Transaction-cost economics have broad applicability in legal department management

“Transaction costs are the costs of making exchanges – the time, effort, grief, and sometimes financial costs – associated with coming to an agreement with someone else.” The definition comes from Peter Leeson, The Invisible Hook: The Hidden Economics of Pirates (Princeton Univ. 2009) at 54, but his point extends to agreements with outside counsel “pirates.”

For example, hourly billing arrangements eliminate transaction costs that burden alternative fee arrangements; everyone understands the time-honored arrangement, no one has to hammer anything out. Bill review has an implicit set of understandings, starting with frequency and format, which negates any call for bespoke alternatives. Outside counsel guidelines pre-establish expectations, as do letters of engagement from law firms. Both documents reduce the costs of making exchanges.

These customs lessen transaction costs between inside and outside lawyers. Other techniques exist. The advantages of networks of law firms and of law firms with constellations of offices are that a law department deals only with one source and that reduces transaction costs. Panels of law firms (or any convergence program) reduce a legal department’s costs of reaching agreement. Stated differently, increased transaction costs – the effort to select a panel or reduce the number of firms retained – pays off in lower costs later.

All of these modus operandi of legal departments and their external counsel reduce transaction costs (See my post of Aug. 14, 2005: transaction costs of transferring a pending matter to a new firm; Oct. 23, 2005: PhD dissertation on transaction costs and legal departments; July 31, 2006: transaction costs, convergence and hiring inside; and Jan. 8, 2008: transaction cost economics argues against retaining outside counsel.).

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