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Should Law Firms Continue to Report Publicly on Profits Per Partner?

Revenue

Revenue (Photo credit: yourdoku)

Jerome Kowalski

Kowalski & Associates

 May 19, 2010

In March of this year, we questioned the wisdom of law firms continuing to publicly report on its revenues and profits.

While humility precludes our suggesting that we alone initiated a public discourse regarding  the question, since this was an issue that had been quietly discussed and whispered about in many corners of the profession, the  volume of the debate was raised by several material decibel with the public announcement on May 12, 2010 by Ralph Baxter the chairman of Orrick, Herrington & Sutcliff that Orrick would simply no longer publicly report on profits per partner.

The volume of the debate has been raised yet a few more notches in the copyrighted article by noted journalist Leigh Kamping-Carter in a copyrighted article appearing in today’s Law 360.

Ms. Camping Carter reported, in part,

[U]nlike publicly traded companies, law firms are not required to disclose [profits per partner], and naturally, some firms have never reported PPP, either out of a preference for privacy or a sense that disclosing sky-high profits would be unseemly, consultants said.

In a rational world, firms would either keep their financial numbers private or would disclose information according to a uniform and regulated set of accounting guidelines, backed up by an accountant’s certification, said Jerry Kowalski, founder of legal consulting firm Kowalski & Associates.

As it stands, however, the number is open to manipulation. Firms can adjust the number of partners they report, shifting between equity, nonequity and counsel status, and altering counts of staff lawyers or temporary lawyers, experts said.

“1 think one of the most misleading of all public financial figures of law firms is in fact PPP,” said Gary Klein, founder of legal recruiting firm Klein Landau & Romm Inc. “Many firm chairs believe that every other firm fudges the numbers, and they might be correct about that, because it’s too indefinite.”

The weaknesses of the profits per partner model “hit home” during the recession, when law firms in the midst of unprecedented layoffs also posted excellent PPP results, said Toni Whittier of Whittier Legal Consulting. And for lateral hires, the number is now just one of a variety of different ways to size up a firm, she said.

Still, rejecting profits per partner as a standard measure would likely entail coming up with a new, more comprehensive model for measuring a law firm’s progress, which could be light years away, consultants said.

One easy metric that could replace profits per partner would be revenues per lawyer, a figure that would take into account gross revenues, minus expenses, divided by the number of full-time lawyers at a firm, consultants said.

“Revenues per lawyer is the ultimate go-to number when you’re looking at a law firm,” Klein said.

But considering the changes in the legal industry, additional metrics like revenue growth,

operational efficiency, the number of lateral hires, major representations, evaluations of the success of alternative fees and staffing changes and, especially, client satisfaction could all eventually come into play, consultants said.

“Is it as easy as latching on to one number? No,” Whittier said. “Does it give you a better idea of how one firm compares to another firm? Yes.

But how will firms assign numerical values to these “soft” measures? So far, it’s not clear. Whittier sees a lot of firms wrestling with how to measure client satisfaction; others have formed committees to study methods for quantifying efficiency, she said. Even Orrick is still working out a law firm equivalent of “earnings per share.”

“Law firms are used to looking at certain numbers, and obviously there’s going to be adjustments in determining alternatives to what theyve been looking at for a long time,” Whittier said.

Besides, reporting profits per partner serves another function: letting top 100 firms boast about their rankings – much like a couple of golfers talking up their golf games, Kowalski said. It’s questionable whether firms would willingly give up the chance to brag.

“Given the nature of the unique economic entities that law firms are, and the unique egos that drive law firms, its quite unlikely in my view that they will stop doing that,” he said.

If it does nothing else, Orrick’s move will at least generate discussion and push firms forward, Whittier said.

“What’s going to turn the tide is some other strong leaders in the bar to stand up and say, once again, ‘Ralph Baxter is right, we’re going to follow suit,'” Kowalski said of Orrick’s CEO and chairman. “And it will happen.”

