The world’s most successful law firms are profitable because they deliver superior value to clients. But what drives value in service delivery? Looking to the data, a key factor is a law firm’s racial and ethnic diversity.
Admittedly, racial and ethnic diversity in this context is a proxy for a firm’s cultural and behavioral correlates. Yet, broadly defined, legal diversity is powerful — diverse legal teams produce significantly better outcomes for clients.
In this article, we want to build the business case for legal diversity by analyzing the empirical foundations of a law firm’s profitability, confirming that firms with higher racial and ethnic diversity also earn higher profits. We also want to highlight the diversity and inclusion (D&I) initiatives at two premier law firms, Cleary Gottlieb and Shearman & Sterling. These initiatives illuminate the cultures and behaviors that give rise to the diversity-profitability correlation.
Foundation of Law Firm Profitability
Empirical researchers derive “appropriate comparisons” to identify drivers of key outcomes. Such comparisons are valuable because they isolate the importance of a given factor under “all else equal” conditions. For example, they let us compare profit margins for firms with many similar characteristics, such as attorney head counts, geographic footprints, etc., but different legal diversity profiles. In turn, we gain confidence that any observed difference in the outcome (profitability) exists because of the isolated factor (in this case, diversity).
Through a multi-year study of law firm profitability, I developed a statistical model that produces the needed appropriate comparisons. The model’s performance is excellent. It explains almost 90% of the variation in profitability across the 200 US-based firms with the largest gross revenue (the Am Law 200).
The analysis combines three years of partner compensation data (FY2015, FY2016 and FY2017) with data on potential profit “differentiators” — factors that make some firms more profitable than others. The list of differentiators includes attorney head counts, demographics and leverage; a prestige score (from Vault); partner head counts for 13 unique practice areas; distinctiveness ratings in three financial services practices; three concentration metrics: i) client-industry, ii) practice area and iii) geography; and a firm-specific effect to accommodate unique (unmeasured) characteristics.
The statistical approach isolates the importance of a specific firm factor; at the same time, it accounts for a range of other factors, some of which also make some firms more profitable than others. Figure 1 reports the subset of differentiators that are statistically meaningful. Each dot reflects a factor’s relationship to profitability — specifically, the difference in average partner compensation between a firm with a high versus an average factor value, and all else equal. Lines through the dots represent uncertainty; since none intersect with the average profitability baseline, we can say the factors in Figure 1 are “statistically significant.”
For present purposes our factor of interest is racial and ethnic diversity — specifically, the percentage share of attorneys with diverse racial and ethnic backgrounds at each firm. Figure 1 shows that this factor’s dot is to the right of the average baseline. What does this mean? Put simply, firms with high racial and ethnic diversity are more profitable than firms with low racial and ethnic diversity.
Thus, at diverse firms, partners take home significantly more money. The predictive visualizations in Figure 2 summarize the difference. The orange curve reflects the model-derived profitability differences for firms with low versus average diversity, and all else equal. The green curve reflects the differences for firms with high versus average diversity. The diversity “dividend” is the difference between the orange and green distributions. Summarizing this difference using the median values (arrow end points), the gap between low- and high-diversity firms approaches $180,000 per partner each year.
This diversity-profitability result is robust to alternative statistical approaches and to analytics that explicitly test for a causal relationship. Yet, without substantive information, this result only gets us so far. If you are like me, you are now wondering why. Why does higher diversity imply higher profitability? In what ways does legal diversity promote exceptional client service?
Why Diversity Drives Client Value
In search of answers, we identified the most profitable Am Law firms that also have top-tier legal diversity numbers. Two such firms, Cleary Gottlieb and Shearman & Sterling, graciously shared information about components of their D&I initiatives. (See the two boxes below that describe these components at the two firms and how they focus on the cultural and behavioral factors that are instrumental to delivering high-value client service.)
Broadcasting the Business Case
Clearly, there is a business case to be made for increasing diverse representation in the legal profession. Firms that staff diverse teams receive more money, and clients relying on these diverse teams experience better legal outcomes. This is the epitome of a win-win scenario. As such, it warrants the attention of every legal department leader and every law firm partner looking to sustain their books of business in a tight legal market.
In the narrative accounts for Cleary Gottlieb and Shearman & Sterling, we see both reasons why these firms profit from D&I initiatives, and how other firms might replicate certain aspects of their culture and behaviors. For Cleary, collecting objective information about attorney utilization in structured settings ensures that its staffing assignments reflect the firm’s diversity demographics. Although the task of reviewing team compositions is itself straightforward, Cleary’s culture of openness regarding the underlying need for such an effort is what makes the review and staffing process effective. For Shearman, a willingness to introduce an innovative interview protocol brought about unexpected returns. These included increased awareness about asymmetric decision making and increased confidence that, at Shearman, decisions are now made under a system that mitigates these asymmetries.
To be sure, the legal profession remains one of the least diverse professions. The challenge of moving the needle rests in part on creating sufficient momentum on a broad enough scale to drive meaningful change. This is not an easy task in large law firms where decision making is diffuse, and incentives fall squarely on maximizing work-related production. The hope is that drawing attention to the business imperative gives further impetus to the profession’s long-standing and laudable moral motivations.