Self-Selection and Screening in Law Firms

This paper develops a framework to analyze the implications of a model where workers with heterogeneous effort costs choose between firms with alternate promotion policies. In one path, the worker faces strict up-or-out rules that potentially destroy valuable firm specific human capital. The other allows for the possibility of permanent employment without promotion. A costly investment, in the form of effort as an associate, is required to reveal productivity as a partner. Workers with high effort costs do not find the investment worthwhile, thus, they will not make partner and select firms without up-or-out rules. Workers with low effort costs are indifferent between the policies at the equilibrium. Up-or-out rules are optimal for firms when they must screen new associates to find partners and have an incentive to maintain partnership quality. The model predicts that wages of both associates and partners are increasing when partnership is more exclusive. For the same partnership threshold, wages are higher in firms that use up-or-out rules. The implications are tested and confirmed in a unique data set of the nation’s largest law firms.