An Rx for Lateral Headache

Imagine visiting a doctor for physical, mental and emotional symptoms that suggest your health is on the decline. Your case is serious and complex, and your doctor and medical team eventually reach a diagnosis worthy of a write-up in a leading medical journal. You are interested in the diagnosis, of course. But what you really want to know is whether there's a cure.

Lateral partner hiring among large law firms is a lot like an ailing patient. We say this having explored more than 30,000 lateral partner moves over a 12-year period. And we're ready to offer prescriptive advice-a real cure for the dysfunctional lateral market.

But first let us recap our test results and diagnosis, which we detailed in earlier issues of The American Lawyer. Just as patients achieve better health outcomes when they understand the medical bases for their treatment, you need to know what's afflicting Big Law concerning lateral hiring so your firm can get well.

Hey, you don't look so good

We have uncovered zero statistical evidence that an aggressive lateral partner hiring strategy in and of itself is associated with greater law firm profitability. If the goal is higher profits relative to peer firms, or even higher revenue per lawyer, a lateral partner hiring strategy based on volume is not working.

An aggressive lateral partner strategy, when it's coupled with an effective vetting and integration process, can increase profitability. Problem is, the typical vetting or integration process is not effective. If it were, higher lateral volume would lead to better firm-level results.

That said, an aggressive lateral partner hiring strategy is significantly correlated with one market outcome: higher gross revenues. This is a very important piece of clinical information. We think law firm managers engage in lateral partner hiring (or acquiesce to the lateral partner hiring urged by powerful partners) because they feel they have to. Such partners came of age during a period of rapid industry growth. Growth feels good. Yet for several years it has been largely absent in most firms. For equity partners who bill 2,000-plus hours per year on client matters, luring Joe or Jennifer from rival firm X is a one-step growth strategy they can easily understand, especially if the clients are brand-name and the portable book is believed to be large. For firm leaders, one way to keep the peace is not to interfere with this logic.

An addiction that can turn deadly

Stated another way, unfocused lateral partner hiring is akin to an addiction that masks more serious physical problems. The addiction can be lethal when combined with large guaranteed contracts and substantial lines of credit (see Dewey & LeBoeuf, Bingham McCutchen, etc.). Yet, it can also be just enough of a palliative to enable senior partners to get to retirement without having to adapt to the New Normal. "My phone still rings. I can feed myself and others. Hire more people like me, but otherwise leave me alone and let me keep more of the money I generate."

Partners in their thirties and forties are more likely to understand the unsustainable nature of the traditional law firm business model, as they are trying to build their own practices while being hamstrung by high rates and nothing unique to sell. From their perspective, the senior lawyers who control the firm seem to have their heads in the sand. Yet the firms themselves have become too large for any partners to stage a successful intervention.

Consider that only 28 percent of managing partners believe that lateral hiring has been effective at their firm, yet 96 percent of firms have made lateral partner hiring a key part of their strategic plan, according to an ALM Legal Intelligence Report (October 2012). That is a remarkable disconnect that suggests that the underlying malady is, at least in part, psychological.

We believe the biggest source of error in the lateral hiring process involves a form of motivated reasoning, or emotion-based decision making, that works like this: The mind has a tendency to lock into conclusions relatively quickly. We use our mental processes to look for evidence that supports our views, while evidence that would undermine those views is discounted or ignored. Psychologists refer to this phenomenon as confirmation bias.

In law firms, confirmation bias can be both a source of competitive advantage and the seed of organizational self-destruction. A lawyer's craft is actually the antithesis of the scientific method, and the intellectual processes by which lawyers earn their living exactly mimic a fundamental source of human cognitive bias. Scientists reason forward from evidence, while lawyers reason backward from desired conclusions or results. The former can produce breakthroughs that reduce disease and famine. But the latter tends to pay better, especially as a partner in a successful firm.

Confirmation bias is among the most widespread cognitive biases that produce systematic, predictable errors in judgment. According to Daniel Kahneman, a psychologist who won the Nobel Prize for his contributions to behavioral economics, such mistakes persist because our minds have a tendency to formulate coherent stories around our limited (and often unrepresentative) experiences. This is true even for highly intelligent people. Why? Because their inventive minds and large working memories enable them to spin more vivid, plausible narratives. Many could make better judgments if they took the time to gather more data, or better data. But the trappings of professional success incentivize them to skip these more humble, time-consuming steps.

