The Emperor’s New Clothes: An Analysis of the Increasing Salary Structure at Large Firms

It has been well reported in the news both locally and nationally that starting salaries at law firms have substantially increased. The salary increases had their genesis last year in Silicon Valley where law firms such as Gunderson Dettmer Stogh Villenueve Frankly & Hachigian in Menlo Park, California, concerned about dot.coms raiding their associates, substantially increased their salaries as much as 40%. A strong economy was generating an increasing level of transaction work and these firms needed to retain their associates. These increases in turn were matched by national law firms and gradually spilled over into regional firms. Recently the Pittsburgh Post-Gazette reported a number of local major law firms are now offering starting salaries in excess or near the vicinity of $100,000, leaving many local firms wondering how they should react.

The increasing legal salary structure parallels major league baseball where large market teams such as the New York Yankees, New York Mets and Los Angeles Dodgers have increase salaries to levels which teams such as the Pittsburgh Pirates can’t afford to pay. The only saving grace is law firms are not judged on winning the World Series. This is important because, as this article will illustrate, the salary competition is not healthy for national firms and could be potentially devastating for most regional or local law firms. In addition, if as this author believes, the premise of the salary increases are flawed, then there are substantial opportunities for law firms which rationally attack the salary issue and communicate their salary structure both internally and to clients.

What has become apparent is the salary increases were based on a mistaken premise that dot.com’s were a threat to law firm employee retention. Since this spring’s NASDAQ correction, dot.com’s are now being viewed more like other businesses; having to demonstrate earnings potential before their stock prices will rise. Therefore, the lure of big paydays, in the form of stock option based compensation to lawyers has waned.

Considering most entry level attorneys do not generate profits in their first four years but rather generate substantial losses at law firms the increase in starting salaries is even more troubling for law firms. In contrast, most professions such as medicine, accounting and engineering do not overpay their younger professionals until they are trained and profitable.

The question then for law firms is what to do about their salary structure if they have already increased salaries? This issue is also important to many local firms who have not responded to the salary increases and who are trying to determine how to react. Some potential strategies are listed below:

Pass the Costs of Increasing Salaries to Clients: This strategy appears less likely to succeed in the current market. Clients have become increasingly vigilant about monitoring their legal expenses. Substantial press coverage on associate salaries has educated clients that many fresh minted lawyers are earning salaries comparable to senior in-house attorneys. In fact, Fortune 500 clients such as DuPont Co., Inc., Monsanto Co., International Paper Co., and Cendant Co. have already stepped forward in the national press and voiced their objections to increased legal fees. Thomas C. Sager, VP & General Counsel at DuPont Co. bluntly stated, “I’m going to do anything in my power to support those firms that resist this . . . I will literally move work if I can, away from those firms that embrace this and to firms that resist this.”

Reaction from Western Pennsylvania companies could be even stronger because this region’s economy has not been experiencing the same growth rates as most major metropolitan regions. Locally, James Sander, Chief Legal Officer at General Nutrition Company, Inc. stated his company “is willing to pay outside legal fees for experience.” Sander observed, “Lawyers that come in from law school don’t have the necessary training to be immediately helpful.” Sander hopes that “the law firms raising starting salaries will subsidize the training until the associates are trained and ready to contribute.” “Higher rates”, noted Sander, “will cause [GNC] to increase its use of smaller and mid size firms to handle outside legal work.”

In a survey of 180 area companies focussing on the top legal officer in the area, respondents agreed that passing the cost on to the clients is wrong. Here are some of the anonymous reactions from various General Counsels, Associate General Counsel and Corporate Counsel.

Asst. GC: My company is not going to pay excessive rates for inexperienced attorneys.

Asst. GC: Higher salaries on top of hours invoiced for essentially training these first years strongly imply to me that these firms can’t even manage their own affairs efficiently, let alone mine.

GC: I am disturbed by the rapid increase in entry level salaries. I would be opposed to any increase in billing rates, which exceeds the increase in CPI.

