Why Law Firms Collapse
42 Pages Posted: 20 Mar 2015 Last revised: 1 Apr 2015
Date Written: March 11, 2015
Law firms don’t just go bankrupt – they collapse. Like Dewey & LeBoeuf and Bingham McCutchen, law firms often go from apparent health to liquidation in a matter of months or even days and they never manage to reorganize their debts in bankruptcy and survive. This pattern is puzzling, especially because it is strangely out of proportion to law firms’ actual financial distress. Most collapsed firms have remained profitable up through the days they dissolved. Drawing on an informal review of every large law firm collapse in the last thirty years, I look for an explanation in law firms’ organizational structures. Law firms are fragile because they are vulnerable to partner runs: When one partner withdraws, she damages the firm, causing still other partners to withdraw, which further damages the firm, and so on. These runs gather momentum from several aspects of law firm structure. The main one is that law firms are owned by their partners, rather than by investors. Partner ownership forces partners into a race for the exits, because it promises brutal financial punishment to partners who stay. As owners, partners directly suffer the decline in profits caused by other partners’ withdrawals and they face extensive personal liability if they stay until their firms dissolve. These forces naturally make a firm’s partners more likely to leave once others have already left. This structure-based theory offers many insights. It tells us that law firms can often collapse inefficiently. It also tells us which firms are most vulnerable and how we can stop them from falling apart.
Keywords: Law firms, partnership, bank runs, organization
JEL Classification: G33, K22
Suggested Citation: Suggested Citation