Leverage just part of 'big business'

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Published on 6/4/07

Lawyer compensation remains a hot topic.

The furor over $160,000 average annual pay for new associates (which we considered in a recent column) had barely died down before one of the nation's ten largest firms gained notoriety (to say the least) when its internal decision to lay off 45 partners, or 10 percent of its total, became public.

The firm then gave a very specific reason for its action: although its revenue ranked in the top ten of all U.S. firms, its profits per partner were number 51 among the top 100. The firm let partners go in order to increase leverage, and thus per-partner profitability, a standard they believe is important for recruiting top legal talent.

Some commentators contended that profits-per-partner is a meaningless figure, one that can easily be manipulated. Such "manipulation" is, in fact, astute financial management.

Consider a recent National Association for Law Placement study of law firm leverage nationwide from 1995 to 2006, which showed that leverage has returned to levels of the mid-1990s. Under one metric used in the study, after reaching a high in 2002 of 1.16 associates to partners, the 2006 figure was .99.

Law firms, on a national average, thus paid more for the work being done per hour.

Failure to use leverage increases costs of operation. No wonder that a law firm unhappy with its profitability would seek to adjust a key economic factor of its operation by elimination of some of its partners. That instantly adjusts the leverage! The remaining partners should be pleased that the firm is sensitive to the real economics of the operation.

Each of the laid off partners was (presumably) added to the partnership because the firm had a strategic goal for his or her practice at some point. However, when the firm's overall strategic goal for profitability was not being met, the leadership made a change.

The decision to do this is not a question of fraud or manipulation — such as attempting to hide profitability problems behind a web of subsidiaries. We're talking about legitimate rearrangement of organizational structures to impact accounting metrics.

Why should law firms, now playing in the big leagues with revenues approaching and exceeding $1 billion, be exempt from the same decisions that face their large corporate clients?

I'm not sure any lawyer currently believes that being a member of a large law firm is anything but "big business." The days of "professionalism" and "collegiality" are in the past. Law firms, both large and small, are seeking not only to report higher profits per partner, but also to take more money home.

That, of course, creates other problems. For example, The Wall Street Journal recently wrote that corporate firms are increasingly entering contingency fee arrangements — and facing big problems if the firm wins.

When many dollars flow into the law firm, who gets what? How much should the lawyers working on the matter receive? Isn't the matter the "property" of the firm? Didn't the firm advance the costs while the matter was being litigated, not the lawyers? Are departed lawyers entitled to any portion of the proceeds? What is fair?

All good questions — and all perhaps inseparable from the Sunday-school lesson that, not money itself, but the love of money, is the root of all evil.

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