GC: Having worked in private practice a number of years before taking a position in-house, I understand the need for firms to hire qualified attorneys. I don’t understand the need to pay starting salaries any more than $75,000 at best. If starting associates are at $100,000+, what are partners making? Clients would prefer to see lower rates. It may lead to the elimination of in-house counsel and increased business for law firms. With higher legal bills, companies are encouraged to bring more lawyers in-house. In today’s society, more lawyers would prefer in-house positions even if salaries were lower.

GC: This is a timely issue for me as the Chief Legal Officer of a large corporation which hires many outside counsel nationwide. Law firms must be made aware that corporate clients cannot be expected to pay large hourly rates to train new associates because they pay unreasonably high starting salaries. This is a gad trend that will ultimately continue to hurt law firms and encourage corporations to continue to perform more work in-house.

Assoc. GC: I suspect everyone’s rate will increase to fund the increase in starting associates’ salaries and corresponding salary increases across the ranks. We’ll pay more for the same quality services. As the billing rates of jr. associates rise, we lose some of the benefit of pushing more menial work down to junior personnel. I also suspect the higher salaries may actually increase attrition in the mid sr. associate ranks as firms attract good candidates who plan to work hard for a few years, or don’t plan to but in fact do, make good money, then move to another position offering a better lifestyle.

Corp. Couns: I find these salaries absurd, especially in light of the unavoidable increase in billing fees. Entry-level associates are unable, under any circumstances, to perform work that is totally independent. Their work will be reviewed by highly compensated partners. We therefore already have a minimum of 2 layers of cost. Any increase is unacceptable. I think firms are becoming more sensitive to this. We will, and have, taken our business elsewhere when we receive inflexibility in costs. There are many competent law firms out there from which to choose.

GC: Law firms did not have to increase every associate’s salary – only the ones whose skill sets are in demand.
Work Associates Harder: The Managing Partner at Akin, Gump, Strauss, Hauer & Feld stated his firm’s response to little more.” Locally partners at a number of firms have echoed these sentiments off the record as one strategy they will have to deploy to recoup the increased costs of salaries. The downside to this strategy is law firm employment, prior to the salary increase, was already a demanding profession. Increasing billing requirements from 1800 and 2000 hours to 2200 and 2500 per year presents serious quality issues as overworked associates could have problems hitting deadlines, responding to clients, learning clients’ business practices, keeping quality at a high level, and staying cheerful. According to Sunder Kekre, Professor of Operations Management and Manufacturing at Carnegie Mellon University’s Graduate School of Industrial Management when presented with this scenario, “Machines in factories fail when flogged to capacity. Likewise, the human machine is also vulnerable to overloads. Stressed lawyers can make poor judgments, overlook facts and give poor legal advice.” The two complaints we hear most often from in-house attorneys is the cost of projects and the difficulty in receiving timely work product. Increasing associate salaries clearly has the potential for exacerbating both of those concerns.

Partners Learn to Accept Reduced Compensation: This is a likely result for firms that allow their salary structures to exceed revenues by substantial margins. However, law firms are volatile business organizations often characterized by fiefdoms attempting to co-exist. Faced with the prospect of declining compensation, partners able to generate work often explore options at other firms. Partners unable to generate work begin looking more expensive to other partners. This volatility can be especially acute at local or regional law firms that are not capitalized to absorb significant loss-generating associate salaries.

Weed Out Under Performing Associates: One option to reduce expenses is to roll back the increases. This is difficult to achieve without impacting morale. In addition, some of the recent hires will develop into outstanding attorneys. A more likely scenario is attorneys with high salaries will be closely evaluated and terminated more quickly if they do not make the grade. Nationally and locally, this strategy is receiving attention. When salaries are too high, this is a reasonable approach. However, it does not afford a firm much opportunity to mentor and train young associates.

