Wednesday, August 13, 2008

Free Agency, Faculties, Law Firms, and Businesses: A Comment for Bill Henderson

Posted by Jeff Lipshaw

Bill Henderson cross-posted his usual massively insightful and deftly written analysis on "faculty free agency" over at ELS, and I posted an equally long comment over there.  I repeat here some thoughts on the problem and the solutions (slightly edited).

1. I'm not sure that law firms are going to give us a better model for structuring faculty incentives for the following reasons. The real question is whether the institution created by the people involved in the institution is greater than the sum of the parts. The underlying assumption in Bill's analysis is that cooperation and coordination indeed do create value that none of the individuals alone can create. What we have is something of a Prisoner's Dilemma game: individual incentives suggest that law professors AND law partners maximize for themselves, but institutions (and perhaps the professors or partners themselves) would be better off if they cooperated. As we know, one way out of the Prisoner's Dilemma is repeat play until the participants learn to trust each other NOT to maximize individually.

2. For precisely the reasons Bill cites (the incommensurability of teaching and service), it is very difficult to demonstrate a payoff to professors that warrants cooperation even after repeat plays of the game. Law firms are a little better, but my intuition, based on long experience, is that the payoffs of cooperation are almost as difficult to perceive for the partners. My theory is that it's because, indeed, it really is very hard to build any such value. The brand "Skadden" or "Weil Gotshal" is so hard to build, and once built, so independent of the contribution of any single partner (collective action problem at work?), that it just doesn't take us anywhere.

3. In my experience (and intuition), complex business models will actually take us farther in terms of the analysis of the ideal cooperation. I don't want to confuse this analytically with the corporate model of organization, as my co-author Larry Ribstein would insist (see Ribstein & Lipshaw, Unincorporated Business Associations, 4th ed., coming to a bookstore near you in 2009), but let's use the model for ease of explanation. There's no doubt in the corporation, we are building a value proposition greater than the sum of the inputs, physical and human capital together, that expresses itself in a measurable output that integrates ALL of the inputs (contra law school for the reasons you point out). That is, the market value of the enterprise not only exists but is measured every day in terms of a share price (and if the corporation is public, you can actually see it change minute by minute!). Whether or not the systems actually work (I don't want to argue the CEO compensation issue here), the goal is to align the interests of the individuals in the organization with that unified measurement of value, and usually by tying compensation to increases in that value.

4. Compensation within a multi-divisional public company is an iterative process of balancing individual initiative with cooperative goals. It's really tough to get right. I don't think you do it by long-term contracts (there's an involuntary servitude aspect to this I'd want to think through). Compensation is the carrot; I think your idea of a contract is the stick. You can encourage cooperation by incentives - tying compensation to sticking around, for example, by vesting it over a period of time - but you still have the problem of the individual versus the collective. If you tie the compensation entirely to the group output, you run the risk of having your stars leave if they are performing but the rest of the company sucks. If you tie it to individual performance, and not the collective output, you get precisely the cooperation issue we are discussing.

My reaction generally was that, even in the corporation, algorithmic solutions did not work. You needed a spirit of cooperation that preceded the compensation, or individuals would nevertheless figure out a way of skewing things to favor their own interests over the collective. Despite all the best HR theory, we still had to deal with the "wooden nickel" problem by means of leadership, not analysis. What do I mean? Take corporate overhead allocations. Business unit leaders hated them because they were a cost to the business they could not control, and cost them money in terms of their own compensation. My position (as GC and hence one of those cost centers) was that focusing on reducing the cost was adding value, but that merely arguing the allocation was not. That is to say, trading costs between units in terms of allocation was merely trading wooden nickels.

To conclude, I have some skepticism over the possibility of a rule-based solution to the problem - rule based in the sense of writing a contract to deal with it or rule based in the sense of developing compensation algorithms. To continue on a theme that I hope is apparent in my writing, the solutions here have to do with something like leadership, and that has a way of not being reducible to rule-following.

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You are over-complicating the analysis. My proposal is simply to come up with an initiative that will add value for students and the institution--e.g., creating skills, building relationship, solving real world problems, etc. Perhaps this is what you mean by "leadership." The administration makes a value proposition to the academic with the idea--"if you agree to build it here, I will supply you with the time and resources to accomplishment it. But you cannot leave for X years. If you do, then there may be some repayment and definitely some reputational harm." ["Involuntarily servitude"? You have got to be kidding! This is contracting 101. It is called win-win.]

Unlike scholarship, the work product thereby produced is not very portable--it is school-specific capital. The intellectual and psychic payoffs a) draw others to the schools, and b) beget more resources because the "school" has proven that it can accomplish something great.

