I have learned a new mechanism to explain the organization of knowledge-based, client-intensive partnerships:
From the property rights perspective, large law firms are poorly suited to sustaining employment relationships because they have no enforceable means of controlling the firm’s key knowledge asset–client relationships. The up-or-out partnership systems that have evolved over time in these firms offer an awkward but workable resolution to this problem. By restricting partnership size to maximize surplus per partner and by making senior attorneys residual claimants, law firms limit the opportunity for sub-groups of partners to grab and leave with the firm’s clients. This action, however, creates additional demand for inexperienced associates who serve as (imperfect) substitutes for their more experienced counterparts. The result is that more associates are hired than can be promoted into a stable partnership. Those associates who do not succeed outgoing partners will be dismissed before they acquire sufficient client knowledge to themselves pose a threat of grabbing and leaving. That law firms find it worthwhile to commit to the costly practice of firing qualified attorneys in order to retain control over client relationships points to the general importance of control over assets in more conventional employment relationships.
The property rights model, in contrast to other explanations, can explain the coincidence of up-or-out promotion rules and partnerships in large law firms. At the root of our model is the claim that law firms cannot rely upon legal mechanisms to establish control over client relationships. We demonstrate that this is, in fact, the case under U.S. law. In addition, the property rights model suggests two propositions that are supported by the available historical, institutional and econometric evidence: (1) up-or-out appeared first in large corporate law firms who specialized in delivering large scale, complex legal services to valuable, long-term clients, and (2) large law firms practice a style of law that limits contact between associates and clients. Finally, the property rights model can account for the otherwise anomalous absence of up-or-out personnel policies in government agencies and large corporate litigation departments [TC: I like this latter point].