What are we to make of the recently released 2016 Am Law 100 numbers? “Rather impressive,” as Am Law put it in The 2017 Am Law 100, the American Lawyer, May 2017: Gross revenue up 4.3 percent and Proﬁts Per Partner (PPP) up 3.0 percent. At face value, not bad.
I don’t know about you, but at least among people I’ve talked to the reaction has been one of incredulity: “Not possible,” “I just don’t see it,” “How can that be?” and so on. When the industry’s scorecard of record seems off, my instinct is to look more closely; shall we?
Self-flattery and Kentucky windage
As privately held organizations, law firms obviously have no obligation to disclose financial results and are free from the shadow of having what they do choose to disclose subject to audit. This includes what information they do or don’t share with the American Lawyer. When the second prong of “trust, but verify” is off the table, we are left with “trust.” Many disinterested observers choose to do just that, but it will come as a shock to no one to acknowledge that suspicion is widespread about flattering adjustments, roundings-up and roundings-down, and 12-month fiscal years that end “as late as January 45th,” as one droll skeptic put it.
This presents analysts with a choice: Take the numbers at face value or try to apply a little Kentucky windage to correct for puffery? I choose to take the numbers as reported. For one thing, I’m clueless where one could even begin if asked to guesstimate a “self-flattery correction factor,” but more importantly, I prefer to focus on trends over time. Since there’s no plausible reason to assume firms have systemically become more honest, or more dishonest, over time, I’m willing to stipulate for purposes of proceeding that while the numbers may be imperfect, they’re probably apples-to-apples from year to year.
Modest data hygiene
One of the first questions an inquiring mind ought to ask about financial performance over time is whether the figures shown are in “nominal” dollars (not accounting for inflation) or in “real,” constant dollars adjusted for inflation. For the Am Law 100, the Bureau of Labor Statistics tells us that the Consumer Price Index (CPI) increased 2.08 percent from 2015 to 20162 and from Am Law itself we know that lawyer head count in the “100” rose 2.72 percent. Adjusting for both these figures:
Illuminating in a number of dimensions, but the headline has to be that real total revenue swung from +4.3 percent to –(0.5 percent) and Revenue Per Lawyer (adjusted for CPI but obviously taking head-count growth into account) from +1.5 percent to –(0.6 percent).
The rich really are different
It’s understandable – this doesn’t make it correct or forgivable – that many of us unthinkingly assume that any given distribution resembles a bell curve. They’re so familiar and ubiquitous that even statisticians call them the “normal” distribution. Problems arise because trailing in their wake are a host of ready-made assumptions.
This matters because the Am Law 100 is not remotely a “normal” distribution; it’s a power curve, with a few big players, a lot more in the middle, and a long tail of smaller fry. This isn’t a technical quibble; it has teeth.
First and foremost is that a bell curve’s “average” is a highly descriptive number; it defines the central tendency of the universe under inspection. For power curves, no such thing holds true; averages aren’t just misleading, they can approach falsehood. Consider a few characteristics of this year’s Am Law 100: (a) 10 percent of the group’s total revenue is accounted for by the top three firms; and another 10 percent by the smallest two dozen; (b) 25 percent comes from the top nine firms and 25 percent from the bottom 50; and (c) the top three’s combined revenue was over $8 billion and the bottom 20’s under USD$7.5 billion. In short, big firms really matter. Their performance can easily move gross measurements for the entire group.
Given this, it’s worth looking at the 100’s nominal increase in revenue (USD$3.5 billion) from a few other perspectives:
- How many of the 100 firms accounted for, say, two-thirds of that increase? The answer is about 20 firms; the other 80 didn’t grow enough in absolute dollars to make much difference, or else shrank outright.
- Eighteen firms reported their gross revenue decreased and 20 reported lower PPP; just as a matter of first- blush intuition, how does this square with what you assume when you hear +4.3 percent revenue growth and +3.0 percent PPP growth?
- And, to exemplify how a small firm can have eye- popping percentage growth without moving the gross number needle much, while a big firm lumbering along with the pack can have the same overall impact but no one notices, consider:
- Husch Blackwell was the No. 1 firm out of the entire 100 in revenue growth rate at +23.2 percent (they merged), adding USD$81 million to their year-before total.
- Skadden was actually below the “average” growth rate at 3.5 percent, but tacked on $85 million, or a rounding-error’s difference with Husch.
Finally, let’s try a drastic thought experiment: Suppose the smallest 20 firms disappeared in a ﬂash; they would obviously be replaced by the largest 20 firms from the Am Law Second Hundred. How would this radical set of “alternative facts” move the numbers? Not much. The smallest 20 Am Law 100 firms generated USD$7,491,600,000 in revenue, and the largest 20 Am Law Second Hundred firms USD$5,819,000,000, or a difference of USD$1,672,600,000. This sounds like a lot of money (it would be to me), but it’s actually only 1.9 percent of total Am Law 100 revenue. Dropping one single ﬁrm (White & Case, No. 11 at USD $1,631,000,000 in revenue) would have an equivalent impact.
Our Original Sin, if you will, in our annual congratulatory fest on the publication of yet another set of strong-looking numbers, is to lump all the 100 firms together in some undifferentiated clump – as if they followed a “normal” distribution. Understandable, yes; and unforgivable. The Am Law 100 is an eclectic menagerie.
And did I mention that big ﬁrms really matter?
Survivorship bias and its kin
Let me close with something you don’t see in the Am Law 100 – or any current performance financial ranking: Firms that didn’t keep up. The Am Law 100, the Fortune 500, the S&P 500, are all rosters of the winners – winning as deﬁned by the guardians of the pertinent index. “Survivorship bias” is the handy term for this, and it stands for “the tendency for failed companies to be excluded from performance studies because they no longer exist. It often causes the results of studies to skew higher because only companies that were successful enough to survive until the end of the period are included.”3
In 2012, on the occasion of the 25th birthday of the Am Law 100, the American Lawyer conveniently reported that only 69 of the original 100 firms from 1987 remained in the ranking, implying a nearly one-in-three attrition rate. Wouldn’t it be instructive to see the “alternative fact” of the 2017 performance statistics for the 1987 Am Law 100 firms? That would be cause for even inquisitive analysts to celebrate.
Meet the author
Bruce MacEwen is president of Adam Smith, Esq. (AdamSmithEsq.com), lawyer and consultant to law ﬁrms on strategic and economic issues. MacEwen has written for or been quoted in: the New York Times; the Wall Street Journal; Fortune, Bloomberg; the American Lawyer and other publications. He is a sought-after speaker and frequently appears at law ﬁrm retreats and legal industry conferences around the world.