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Information asymmetry and outside counsel management

The two winners of the 2001 Nobel Prizes in Economics had years before made breakthroughs in information asymmetry, an advantage enjoyed by sellers over buyers because they know much more about their product and service than does the buyer.

How might information asymmetry pervade outside counsel management? Law firms – sellers of legal services – know more about their competencies and economics than do law departments – buyers of legal services. For example, partners understand the skills and capabilities of their associates. Firms know what prior work product, such as briefs or research memoranda, they might be able to use on a matter. Firms know how familiar they are with the particular service needed by the client. They know how busy they are, which the law department does not, and how well they manage projects. For all these reasons, hourly billing leaves all the benefits of information asymmetry on the side of the law firms.

For these same reasons, when law departments insist on billing arrangements that shift some risk to firms, firms resist losing a good thing. Moral hazard applies when law firms can bill for the hours they work. If something goes wrong, and more work is needed or the work is done less efficiently than it might have been done – no worries!

Competitive bids at fixed prices for unknown streams of legal work make law firms very uncomfortable. The advantage of information asymmetry switches in favor of the law department. Not that the law department can see over the next legal hill, but it does possess a more intimate knowledge of the company, the legal issues that have arisen in the past, and their posture towards future legal issues.