Document Type

Article

Publication Date

2006

Publication Citation

84 North Carolina Law Review 1691 (2006)

Abstract

During the last decade, many of the nation's largest law firms have converted from single-tier to two-tier (or multi-tier) partnerships. A two-tier firm contains separate tracks for equity and nonequity partner. The equity tier typically controls the firm and enjoys a larger per capita share of the firm's profits. At present, two-tier partnerships make up 80 percent of Am Law 200. The conventional explanation for the growth of the two-tier system (or, conversely, the abandonment of the single-tier) is that it produces higher profits per equity partner (PPP), thus solidifying the prestige of the firm and improving its ability to attract the best legal talent. Drawing upon a comprehensive dataset of Am Law 200 firms, this study documents that average PPP is significantly higher in single-tier firms, even after controlling for geographic market segment and firm leverage. The higher profitability of single-tier firms appears to be a function of higher levels of reputational capital, which enable single-tier firms to (a) attract and retain a more lucrative client base, and (b) run a more rigorous promotion-to-partnership tournament.

Based upon a ten-year longitudinal sample, this study also found negligible statistical evidence that the two-tier structure, after controlling for relative starting position and geographic market, is associated with larger gains in PPP. In light of its uncertain financial benefits, the author theorizes that the two-tier structure is primarily a bonding mechanism used by less prestigious firms to institutionalize a marginal product method of partnership compensation and consolidate managerial control for the benefit of the firm's most powerful partners. Failure to switch to the two-tier structure leaves the firm vulnerable to defections and possible collapse. As a result, the primary economic benefit of the two-tier format may be firm stability rather than higher average PPP. Finally, this study provides some evidence that the appeal of permanent nonequity partnership status, which typically entails fewer professional demands, may set in a motion an adverse selection problem at the associate recruitment level, thus undermining some of the perceived benefits of a two-tier (or multi-tier) format.

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