Earnings Inequality and Coordination Costs: Evidence from U.S. Law Firms

Earnings inequality has increased substantially since the 1970s. Using evidence changes from con…dential 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 linkingspans of control and earnings inequality, is responsible increases in inequality.We …first show that earnings inequality among lawyers increased substantiallybetween 1977 and 1992, and that the distribution of partner-associate ratiosacross offices changed in ways consistent with the hypothesis that coordination costs fell during this period. We then propose a "hierarchical productionfunction" in which output is the product of skill and time and estimate itsparameters, applying insights from the equilibrium assignment literature. We…find that coordination costs fell broadly and steadily during this period, sothat hiring one's fi…rst associate leveraged a partner's skill by about 30% morein 1992 than 1977. We …find also that changes in lawyers' hierarchical organization account for about 2/3 of the increase in earnings inequality amonglawyers in the upper tail, but a much smaller share of the increase in inequalitybetween lawyers in the upper tail and other lawyers. These fi…ndings indicatethat new organizational efficiencies potentially explain increases in inequalitybetween individuals with very high and median earnings more broadly.[...]