s. The name Bob Gunderson has become legendary among grateful associates like his Silicon Valley firm Gunderson Dettmer. , pushed through a dramatic increase across the entire associate pay scale, starting with starting salaries of $125,000 (up from $95,000 the previous year) plus bonuses. The herd followed, with all the big SF/SV/LA companies quickly matching the new pay scale, and of course New York couldn’t afford the West Coast upstarts to pay the top salaries, so the Gunderson scale became the national pay scale. for top law firms. Who were you supposed to pay for that huge pay rise?

The law firm’s overhead consists mainly of compensation. Well, that plus expensive office space in prestigious buildings, rich summer programs for partners and many other little things that generally reflect the attitude of operating in a “low-cost” environment. Naturally, the partners did not want to let their profits fall as a result of higher associate salaries. So billing rates went up and up, passing the higher cost of doing business on to clients. Billing rates roughly doubled between 2000 and 2010 at large SF/SV/LA firms for the same people doing the same work. Check out this helpful chart that comes from my related blog post at http://bll.la/55 (it’s a good read in its own right, in my humble opinion).

Back to Econ 101. What happens when you double the price of something? Demand for it is falling. On a side note, buyers are looking for substitutes, or they choose to do less, do it themselves, hire more internal staff, outsource labor intensive work to India, etc. Well, not necessarily; in an inflationary period, you may need to increase nominal billing rates to keep the real cost of things constant. But the years 2000-2010 were not exactly a boom period overall, inflation hovered around 3%. In fact, the Nasdaq chart from that time looked like this (taken from my answer to What was Silicon Valley like after the bubble burst in the early 2000s?):

See the change in billing rates in the years since 2000 versus the Nasdaq Composite Index over that period. Did you notice the difference? The rate charging chart reminds me of a cynical observation I’ve heard that in government bureaucracies, budgets and staff seem to have an exogenous growth rate that bears no resemblance to the amount of work they are actually responsible for year after year. In any case, why didn’t it collapse in the big law firms after 2000?