Summary: A report states that certain law firms will be hurt financially because of the Cravath Effect.
In June, Cravath, Swain & Moore changed the legal world when it announced that all first year associates would earn salaries of $180,000 instead of the industry standard of $160,000. This salary increase created a “Cravath Effect” and other BigLaw firms began to change their sliding pay scale to match. While associates understandably were excited about the raises, critics such as Bank of America worried that clients would end up paying for the salaries. Other naysayers said that the increase would only cause firms to make their associates work more billable hours, hurting women with families. Now a new report reveals that certain law firms may actually be hurting themselves following Cravath’s lead.
Using data from ALM Intelligence and RivalEdge databases, researchers found that the salaries will significantly impact certain firms’ bottom lines. The table below shows how some firms will be unscathed by the salary increase while others will be hurt unless they find ways to increase their profitability. Judging by the range of profit per equity partner (PPP) on both lists, there appears to be no correlation between PPP and the Cravath Effect. Instead, the firms that will be most harmed are those with high leverage and low margins, according to Law.com.
“Most law firms that raise salaries are playing a game they can ill afford to play,” BCG Attorney Search founder Harrison Barnes said. “They are like someone who is already deeply in debt purchasing an expensive car and going on an expensive vacation to keep up with the neighbors. They are like an athlete who is using illegal drugs to try and compete more effectively. In short, they are doing something they should not be doing that is almost always going to have adverse consequences in the future.”
According to Law.com, the Most Impacted Firms are on the list for two reasons, lower revenue per lawyer (RPL) and/or low profit margins. The website stated that firms such as K&L Gates, Perkins Coie, Mayer Brown, and Foley & Lardner are hit hardest by the associate salary increase because they have revenue per lawyer (RPL) of less than $1 million. The million RPL is the threshold number needed for firms to not feel an impact from the raised expense of higher salaries.
When it comes to profit margins, K&L Gates, Perkins Coie, and Orrick have profit margins that are less than the Am Law 50 average, Law.com said.
So how can law firms increase their profits? One way to get that extra money would be to push the costs onto clients by rate increases. This was a fear of Bank of America’s back when the new pay scale was announced last summer. BOA’s global general counsel sent out a scathing memo, stating that the company would not absorb any of the law firms’ rising overhead.
“While we respect the firms’ judgment about what best serves their long-term competitive interests, we are aware of no market-driven basis for such an increase and do not expect to bear the costs of the firms’ decisions,” wrote David Leitch, Bank of America’s global general counsel.
Overall, the potential harm that the aforementioned firms may experience is due to their wanting to follow Cravath’s lead without having Cravath’s financials. Thus, these firms were setting themselves up to fail, Barnes said. He stated that history has shown us that firms who try too hard to keep up with the joneses tend to layoff attorneys in the future.
“Raising salaries generally overextends law firms, because the increased salaries have no connection with the market and the level of demand actually enjoyed by that particular firm,” Barnes said. “Paying Cravath salaries does not turn a firm into Cravath.”
- Related: Law Firms Across the Globe Match Cravath Bonuses
- Related: Firms Follow Cravath’s Base Pay Scale Increase
Source: Law.com, BCG Attorney Search
What do you think will happen to certain firms because of the Cravath Effect? Let us know in the comments below.