Originally published for Thomson Reuters Legal Executive Institute on February 24, 2015
Georgetown Law Professor Jonathan T. Molot has written a thought-provoking article in the latest edition of the Southern California Law Review: “What’s Wrong with Law Firms? A Corporate Finance Solution to Law Firm Short-Termism.”
Prof. Molot brings more than his academic work to bear on his article. He has practiced at two prestigious law firms and is co-founder of Burford Capital, a firm that funds litigation in exchange for a portion of the settlement or awards.
Prof. Molot offers a reasonably negative assessment of the current state of American law firms, aptly summarized in the first paragraph:
Lawyers and clients are unhappy with the contemporary law firm. Associates complain of being treated like “leverage tools” and given inadequate opportunities for mentoring, training, client contact, and career advancement. Clients feel overcharged and underserved, and are constantly searching for a better deal from another firm. Even partners—the ones who profit from associate hours and client billings—have grown tired of the “what-have-you-done-for-me-lately” culture in which they have to bill and earn as much as possible during their productive working years and who, like clients, are far too willing to chase a better deal at another firm.
What makes Molot’s article provocative are his diagnosis of the cause of this state of affairs and his proposed cure.
Molot blames the woes of the American law firm on “its outdated partnership model.” While recognizing that there are other issues at work, he calls the business model a “root cause” for the current state of affairs:
The law firm partnership is a poor institutional choice for the delivery of legal services in today’s legal market. Its structure fails to serve virtually all of its stakeholders.
Molot contends that the partnership structure produces a confusion of ownership and employment. Law firm partners are technically “owners” of the business, and therefore have a direct say in management decisions. Yet their entire financial return consists of annual cash compensation, with no other return on their investment in the firm. And they surrender their equity, with no appreciation, when they retire. According to Molot, this leads to management policies and partner behaviors that put undue emphasis on short-term partner income, at the expense of long-term considerations, including, importantly, building sustainable client relationships, looking after the well-being of the lawyers, and making investments in the firm’s future.
The problem with law firms is not that they are run as businesses, says Molot, “but that many of them are poorly run as businesses.” The confusion of ownership and employment disables them from making the best long-term decisions. He contrasts the “short termism” of law firms with the approach that Google took in its early days to elevate concerns for client and employee satisfaction over concerns for short-term profits. “Imagine if Google had to take a vote of its employees every time it made an investment…”
Molot advocates permitting law firms to change their models to award senior lawyers (the analogue to today’s “partners”) permanent and monetizeable equity interests. He proposes two changes to get there: “permanent equity” and outside investment.
Permanent equity would involve granting equity interests to senior lawyers which vest and remain their property after they retire from the firm. These equity interest holders would participate in the financial success of the firm by receiving dividends. As the firm flourishes during and after the lawyers’ time at the firm, the owners would benefit directly.
Permitting outside investment would create a market value for the equity. Not only could the firm raise capital directly be selling equity, partners would be able to sell their vested equity, at the market value the firm’s success warrants. This would create the prospect of meaningful financial return for the partners’ investment of time and money in the firm during their working years.
Taken together, Molot contends, these changes would have a material impact on the outlook of the “partners” during their time at the firm. Since they would benefit directly from the firm’s success over the long term, they would more likely agree to actions that would take the long-term view. Molot does a particularly good job of illustrating why the prospect of a financial interest in building a strong institution would also promote important behaviors such as developing the next generation of lawyers and building institutional client relationships.
Prof. Molot’s article makes a constructive contribution to our ongoing discussion of the future of law firms.
It identifies the law firm business model as part of the problem. Whether or not one agrees with his solution, Prof. Molot provides a cogent case that the current model is at the “root” of contemporary firm challenges.
In addition, it will generate further, and much needed, discussion of outside ownership. Prof. Molot’s article quickly generated stories in The New York Times and The Washington Post. William C. Hubbard, President of the American Bar Association, commented for the Times article. The underlying issues are numerous, diverse, and complicated. They deserve a thorough and pragmatic airing.