Professional Service Firms Should Stay Off Wall Street

(With Corrections)
Hutong West
Sunday, Sunday
1228 hrs.

About two years ago, the New Yorker ran an excellent article plumbing the question of whether Wall Street firms were capable of doing social good. In the heart of the article, however, was a revelation that should waken the leaders of any professional service firm from their dreams of IPO riches. (Keep in mind that I am thinking more about advertising agencies, investment banks, management consultancies, PR firms, and the like. As one reader correctly pointed out in comments, law firms, accounting firms, and auditors tend to remain private, though event that structure has limitations.)

Big doesn’t necessarily mean bad, but when the Wall Street firms grew beyond a certain point they faced a set of new challenges. In a private partnership, the people who run the firm, rather than outside shareholders, bear the brunt of losses—a structure that discourages reckless risk-taking. In addition, small banks don’t employ very much capital, which allows them to make a decent return by acting in the interests of their clients and relying on commissions. Big firms, however, have to take on more risk in order to generate the sorts of profits that their stockholders have come to expect.

Not long ago I had a delightful dinner in Beijing with the nonagenarian founder of one of the world’s premiere professional service firms. We spent much of our time talking about the history of the firm, where he had gone right, and where he had gone wrong. I flatter myself to think that there was more to the discussion than a self-indulgent trip down Memory Lane: that is not the style of this old-school Southern gentleman. I prefer to think he was passing me warnings about my own little firm.

He told me that in retrospect one of the greatest errors his industry had made was in trading the partnership structure for public listing. It was an error for the people (it dehumanized them,) the partners (it took away their incentives), and the clients (it refocused firm management on their corporate overlords more than on client work.)

There are many virtues to the corporate structure and public ownership. For professional service firms they are outweighed by the risks and the downsides. Investment banks are learning this the hard way, as are advertising, public relations, and management consultancies. After the one-time IPO payoff for the partners, the benefits of public ownership start looking thin.

I don’t expect this revelation will slow the velocity of conglomeration and public ownership of professional service firms. I do expect, however, that wiser clients are going to start evaluating firm ownership when they choose service providers. The burden of proof will be on the publicly-owned firms to prove that they will get senior-level time and attention and maximum value to the clients.

Alexander de Santos

A very weird article. Professional services firms, by which I take you to mean lawyers, accountants and auditors, never go for IPO’s as there would be a massive conflict of interest if they were owned by the general public. Which is why there are none listed. I think the author is a little confused on this point, unless he cares to elaborate upon what he actually means.

David Wolf

Thanks for your comment. My definition of professional service firms actually spans a bit wider, to include the public relations firms, advertising agencies, investment banks, and management consultancies. Several companies falling into the first three categories are public. LegalZoom, which I would consider a law firm, is planning an IPO.

Alexander de Santos

Legl Zoom aren’t a law firm, thats a misunderstanding on your part. They are document providers. You need to be careful about making such statements and suggesting “professional service firms” when in actuality you don’t mean the biggest part of this definition. PR or market research (what you do) is rather different from law, tax or audit.

David Wolf

Thanks, Alex. I’ve revised the article to reflect my thoughts and to address the misunderstanding you pointed out.