Why Firms Fail: A Diagnosis of the Death of Dewey LeBoeufBy Burkey Belser
June 28, 2012
It wasn’t the debt. It wasn’t the recession. The demise of Dewey LeBoeuf’s was caused not by a single death blow but by systemic disorder.
A Rosy History
The dissolution of Dewey LeBoeuf is a very big deal: It is the single largest firm in the history of the U.S. to declare bankruptcy. But for many years, the New York behemoth was the picture of financial robustness: one of the big boys of corporate law, with a white shoe pedigree, it had expanded over the last few decades across the globe, opening offices in Beijing, Paris, Abu Dhabi and elsewhere. But, since its merger with LeBoeuf in 2008, the reality was that Dewey was slowly and secretly hemorrhaging. How bad its state of health had become was made clear at a partners’ meeting to discuss the firm’s finances last January. According to Insurance Journal, partners were then informed by Chairman Steven Davis that “of Dewey’s approximately $250 million in net income for 2011, about half was committed to pension obligations to retired partners and compensation that was owed to certain partners for the two prior years”. Partners began defecting en masse, and any last-minute cure through a merger was wiped out when the Manhattan District Attorney began to investigate Davis for wrongdoing.
So, how exactly did a firm that was raking in $900 million just a few years ago wind up dead as a doornail? It came as a complete surprise not only to Joe Public but to many of the partners and associates who worked there.
Symptoms of Ill Health
Much has been made about Dewey’s singular and bewildering compensation packages for star partners, which made the firm top heavy with financial commitments. Add to that an enormous amount of money owed from Dewey’s rapid expansion plans since its merger with LeBoeuf, (Dewey has outstanding bank and bond debt totaling approximately $230 million), and the firm was positioned to topple over when the market crashed (Reuters).
But Dewey’s phenomenal debt grew out of a deeper dysfunctionality, “characterized by a lack of disclosure and controls where an inner circle of partners reaped most of the rewards” (Bruce MacEwen). As Alexandre Montagu, writing in the Huffington Post, observes: “the failure of the firm is not the result of an isolated incident of mismanagement. To be sure, the guaranteed payouts to star partners and the unusually large debt amassed by the firm did precipitate the fall; however, the payouts and the debt were only symptoms of a much deeper structural malaise affecting the entire legal industry.”
Many commentators are now asking if Dewey’s meltdown is just the tip of a big firm iceberg. Greenfield/Belser posed a similar question several years ago. In 2002, our research division, The Brand Research Company, conducted a census of failed firms by speaking with the management of those firms, not the rank and file. We also compared those failed firms with firms whose revenues had increased by 5% or more for two successive years. We learned definitively why some firms succeeded while others went under. Our report, Why Firms Fail, Why Firms Succeed, became a prescription for the success of firms and a warning of their failure. We demonstrated the structural weaknesses that were predictive of collapses like Dewey’s.
We interviewed leadership using a questionnaire that included 140 law firm qualities—everything from collections to values—and looked for correlations. We scored the answers on a 0–10 scale. We found the most telling results by comparing the mean scores of the successful firms to those of the failed firms.
The study showed that failed firms were much more likely to adopt an autocratic style (5.1 vs. 3.0) than successful firms. While democracy is still a greater predictor of success (6.4 vs. 4.9) than autocracy, the most effective management style is consensus-driven (7.9 vs. 5.0). In Dewey’s case, as one observer commented, “if the leadership of the combined firm had placed the interests of the firm ahead of their own interests, this would never have happened” (CNN).
Clearly the key to building consensus is communication. In other words, as partners agree to cede decision-making authority to leadership, leadership must in return keep partners informed and involved. The study results confirm one piece of folk wisdom—lack of communication leads to suspicion; suspicion leads to fear; fear leads to failure. Leaders who communicated a common purpose (7.8 vs. 3.5) and promoted a shared culture (8.6 vs. 4.3) were dramatically more likely to preside over extraordinarily successful firms. A clear road map leads everyone toward a common goal. In Dewey’s case, communication and input, even at the highest levels, was lacking, as many partners and associates were kept in the dark.
The study confirms this principle again and again. For example, 92 percent of successful firms communicated the strategic plan all the way down the chain of command to associates and staff, while only 43 percent of failed firms did so. One successful firm leader acknowledged, “The plan has been developed with input from all lawyers, including associates and the senior staff…This is a significant change.”
Compensation and Debt
Ninety percent of successful firms have a financial plan as opposed to only 67 percent in failed firms. Successful firms are much more likely to carefully manage their capital commitments (9.0 vs. 5.8). At the same time, successful firms are much more likely to carry a reasonable debt load (9.5 vs. 6.0). Tracking procedures in successful firms are clear and quantifiable. Penalties for failure to achieve the goals are understood, and individuals are held accountable.
Reliance on a small number of rainmakers is a vulnerability that no firm should endure for long. This was a key weakness for Dewey, who aggressively poached star talent from other firms with the promise of those hefty compensation packages. Those rainmakers were still rewarded regardless of their performance.
Our report proves that no single incident can cause the collapse of any healthy firm. In fact, there is no such thing as a precipitous firm collapse. It only appears that way. A sequence of events causes firms to fail. Likewise, there is no panacea that will ensure extraordinary success. But we have learned that there are characteristics that can affect the probability that a firm will fail or enjoy outstanding performance.
In addition to the above, we found that brand identity matters. There is a strong correlation between firms that believe they have a strong brand and firm growth.
Faith rules. Vision and leadership matter. Communication is critical.