I do not need to be abstract about these ideas. At Case, Andy Morriss built a fabulous course that made contact with all the Cleveland practitioners who has expertise in Cayman Island financing and weaved them into his Cayman Island finance course. He also made contacts in Cayman and flew his course down there for one week a year so that students could meet personally all the relevant players. Students claimed it was the most amazing experiences of their law school careers. Jobs were offered, careers where launched. Now at Illinois, Andy repeated the course (with Chicago practitioners) and added an course on China-ventures that are set up and financed from Hong Kong. Once again, students were blown away by the knowledge, skills, and insights they gained.

In my opinion, Illinois should offer Andy a long-term contract that permits him to accelerate and expand these course offerings. Andy is five years ahead of any competitor and has unique human capital (I guess what you refer to this as leadership). This could be a HUGE competitive advantage for Illinois. Locking Andy in for five years protects both of their respective interests.

Jeff, I realize that lawyers (and especially law professors) run down ideas as impractical. That is our particular skill. But to say that "complex business models" is really what is required for a law school with less than 50 full-time faculty is, well, complete obfuscation. First say (specifically) why the above proposal won't work. And be prepared to eat crow if you get too clever. The "Way Back" machine captures our analysis into perpetuity.

BTW, I never said that law firms are the model. A few law firms manage to generate firm-specific capital. Most don't, for reasons I stated in the original post. We can learn something, however, from a few exceptional firms. Which firms, therefore, is key.

Posted by: Bill Henderson | Aug 13, 2008 12:25:29 PM

Bill, I love your goal of creating a mission beyond self-interest within a faculty. You should get all the credit in the world for raising the issue. The wonderful thing about your idea is this: "an initiative that will add value for students and the institution--e.g., creating skills, building relationship, solving real world problems, etc."

I agree with you that doing something like what Andy does is great accomplishment. The task of leadership is persuading others to see it first as capital, and then to do what we can to make it school-specific.

First, is Andy's admittedly wonderful accomplishment capital? Well, yes, of course, it's capital, but that begs the question of the value of the capital. What is important is that the capital have value in the eyes of the evaluator, and we haven't defined who that is, or how he/she measures the value. Is the evaluator the faculty, the bar, or students? We started with the problem that how they value the school's capital is the subject of some debate. Not to put words in his mouth, but I think Brian Leiter, at one pole, would say that the only thing that really matters to anybody, at the end of the day, are the scholarly bona fides of the faculty. Everything, including the desire of students to attend, derives from that. The closest thing to a unifying value metric we have now is the USNWR ranking, and the "value" aspects to some of its components are hardly reassuring! This is a leadership issue.

As to whether the capital is school (versus professor) specific, will the program continue at Case without Andy? That is where the rubber meets the road in terms of school or person specific capital. What I think you are saying is that the program stands a greater chance of being institutionalized the longer Andy is at a school, the more successors are built into the programming, etc.

So I am still with you that the only way to create school-specific capital is to have evaluators see it as such, and to keep people around long enough to get the programs institutionalized. My point is not to throw cold water on it, but to suggest: (a) doing that is really aspirational (read: difficult but not impossible); (b) the task is difficult (but not impossible) even where, unlike in law schools, there is a unifying metric (that's the only reason for distinguishing a complex business), and (c) in my experience, contracts are not motivators, they merely legalize a more, how shall we say, emotional commitment.

Employment contracts, or personal service contracts, aren't the basis of great accomplishment. I am thinking of the noted Bruce Springsteen case, where he had a contract (I can't remember if it was performing or recording) he wanted out of, and the court ruled he couldn't get out. So he simply didn't perform or record, whichever it was. (That was the basis of my involuntary servitude comment - Springsteen was no longer a volunteer, but the contract called for servitude! So what the other party got was involuntary servitude!) You can perhaps lock Andy Morriss in with a contract - that's the stick. But you can't make him an inspired creator of value with one - that takes a carrot. And my point earlier was that even carrots have their issues!

I truly believe that what inspires people to great performance is a sense of mission, purpose, creation, posterity, whatever, and contracts are the tail of that dog. Cool. Do five year contracts. But do it within an institution marked by inspired and inspiring leadership.

Posted by: Jeff Lipshaw | Aug 13, 2008 2:07:07 PM

I agree.

Regarding metrics, alumni, practicing lawyers, and students light up with Andy's venture. So the payoff is employment for students, good will, willingness of outside constituencies and alumni to fund this endeavor, good will, positive press coverage, possibly a boost (long term ) in USNWR lawyer-judge scores, and credibility when the law school asks for more money for more ambitious programs. It is capital; just not necessarily $$ for buying chaired professors.

And yes, the longer he is there, the more it becomes Illinois and not Andy Morriss.

Posted by: Bill Henderson | Aug 13, 2008 2:40:14 PM

It's really very simple: defined benefit retirement plan.

Posted by: Steve Bainbridge | Aug 15, 2008 11:37:01 AM

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