Transactional lawyers have been variously described as transaction-cost engineers, reputational intermediaries, and regulatory experts. In Law Firm Selection and the Value of Transactional Lawyering, I argue that, within elite law firms, transactional lawyers also serve to aggregate market information. Law firms with high-volume transactional practices acquire private information about the set of value-increasing deal terms for certain transaction types and the pricing of those terms. Repeat-player law firms can thus help their clients value such terms more accurately, giving them a significant bargaining advantage in deal negotiations.
This informational role played by elite law firms arises as follows. Although many corporate transactions become standardized and even commoditized over time, others (such as mergers and acquisitions and leveraged financings) are heavily negotiated and tailored. Such transactions are characterized by the constant development of new terms, rapid shifts in the market “price” of individual deal terms, or both. Yet these terms are often not publicly accessible, at least for some period of time. For a given deal, then, the final set of negotiated terms will be determined by a combination of market forces and bargaining under incomplete information, and will thus be heavily affected by the parties’ respective information in the bargaining stages. To maximize its payoff from this type of transaction, a party should be aware of any novel, value-increasing terms, and should know both the expected payoff of each term to each party and the value of the parties’ respective outside options. For transactions with rapidly changing terms, a necessary (though by no means sufficient) condition to acquiring that information is real-time access to the terms of a significant volume of recent comparable transactions.
The most obvious means for parties to obtain this information is through law firms that routinely engage in the type of transaction at issue. Elite law firms retain a virtual monopoly over the complete deal terms for such transactions, because they are repeat players across a range of different clients and, unlike other transaction participants, they negotiate and draft the full panoply of transaction terms, from signing to closing and potentially beyond (through disputes, renegotiation, and resolution). While third-party data providers have made substantial inroads in aggregating and comparing corporate deal terms, they are largely confined to reviewing publicly available agreements ex post. Law firms’ market knowledge provides clients with a valuable bargaining advantage in deal negotiations, which should lead to more favorable deal terms. If high-volume firms can credibly convey the benefits of their market knowledge to clients, they should attract a still greater volume of transactions. Their access to market information thus becomes a self-perpetuating advantage.
In turn, law firms’ market information provides at least a partial explanation for several puzzling features of the contemporary law-firm landscape. First, many observers have predicted the eventual decline of the “Big Law” model of U.S. law firms, due to the commoditization of legal work, increased competition from in-house counsel, the decline of relationship lawyering, and law firms’ inability or unwillingness to lower their fees, among other ills. At the same time, however, the small set of firms with the most elite (and expensive) transactional practices are thriving and pulling further ahead, creating a widening gulf within Big Law. What accounts for the widening inequality among law firms? The most plausible explanation is that the top-ranked firms provide clients with one or more valuable benefits that lower-ranked firms cannot. I argue that the top transactional firms serve a unique market function – aggregating market information – that allows clients to better price transaction terms. This pricing function – traditionally thought to be limited to investment banks – is one that cannot be replicated or subsumed by in-house counsel, other service providers, or commoditized contracts. There is thus cause for optimism about the future of elite firms – that is, firms that compile market information for the very largest transactions by dollar value. There should always be some subset of transactions that resists commodification, and law firms with a significant market share of such transactions should always retain their private market knowledge of such transactions as a crucial advantage over their in-house counterparts.
Law firms’ market information helps explain another puzzle – that of the ever-expanding corporate law firm. Various theories have been advanced to explain the increasing prevalence of the mega-law firm. While each of these no doubt provides a partial explanation, under the market-knowledge hypothesis, larger firms also reflect the self-perpetuating informational advantage derived from greater deal volume.
Finally, the hypothesis that elite firms (effectively) sell market information challenges fundamental and longstanding assumptions about the law firm/client relationship. The rules of professional responsibility for lawyers zealously endorse the confidentiality of client information. Yet, in practice, clients are paying for law firms’ ability to pool transactional information across clients and to make use of it in negotiations. They are, in effect, merely purchasing information from law firms, which in turn are merely engaged in the increasingly ubiquitous practice of knowledge management. Yet this form of knowledge management should continue to generate above-market rents for elite firms, which have better (and sometimes exclusive) access to the underlying information relative to other market participants.
The preceding post comes to us from Elisabeth de Fontenay, Associate Professor at Duke University School of Law. It is based on her article, “Law Firm Selection and the Value of Transactional Lawyering,” which is available here.