Elements of agency theory that shed light on law department management

The broad field of agency theory, which deals with the consequences of contractual behavior, has much to teach us about law department management (See my post of Jan. 28, 2007 for a start, and a rebuttal.). A paper entitled “The Practical Significance of Agency Theory,” by Alexandre Padilla at the Metropolitan State College of Denver, offers a useful framework to think about those lessons in what is also called the principal-agent field. “The key elements in the principal-agent literature are the structure of preferences of the parties to contract [relative risk aversion], the nature of uncertainty [cause-and-effect relations], and the informational structure in the environment [asymmetry].”

I have written previously on risk aversion and in-house lawyers (See my post of Jan. 16, 2006 about it and the principal-agent challenge.) as well as on cause and effect (See my posts of Jan. 27, 2006; and Nov. 11, 2007.).

As to the balance of knowledge (information) between law departments and law firms, among the problems Padilla explores are those where two sides to an agreement have asymmetric information (See my posts of Dec. 23, 2005 about asymmetric information and outside counsel; and Jan. 13, 2006 #1.). A law firm, for example, knows more about the discovery software it proposes to use than does the litigation manager in the client’s law department.

Credence goods, where an expert recommends expenditures by someone who is much less knowledgeable (See my post of April 26, 2006), confront in-house counsel all the time as a law firm urges research, contractual elaboration, meetings, or a motion that just so happen to bring more fees to the firm.

Another topic studied by agency theorists are contractual incentives to counteract the pernicious effects of agency problems (See my posts of Aug. 4, 2007 on outside counsel bonuses; and May 23, 2007 for inside-counsel bonuses.). Outside counsel guidelines could be viewed as quasi-contracts or, when signed by firms, as actual contracts that try to establish incentives and punishments.

Agency theory also draws on game theory (See my posts of Aug. 14, 2005; Feb. 8, 2006; and June 6, 2006 #2.). A second post continues this topic of agency theory (See my post of Jan. 1, 2008.).

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