Does this sound like any lawyer you know? In our experience, large, successful law firms are rife with this mindset.

You're doing what?!

Lateral partner hiring works poorly at most firms because they follow an invalid process. They don't realize it, however, because each selection decision is based on reasons that sound compelling. That is what Kahneman refers to as the "illusion of validity." Perhaps ironically, the seeds of a solution lie in a fundamental concept of legal practice: the notion of due diligence.

One of the most on-point examples can be drawn from Kahneman's experience in the Israeli army in the 1950s, which he describes in his 2011 book, "Thinking Fast and Slow." Kahneman was given the task of evaluating candidates for officer training. Up to that time, the primary evaluation method was the "leaderless group challenge," which required a group of soldiers, stripped of their insignia of rank and strangers to each other, to navigate an obstacle course as a group.

Evaluators watched as some soldiers managed to take charge. Evidence of cooperation was noted, as were contributions to group success. Attributes such as stubbornness, submissiveness, arrogance, persistence and vindictiveness could also be directly observed. "Under the stress of the event," writes Kahneman, "we felt [that] each man's true nature revealed itself. Our impression of each candidate's character was as direct and compelling as the color of the sky."

But there was actually no correlation between the recommendations and subsequent actual performance, thus revealing the process to be invalid. This knowledge had remarkably little effect on the evaluators, who continued to make confident recommendations on the basis of a selection process that was repeatedly shown to be invalid.

Kahneman believed that algorithms based on objectively collected data were better behavior predictors. So he devised a series of questions for eliciting relevant, historically based information. Rather than probing how soldiers' minds worked, Kahneman focused on examples of past behavior.

He then introduced the new process to his team of evaluators. They were told, "Your function is to provide reliable measurements. Leave the predictive validity to me." The interviewers came close to mutiny. So he compromised and said, "Carry out the interviews exactly as instructed, and when you are done, have your wish: Close your eyes, try to imagine the recruit as a soldier, and assign him a score on a scale of 1 to 5."

Much to Kahneman's delight, the new system proved to be a valid and reliable method for predicting future performance. Yet what surprised him the most was that the "close your eyes" exercise did just as well as the combined score of the six objective scales. His takeaway: Intuitions can be tamed and made useful-but only after a disciplined collection of objective information and disciplined scoring of each separate trait. These are the hallmarks of a valid process.

A bitter pill

Yet valid processes have been tough to swallow. That's thanks mainly to hostility to the notion that mathematical equations can outperform the dedicated, sincere and nuanced judgments of experts, Kahneman says. This is slowly changing, though, as predictive analytics becomes the cornerstone of competitive advantage in various industries.

Perhaps the best contemporary parallel to the lateral partner conundrum is the evaluation of managerial talent by venture capital and private equity firms. As most fund managers will concede, the most reliable predictor of a positive financial return is the quality of the management team of the companies in which they invest. It is now a common industry practice to evaluate the skills and competence of managers using a rigorous, standardized process. If the resulting scores are too low, the deal is killed.

One of the best-known companies in the "human capital evaluation" space is ghSmart, a large Chicago-based professional services firm composed mainly of psychologists and MBAs. It was founded in the mid-1990s by Geoff Smart, who was at the time earning his Ph.D. in psychology. His dissertation modeled the financial returns of venture capital firms, based on the type of human capital due diligence used by each fund.

The most common due diligence method was what Smart termed the "art critic" approach, which relied upon gut feel and intuition. Yet the strongest returns went to fund managers who utilized "airline captain" methods: those based on their similarity to the methodical, exhaustive checklists used by pilots. According to the funds' internal rates of return, "airline captains" outperformed "art critics" by a factor of three. Smart's company has gone on to be the subject of two Harvard Business School case studies, and its clients include the Blackstone Group, Bain Capital, KKR, Goldman Sachs and the Citadel Investment Group.