             Publicly traded companies, report on revenues and profitability in accordance with SEC regulations, and more significantly, in accordance with standards required by the accounting profession, namely, Generally Accepted Accounting Principles, measured by General Auditing Standards, accompanied by an opinion by a firm of certified public accountants that such standards had been consistently applied.  Other companies report in the same consistent fashion to its lenders and stakeholders. In no public announcement or report by any United States law firm has there been such a certification.  UK law firms do have the obligation to report, in accordance with various regulations and standards information concerning revenues and profitability.

The anomaly of the current pronouncements by law firms is further confounded by the fact that law firm reports on revenues and profitability (as well as headcounts and partnership compositions) are virtually simultaneously issued to different media and to organizations such as the National Association for Legal Placement in completely inconsistent and often contradictory fashions.

The profession should also take note of the very public ruckus created by publicly released information regarding $5,000,000,000 in bonuses recently awarded by Goldman Sachs to various managing directors and officers.  Yet, there is no report issued by Goldman Sachs that of payments to such personnel equaled or averaged any particular amount. The public outcry of this excess in the current economic climate was rather deafening. Yet, in fact, the only actual report of revenues and profitability issued by Goldman Sachs was the one it was required to issue pursuant to SEC requirements, since, among other things, Goldman is a public company and the public report was made in accordance with GAAP, certified by its outside public accounting firm.

Law firms should, among other things, take particular note that the public brouhaha of the publicly released information by Goldman is now occurring in an equivalent fashion by and among the clients of the law firms that feed law firms with revenues.  These same clients,  stung by The Great Recession and dealing with their own concomitant drop in revenues and reduced profits must be completely appalled by the profession’s hubris in recently reporting either non-material declines in profitability or, in too many instances, public boasts of increases in profitability, particularly in light of the fact that a number of surveys conducted by the Association of Corporate Counsel, various law firm consultants, http://www.legalonramp.com and law firms themselves all consistently report that consumers of legal services share the view that lawyers already “make too much money.”

Accordingly, public boasts of profits per partner and, particularly, reports of increases in PPP only serve to give further credence to that view. Thus, these public pronouncements produce serious collateral damage in the form of increasing client insistence that fee structures be reduced, increasing commoditization of legal services and that pricing of legal services be doled out through the same prism consistently applied by corporate purchasing agents, namely, with the same corporate discipline in which clients seek vendors of other goods and services are procured, namely price being the same primary factor.

In short, public reports of PPP results in a direct shot to the foot — or perhaps to other more vital organs.

Is Ralph Baxter correct?  Should all responsible firms follow suit?  We certainly think so.

[Update:  In a post of August, 2011, we explore some of the smoke and mirrors that sometimes unfortunately finds its way in to some law firms’ financial reports.  And to some public disappointment, Orrick did in fact release its financial information to AmLaw for inclusion in the 2010 rankings.]

(c) Jerome Kowalski, May, 2010, all rights reserved.

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6 Responses

  1. […] on grading.  Insofar as some firms may not voluntarily supply such information, perhaps relying on our view on the subject, US News boldly reported that it “will be able to secure from various sources quantitative data […]

  2. […]             A principal problem in the ACC Corporate Challenge is its rather wholesale reliance on defined metrics. Professor Steve Harper, a former Kirkland partner, recently reported that reliance on metrics is frequently misplaced.  I long ago joined a chorus of others in raising the issue of the “mother” of all metrics; the much touted annual AmLaw 200 report on law firm profitability is slightly less than gospel. […]

  3. Which is more important for any company: revenue growth or profit?…

    EBITDA and similar metrics have no place in evaluating a law firm, whose only real assets are its partners who are largely employees at will (http://kowalskiandassociatesblog.com/2010/03/16/law-firm-partner-layoffs-hardly-a-new-or-shocking-development/

  4. […] their numbers when reporting to AmLaw.  While the fact is that this piece was hardly news (we addressed the issue in May of 2010), and later addressed the fact that some law firms unfortunately game the financial […]

  5. […] consultant Jerome Kowalski urges firms to stop reporting PPP, as Orrick, Herrington & Sutcliffe LLP announced it would last […]

  6. […] own advice is forget about boasting about your PPP; instead, make the far more important investment in enhancing the firm’s long term relationships […]

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