Saturday, December 10, 2011

Counter Offers and Prospect Theory

Prospect theory
One of the things you hear in law teaching is how salary increases are the result of counter offers. A faculty member gets an offer from another school and then asks her dean to match or beat it or she will leave. (I am not sure the dean's response is really a "counter offer" unless it's viewed as a response to an offer made by the the threatening faculty but that is for contracts teachers to figure out.)

Before getting into the main point, I think it is important to note that the number of offers faculty talk about having exceeds the number they actual have and this exceeds the number they would actually accept. In short, there is a bit of gaming. [A second point that is unrelated: Hey UT Law School, I need a loan.]

Most of the time when I hear of counter offers I think about prospect theory -- what is this obsession deans have with keeping people from leaving. So often their efforts are misguided. When it comes to faculty there are good loses and very few good keeps that are also controllable.

Offers from other schools fall into three categories; Ones the Dean cannot possibly keep the professor from taking, those that the person would not take even if the dean did nothing, and those in which the dean's actions may make a difference.

At my school we have had two people go to much better schools. The deans involved had no chance but foolishly acted like they did. Foolish not just because they had no chance but because these were good losses. It was a feather in our cap to have them move on and, perhaps, less of a feather if they had stayed becuase,alas, they would still be at UF. Similarly, when the professor is going "back home" or to a highly preferable geographic or life style setting, forget about it. Let them go.

When the offer is from a school down in the pecking order and the professor shows up to discuss it with the dean, it's a "tell" -- they have mixed feelings and it may just be posturing. They may or may not go and the dean may make a difference but should seriously consider not budging. Admittedly, this is related to my view that virtually all faculty at schools from 25 on down are fungible in that no students or alums and not many faculty will even notice they are gone. Still, just how many students is the person teaching? How flexible has he been? Does he pimp articles of others by badgering the law review? Does he work for the good of the whole or just for himself? This could well be another good loss. Plus there are few ways to undermine whatever morale there is than by giving a huge raise simply because a lesser school will pay him more money. I do not follow that logic but many deans rely only on short term or myopic logic.

Somewhere between these two good losses there are those a dean should try to avoid and he could make a difference. One reason to keep someone is simply to avoid the transaction costs of replacing him. If the potential increase in productivity from a replacement is low or negative and the money saved in transactions costs relatively high, it makes sense to try to hang onto the person up to a point. That point depends on the salary for the replacement.

My perception which is admittedly mostly anecdotal, is that deans have an irrational aversion to letting people go. Unless the person is really awful I've seen them stretch to keep them even when we would not hired them today as a lateral. I've even seen them cave into threats to leave and efforts to leave that did not pan out.

Ours is an odd profession. I remember being on the way to my first teaching job and this thought occurred: "I know a fair amount of economics [not as much as I thought I did] but I did not take any courses on teaching." A similar thought occurs to me when I look back at over 30 years of the decision making of administrators. "Most of these deans were law teachers and scholars and many of them not that good. Now they are in management. Have they taken any courses on management"

Thursday, December 01, 2011

A Degree of Practical Wisdom: The Ratio of Educational Debt to Income as a Basic Measurement of Law School Graduates’ Economic Viability

Jim Chen, A Degree of Practical Wisdom: The Ratio of Educational Debt to Income as a Basic Measurement of Law School Graduates’ Economic Viability, 38 Wm. Mitchell L. Rev. (forthcoming 2012):
This article evaluates the economic viability of a student’s decision to borrow money in order to attend law school. For individuals, firms, and entire nations, the ratio of debt to income serves as a measure of economic stability. The ease with which a student can carry and retire educational debt after graduation may be the simplest measure of educational return on investment.

Mortgage lenders evaluate prospective borrowers' debt-to-income ratios. The spread between the front-end and back-end ratios in mortgage lending provides a basis for extrapolating the maximum amount of educational debt that a student should incur. Any student whose debt service exceeds the maximum permissible spread between mortgage lenders' front-end and back-end ratios will not be able to buy a house on credit.

These measures of affordability suggest that the maximum educational back-end ratio (EBER) should fall in a range between 8 and 12 percent of monthly gross income. Four percent would be even better. Other metrics of economic viability in servicing educational debt suggest that the ratio of total educational debt to annual income (EDAI) should range from an ideal 0.5 to a marginal 1.5.

EBER and EDAI are mathematically related ways of measuring the same thing: a student's ability to discharge educational debt through enhanced earnings. This article offers guidance on the use of these debt-to-income ratios to assess the economic viability of students who borrow money in order to attend law school.

To offer good financial viability, defined as a ratio of education debt to annual income no greater than 0.5, post-law school salary must exceed annual tuition by a factor of 6 to 1. Adequate financial viability is realized when annual salary matches or exceeds three years of law school tuition. A marginal, arguably minimally acceptable level of financial viability requires a salary that is equal to two years’ tuition. The following table compares some tuition benchmarks with the salary needed to ensure the good, adequate, and marginal levels of financial viability identified in this article:

TuitionSalary needed for good viabilitySalary needed for adequate viabilitySalary needed for marginal viability
Available for download on SSRN at Highlighted by Paul Caron on Tax Law Prof Blog, by Karen Sloan in the National Law Journal, by Sam Favate on the Wall Street Journal's Law Blog, by Debra Cassens Weiss in the ABA Journal, and by the Ed Clinton Law Firm Blog. Paul Caron has kindly written a follow-up post.