The doctor's orders

Law firms, too, can use a valid process to more effectively select successful lateral partners. Yet such a maneuver requires law partners to acknowledge the limits of their vivid, overconfident, outcome-driven reasoning powers and subordinate themselves to a structured process that gathers and analyzes truly reliable and relevant data. Our prescription for improving lateral hiring has seven steps:

1. Assess the laterals you already have. Categorize and quantify lateral partner success and failure. The metrics that come most readily to mind are financial, though a law firm would do well to score cultural costs and benefits of each lateral hire, such as how they treat staff, help train junior lawyers or accept (or buck) firm norms. The law firm should also allocate a reasonable estimate for the management and staff time and effort that specific lateral partners have consumed because of performance, personality or ethical issues, as this energy could have been redirected to activities of higher value. This is an exercise in cost accounting, one that requires someone with the skill and objectivity to do it right.

Law firms that fail to take this step deny themselves an important tool, because many partners will react with skepticism to the steps that follow. Presenting them with objective evidence of the firm's lateral partner track record, and making them more accountable for their input into the lateral partner process, is the only effective counterweight.

In one Am Law 100 law firm, the new CFO did a preliminary analysis of the firm's lateral partner "hit rate" and concluded that four out of five were financial failures. In another Am Law 200 firm, a statistical analysis of lateral hiring was conducted as a first step to improving the process. After management reviewed its own performance, the firm's lateral hiring ground to a halt.

The final reason to quantify the lateral partner problem is that it provides the baseline information for the measurements described in the next steps.

2. Educate the stakeholders. This is the most likely point at which any effort to improve lateral hiring will fail. It requires at a minimum that relevant partners, members of management and others be informed of the move toward a valid process for lateral hiring, and of the basis for that decision. The hope here is that law firm partners will relinquish control over an invalid hiring process when confronted with the firm's unacceptably poor track record of lateral partner hiring, and the mountains of studies documenting how very bright people are highly susceptible to cognitive biases.

On the basis of our experience presenting data to lawyers, we are skeptical that this step will be successful in most cases. Firms incentivize revenue production, and many high-performing partners are loath to invest a lot of time to listen to what is likely to be perceived as "academic mumbo jumbo." They are, after all, overconfident, an attribute that tends to be rewarded by the firm's clients. If you forward them this article, many will not take the time to read it. But conversely, if firm managers try to tinker with the lateral partner hiring process in a manner that these partners fail to understand or agree with, the resulting outrage and indignation is potentially limitless, and will likely derail the entire process. This is quite a conundrum.

Successfully educating stakeholders is primarily a test of a firm's leaders. It will happen only if the firm's leadership makes it a priority.

3. Evaluate why laterals would want to join your firm. Hiring a lateral partner is, functionally, a business combination with a six- or seven-figure price tag. The only such deals that make sound business sense are those that are highly likely to enhance the firm's future enterprise value. This occurs most often when the lateral partner's assets-industry expertise, practice area expertise, client base, or reputation-fill voids or leverage strengths at the firm. A firm that engages in objective strategic planning can readily identify the relatively few situations where both the firm and the lateral partner are likely to benefit. The firm's leadership should write out those business conditions on a single sheet of paper.

Lateral hires can change law firms for many reasons, but only a small subset of those provide a basis for a favorable business combination. For example, does the partner have clients that better align with the new firm's industry focus? Require more specialized services lacking at the current firm? Need assistance in foreign markets that the new firm's geographic platform can provide? Need the new firm's rate structure, innovative flat fees or advanced use of process and technology? All of these are good stories, but for the new firm to benefit, the stories need to be true.

4. Build lateral partner scorecards. Steps four through six are the core of the prescription, representing the most significant changes to the process of lateral hiring at most firms. Think of these steps as similar to the routine due diligence many attorneys perform for their clients every day: the execution of an agreed-upon set of reasonable procedures, designed to ensure that high-quality information relevant to the decision at hand is gathered and that negative outcomes are foreseen and avoided.

The scorecard is a measurement tool used to evaluate two broad sets of criteria: business logic (Are the factors that comprise a favorable combination truly present?) and the skills and attributes of a high-quality lawyer. The scorecard itself mimics the airline pilots' checklists. Moreover, it requires decision makers to undertake "a disciplined collection of objective information and disciplined scoring of each separate trait," to quote Kahnemann, thus overcoming subjective biases that would otherwise derail the process.

