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February 17, 2012 10:56 AM

The Lateral Bubble

Posted by Steven Harper

Most big-law leaders say that they have to keep pushing equity partner profits higher to attract and retain rainmakers. They have repeated that mantra so often and for so long that the rest of the profession has accepted it as an article of faith.

Perhaps it's true, but two stories in the February issue of The American Lawyer prompt this heretical question:

What if the lateral hiring frenzy is creating a bubble?

Victor Li's "This Time It’s Personal" describes the state of play: lateral hiring is way up. Law firm management consultants, including my friend Jerry Kowalski, predict more of the same for 2012 as firms counter revenue lost with the departure of partners to prevent the death spiral that can result. Such fear-driven behavior can easily lead to overpayment for so-called hot lateral prospects that turn out to be, well, not so hot.

As I've observed previously, the reasons for the lateral explosion have much to do with big law's evolution. The prevailing business model encourages partners to keep clients in individual silos away from fellow partners, lest others claim a share of billings that determine compensation. Paradoxically, such behavior also maximizes a partner's lateral options and makes his or her exit more likely. In other words, the institutional wounds are self-inflicted.

But Li's article quotes several firm leaders who emphasize that, while more money did indeed motivate some partners to switch firms, the search for a global platform was also a factor. Frank Burch, cochair of DLA Piper, acknowledges that enticing a lateral hire requires that the money offered be comparable to what the attorney was already making. But he also says that his firm "did a lot of hiring from firms that reported higher profits per partner" than DLA Piper. The article cites four: Paul Hastings; Skadden, Arps, Slate, Meagher & Flom; White & Case; and Morgan, Lewis & Bockius.

Except that in "Crazy Like a Fox" (also in the February issue of TAL), Edwin B. Reeser and Patrick J. McKenna correctly observe that a firm's average PPP is not all that informative. The authors focus principally on the growing cohort of nonequity partners amid a climate in which clients are unwilling to pay for first- and second-year associates. But Reeser and McKenna make a telling point on a seemingly unrelated topic: the income gap within equity partnerships has exploded.

They note that a few years ago the equity partner pay spread was typically three-to-one; at some firms it's now ten-to-one or even twelve-to-one:

"Over the last few years there has been a dramatic change in the balance of compensation, to a large degree undisclosed, in which increasing numbers of partners fall below the firm's reported average profits per equity partner (PPP). . . . Typically, two-thirds of the equity partners earn less, and some earn only perhaps half, of the average PPP."

(Trying to justify this trend, some firm leaders have offered silly explanations, such as geographical differences.)

Now apply this learning to Li's article. A firm's average PPP isn't luring high-powered lawyers; the money at the top is. Perhaps the desire to provide clients with a better global platform plays a role in some laterals' decisions, but most of the firms experiencing the highest number of lateral partner departures in 2011 are already worldwide players. In fact, four firms—DLA Piper, K&L Gates, Jones Day, and SNR Denton—are simultaneously on both the most departures and most hires list.

Consider this issue from another perspective. When Jamie Wareham became big law's highly public $5 million man last year, did leaving Paul Hastings for DLA Piper improve his ability to serve clients? Doubtful. But the bubble question is far more important to the firm: Has Wareham been worth it? Only he and his new partners know for sure.

That leads to a final heretical question: Where a lateral bubble develops, what happens when it bursts or, perhaps more perniciously, develops a slow profitability leak? Nothing good. For the answer, ask those who once worked at HowreyHeller Ehrman, or one of the many other now-defunct firms whose leaders thought that acquiring high-profile laterals offered only upside.

Steven J. Harper is an adjunct professor at Northwestern University and author. He recently retired as a partner at Kirkland & Ellis, after 30 years in private practice. His blog about the legal profession, The Belly of the Beast, can be found at www.thebellyofthebeast.wordpress.com. A version of the column above was first published on The Belly of the Beast.

 

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