Earnings Inequality and Coordination Costs: Evidence from U.S. Law Firms – Thomas Hubbard, professor of strategy at the Kellogg School and Professor Luis Garicano of the London School of Economics. February 2016.

“Earnings inequality has increased substantially since the 1970s. Using evidence from confidential Census data on U.S. law offices on lawyers’ organization and earnings, we study the extent to which the mechanism suggested by Lucas (1978) and Rosen (1982), a scale of operations effect linking spans of control and earnings inequality, is responsible increases in inequality. We first show that earnings inequality among lawyers increased substantially between 1977 and 1992, and that the distribution of partner-associate ratios across o¢ ces changed in ways consistent with the hypothesis that coordination costs fell during this period. We then propose a “hierarchical production function” in which output is the product of skill and time and estimate its parameters. We find that coordination costs fell broadly and steadily during this period, so that hiring one’s first associate leveraged a partner’s skill by about 30% more in 1992 than 1977. We find also that changes in lawyers’ hierarchical organization ac- count for about 2/3 of the increase in earnings inequality among lawyers in the upper tail, but a much smaller share of the increase in inequality between lawyers in the upper tail and other lawyers. These findings indicate that new organizational efficiencies potentially explain increases in inequality, especially among individuals toward the top of the earnings distribution.”