Re-Evaluate the Salary Structure: A better option is to re-evaluate a firm’s salary structure. Today law firms cannot be successful by only providing competent legal advice. Rather, firms today must also manage the economies of their firms in order to provide their lawyers with a satisfactory return. A reasonably salary coupled with a bonus or profit sharing structure based on billable hours, client feedback, business generation, special projects or other quantifiable criteria rewards profitable attorneys and aligns expenses with revenues. Because firms are not overpaying, it enables them to retain attorneys who take longer to develop without overpaying them. While this initially could sound unreasonable to young attorneys, the upside is that they are getting additional training, less pressure to perform immediately, and some relief from high billable hour requirements, all of which are certainly reasonable trade-offs. An important aspect to this strategy is to clearly communicate to associates the firm’s compensation philosophy and the opportunities created by the structure, and contrast this structure with the widely reported problems associated with overpaying associates. This open dialogue can minimize office coffee-break gossip that occurs in all law firms when perceived inequities occur, and can stem the tide of associate defections leaving for greener pastures. This strategy makes sense both for firms who are pondering salary increases and those who are overpaying young associates.

Market Salary Structure to Your Clients: Clients are as concerned about legal expenses. Firms that overpay young associates are creating a significant marketing opportunity for those firms who elect not to follow their lead. If that strategy is adopted and communicated effectively both internally and externally, a law firm staffed with the appropriate first chair partners leading projects can grow substantially even in a stagnant market. This strategy has worked in Pittsburgh. Some of our law firm clients have effectively, efficiently and profitably worked with the corporate clients to staff national projects with dozens of contract attorneys at rates, which higher cost law firms could not have afforded to staff. Long-term growth potential and profitability are the real long-term keys for law firms who wish to attract and retain strong associate talent.

Focus on Staffing Efficiently: There is nothing wrong with selectively rewarding and paying a premium to attract the best law students. It does result in hiring some strong associates. Law school grades are one important indicator of legal potential. However, many tasks at law firms are labor intensive yet still too legal to be staffed with paralegals. Areas like due diligence, document and privilege reviews, deposition summaries, and research and writing are well suited for reasonably priced contract attorneys who can handle this type of work profitably for a law firm while saving clients money. Further more, these types of projects give firms an opportunity to evaluate contract attorneys for permanent hire based on their work ethic, personality, ability to juggle and prioritize assignments. These important skills do not appear on a law school transcript. Deploying attorneys on a trial basis is the best way to evaluate these characteristics which manifest themselves on the job. Even large national law firms should not lose sight of the fact that they often have a number of partners who did not make Law Review or attend a top law school. Firms of all sizes should have a strategy to attract these well-rounded attorneys.

Eliminating or Reducing Practice Areas: Some national firms bitten by the salary bug have reacted by eliminating non-core practice areas where they do not have the resources to hire new associates. Landels, Ripley & Diamond, a mid-size firm in San Francisco, phased out its nine-attorney labor department and five attorney corporate practice to focus on core competencies where they could effectively recruit new lawyers. While focusing on core competencies makes sense in a competitive legal market, eliminating peripheral and profitable departments may not always make sense. If the issue is an inability to generate sufficient work, then scaling back to core competencies is a valid strategy. If the issue is inability to staff long-term, then one strategy is hiring experienced and technically strong but are not “rainmakers”. The firm can avoid the training expenses associated with maintaining a core department and focus on generating profits. If there is a good fit with the contract attorney, the firm can consider hiring that attorney to support any growth that occurs from a strategy focussed on generating efficient work product.

The salary dilemma is one that will not disappear on its own. It harms: (1) firms losing money by overpaying associates, (2) firms which, like deer caught in the headlights, do nothing and risk losing associates to other firms, (3) young overpaid associates facing unreasonable expectations for performance and higher billable hour requirements, (4) nonbusiness-generating partners looking expensive, (5) clients struggling to get timely work product from firms and to keep legal fees reasonable, and (6) law school graduates not getting hired at larger law firms because the starting salaries do not match their law school transcripts. However, adversity creates opportunity. Firms that capitalize on the overpayment of young associates by resisting the trend can build a stronger foundation to grow successful practices.