Wednesday, February 18, 2015

A Path Best Avoided: A Proposal for Law Firms to Go Public

A Path Best Avoided: A Proposal for Law Firms to Go Public

Over recent years, the economics of the legal profession has come under significant pressure.  Law firms have tried mergers and layoffs to get ahead of billing pressures.  In a recent law review article, Jonathan T. Molot, a Georgetown law professor, suggests that law firms take on outside investors by going public.[1]  Professor Molot suggests that outside capital would solve the problem of retaining key professionals and making needed investments in technology.  For the largest legal practices, the professor’s proposal might solve their business problems.  However, for clients, rank and file employees, and the public, this is a bad idea.

Forty years ago, investment banks were private companies largely owned by their executives.  The industry complained that it didn’t have sufficient capital to invest in their business and retain key bankers, brokers, and traders.  For the major investment banks (Goldman Sachs, Merrill Lynch, Morgan Stanley), becoming public made the existing executives incredibly wealthy and provided capital for expansion.  However, it created more problems than it solved.

While the founding and existing partners became fabulously wealthy, the younger partners and senior associates were left behind.  And while the additional capital was helpful in financing deals and technology projects, it turned out to be insufficient.  Eventually the investment banks ran short on capital again and clamored for the repeal of Glass-Steagall so they could merge with banks.  Going public hadn’t solved their long-term problems.

Going public created a far more pernicious problem that continues to plague us.  When Wall Street investment banks began to accept outside capital, they fundamentally changed the alignment of interest that inhibited executives from taking excessive risks.  As private companies, investment bank executives put their own wealth and livelihood at risk when they underwrote a deal.  As public companies, executives were able to make bets with other people’s money.  Lehman and Bear Stearns managers might have been a bit more prudent if their entire net worth had been at risk.

In my view, major US law firms would follow a largely similar path as the investment banks if they went public.  Instead of looking out for the interests of their clients, lawyers would suddenly be concerned about keeping mutual fund and hedge fund investors happy.  Moreover, the management team would spend many hours formulating stock option plans designed to give themselves short-term payoffs.  The pressures of retaining key individuals wouldn’t go away: it would just get more expensive.  And even if going public were a real solution, it would only work for a tiny fraction of the legal industry.  Over 99% of the law firms in America are way too small to even consider going public.

Professional intermediaries shouldn’t be public companies.  The fact that accountants, investment banks, and rating agencies have gone public is the best evidence against the idea.   Fortunately, the American Bar Association has rejected the idea of law firms going public on two occasions since 2000, and I hope they will maintain that position.


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