The Real Lessons of the Dewey & LeBoeuf Collapse

By Mike Dorf

A few weeks ago, the New Yorker ran an article by James Stewart describing the collapse of the Dewey & Leboeuf law firm.  (The article begins here but the rest of it is behind a pay wall.)  The timing of the story is a bit odd, coming well over a year after D&L filed for bankruptcy, but the substance is in some ways even odder. Much of it focuses on the connections of the family of a former D&L lawyer/manager to the mafia, even though there is no evidence whatsoever that he himself had ever been involved in any mob activity.  Nor is there a suggestion in the article that any of the family connections had anything to do with the firm's collapse.

So what led to the firm's demise?  Stewart correctly points to the use of debt to guarantee large annual pay for star lawyers, many of them lured to D&L or to the pre-merger firm of LeBoeuf, Lamb, Greene & MacRae through the promise of such packages.  When the firm's earnings were insufficient to meet its obligations to the high-earning partners and others, it went under.

Stated that way, the story sounds very much like any of a number of garden-variety personal and business insolvencies.  Overly optimistic about prospects, a firm or family takes on too much debt, and then when events take a turn for the worse (a global financial crisis causes a recession or the family breadwinner gets laid off from what had seemed a secure job), there is insufficient revenue to meet obligations.  Nothing special here, right?

Well, maybe.  In the New Yorker article, Stewart also points to a different phenomenon.  He notes that whereas most of the top NY firms had traditionally compensated their lawyers according to a "lockstep" formula, LeBoeuf and the post-merger D&L used an "eat what you kill" approach, and that the latter undermined the sense of shared mission and firm loyalty at the post-merger firm.

I agree with the general proposition that, other things being equal, lockstep compensation is better for an institution than so-called performance-based pay.  Lockstep systems encourage esprit de corps and teamwork, while discouraging people from regarding their co-workers jealously or focusing overly on money rather than the job itself.  But performance-based pay works better in contexts in which a culture of complacency has arisen and even apart from that, may be unavoidable in a market in which there is intense competition for top performers.

Moreover, there are examples of enterprises functioning cohesively despite wide pay disparities.  Consider the two-time defending NBA champion Miami Heat.  Their three star players--Lebron James, Dwyane Wade and Chris Bosh--each earn about $19 million in annual salary, while most of the role players earn less than a fifth of that.  Yet there is every reason to think that the role players are fully committed to the enterprise.  Indeed, were it not for Ray Allen's buzzer-beating three-pointer in game 6 of the NBA Finals earlier this year, the Heat would not be league champions.  Does Allen resent the fact that James, Wade and Bosh earn much more than he does?  Perhaps a little bit, but Allen is still paid extremely well by the standards of regular people and winning a championship is itself a kind of compensation.

One may be able to say the same thing about law firms.  For many years, I worked as an occasional consultant for Dewey Ballantine, getting paid at an hourly rate.  For a year after the merger, I was "Special Counsel" to D&L, working with the same group of first-rate litigators from Dewey, now sometimes supplemented by excellent lawyers who had come from LeBoeuf.  (None of the lawyers with whom I worked directly is mentioned in the New Yorker article.)  I was paid well and the work was always interesting, sometimes fascinating.  I had no idea how much money the full-time lawyers were earning and whether I was "underpaid" relative to them.  Perhaps that reflects my own preferences, but it seemed true of the full-time lawyers with whom I worked as well, not all of whom were rainmakers.  Before the post-recession post-merger firm began firing associates and partners, the performance-based compensation did not appear to undermine morale.  Again, other things being equal, I think that lockstep compensation systems are generally superior to performance-based compensation, but performance-based compensation can work too.

The real story here, therefore, is much less about lockstep versus performance-based compensation than it is about the shortsightedness of guaranteeing multimillion dollar payouts to partners, even when revenue falls off.  That approach was "performance based" in the sense that it rewarded stars based on past performance, but any sensible compensation formula ought to take account of revenues. If we were to search for a sports analogy, the bloated contracts of Alex Rodriguez or Albert Pujols seem much closer  to the D&L guarantees than do the Miami Heat contracts.  Indeed, the Yankees overpaying ARod and the Angels overpaying Pujols are less egregious than what LeBoeuf and then D&L did in borrowing money to guarantee the payouts to star lawyers.  Having to carry the salary of ARod or Pujols undermines the on-field success of the Yankees or the Angles because it ties up money that could be spent on cheaper players who are not past their prime. But at least it doesn't bankrupt the team.