As concerns over the economy lessen, sentiments among law firm executives rose for the second quarter in a row, recovering from six consecutive quarterly declines and a historic low in the fourth quarter of 2022, according to the Thomson Reuters Law Firm Financial Index. An increase in demand growth and a decline in direct and overhead expense growth are driving this improvement.

Law firms are striving to further lower expenses, but not at the expense of jeopardizing their pipeline of talent. This delicate balancing act has become more complicated due to the recent U.S. Supreme Court decision to overturn affirmative action, with some law firms now being sued over their hiring practices.

Demand and expenses

Demand growth has turned positive, driven by countercyclical practices—areas of law in which demand runs counter to broader economic sentiment. These areas include bankruptcy (5.7%) and labor and employment (2.4%). Litigation also experienced positive growth (4%), along with antitrust and regulatory demand (4.6%), two areas that generally remain stable amid economic uncertainty. Mergers and acquisitions and real estate experienced the largest declines in rate of growth, at negative 6% and negative 8.4%, respectively. 

Although second-quarter growth rates for both direct and overhead expenses still remained slightly elevated from pre-pandemic levels, the notable trend is downward for expenses and upward for demand. The trend lines coming close to equilibrium again is a welcome sign that stability is returning to the industry.

Direct expenses—including lawyer headcount—overall remained fairly steady in the second quarter compared to the previous quarter. However, breaking down the data by firm size reveals that hiring strategies remain bifurcated, with middle market firms still hiring but larger firms decreasing head count overall

Although midsize firms have slowed the rate at which they are hiring, we may see firms of all sizes in lockstep once more in the coming quarters. In the first quarter, midsize firms grew their yearly lawyer head count at a rate of 4.9%. However, in the last six months they have grown their head count by only 0.6%. Positive growth rates mean they are still hiring, but this has slowed.

Am Law 100 firms have taken a very different approach, as noted in our summer issue of The Real Economy Industry Outlook. Those firms decreased associate head count by 2.5%, primarily through hiring freezes or layoffs. This helped them limit direct expense growth in the second quarter to only 1.7% year over year as compared to 4.8% year over year in the first quarter. Midsize firms also experienced a drop in yearly direct expense growth, but not as dramatically, dropping from 8.3% in the first quarter to 4% in the second quarter. 

As the labor market remains historically tight, attracting and retaining qualified legal professionals will likely remain one of the top issues firms will face for the foreseeable future. While formulating recruiting strategies, many law firms have implemented diversity hiring practices over the past decade to combat inequality in the representation of lawyers. Today, white men and women are more prevalent in the legal profession as compared to their percentage of the overall U.S. population, according to the American Bar Association.

Law firms’ diversity, equity and inclusion (DEI) initiatives focus on recruiting and hiring practices, internships, scholarships and other programs. Nearly all firms (97%) that qualified for participation in Bloomberg Law’s 2023 Diversity, Equity and Inclusion Framework have a public statement committed to diversity and inclusion. Additionally, 80% of the participating firms require diversity within a pool of candidates for management and leadership positions, according to Bloomberg Law, and 80% of top law firms have a full-time senior DEI role.

Earlier this year, the U.S. Supreme Court struck down race-conscious admissions programs, prohibiting affirmative action policies. This action has cascaded to encourage DEI critics, lawyers and advocacy groups to challenge diversity programs more broadly. This includes targeting law firms that have implemented race-specific DEI recruiting initiatives.