Creating a high-quality scorecard also requires someone with patience and objectivity to develop and ask a set of structured questions to domain experts-the highly successful lawyers within your own firm-who are willing to share their time and expertise. The answers to those questions then form the basis for the firm's lateral partner scorecard. In our experience, some scorecard attributes are global across all legal service organizations, while others are specific to particular legal roles (such as a technical specialist or practice group leader), and still others are cultural and thus peculiar to the firm itself.

5. Design the interview process. This requires answers to two related questions: What is the structure of the interview? And who will conduct the interview?

With respect to the format, the key point is that the interview must be organized around the scorecard, and focused on the candidate's career history and motivations for making a lateral move. This structure permits a candidate to tell his or her story in a coherent, chronological manner and enables valid comparisons across multiple candidates. Questions should be retrospective, and designed to elicit narratives of specific examples of behavior that inform the attributes in question. The central consideration here is not so much the wording of the specific questions as the quality of information elicited.

We recommend that the interviews be conducted by personnel who can set aside their own existing preferences and faithfully follow the scoring process. For example, in choosing between two groups of partners, one group composed of good listeners with no particular preconceptions about lateral hiring and another group with strong preexisting views, choose the former. In this context, lawyers' (profitable) skill in motivated reasoning is an enemy, not a friend.

The interview process must be insulated from internal political pressures. One structural way to solve this problem is to hire independent outsiders to conduct the due diligence interview; they are removed from internal politics, and in fact have every incentive to produce reports that will be seen as valid one, two or three years into the future. This is the standard practice in the private equity industry.

A second option is to delegate the task to an internal panel that makes a written group recommendation based on the lateral partner scorecard. The structure and thoroughness of this process makes it much more difficult to second-guess, though don't be naive enough to believe it won't happen. The panel format, however, will reduce political backlash from partners who believe they possess a unique radar for locating lateral talent.

In our experience, firms often worry that an in-demand lateral candidate will be put off by a rigorous due diligence process that digs deep for information. Some lateral candidates might, but those are unlikely to include the handful of partners where the business logic for the move is compelling. More often, they will be impressed and grateful. Why would the best attorneys-the most able, with great clients they care deeply about-auction themselves for the highest short-term pay package when they can make more money over the long term by moving to a firm with complementary assets and a clear strategic vision? Firms ought only to want candidates who can see this logic on their own and are eager to discuss it; the rest of the lateral market is composed of lemons you are trying to avoid.

6. Interview laterals using the due diligence process. After all the preparatory work, this is the shortest step. Remember to retain all records related to the interview process. You will need them for the next step. And watch out for these warning signs of a potentially bad lateral hire.

7. Evaluate the effectiveness of the hiring process. The core question is whether the "cure" was the worth the high price of the "treatment." This is an empirical question that can be evaluated with data, the baseline information for which is provided by step one.

One way to calculate the effect of the new approach is to compare the performance of new lateral partners during their first, say, 24 months at the firm against partners of a similar age, experience and practice area. If the system is working, the average performance of the new laterals should be much higher. And through sound accounting and statistical methods, those benefits can be quantified in real dollars.

For cultural and political reasons, many firms would prefer to pilot-test any new approach to lateral hiring before adopting it firmwide. One of the main advantages of doing so is that it permits the firm to use a controlled experiment to assess the efficacy of the new method. The existing method (the control group) is operated in parallel with a new method (the treatment group). The key factor is that the control and treatment groups need to be as similar as possible; this is most effectively accomplished by selecting the two groups randomly. At the end of the clinical trial period, the outcomes of the two groups are compared, and the benefits assessed. In empirical scientific research, this approach is the gold standard; it is how scientists determine the efficacy of new drugs, governments assess the effect of public health campaigns and businesses measure the impact of their marketing efforts. Lawyers who would argue against such an approach have become unmoored from the most fundamental principles of the physical and social sciences.

We have spent thousands of hours trying to unravel the mysterious logic of the large-firm lateral partner market. Evidence suggests that a key component of that puzzle is lawyer exceptionalism: a belief among lawyers that other disciplines and industries have nothing to teach them. We disagree. The process above represents our best prescriptive advice for fixing lateral partner hiring. We expect to hear myriad rationalizations for why they won't work; we are under no illusion that everyone will follow them. The question is, will you and your firm.

Source: The American Lawyer.