Paul L. Caron

Tuesday, November 22, 2011

Schlunk: Is a Law Degree a Good Investment Today?

Tax Prof Herwig Schlunk (Vanderbilt), Mamas 2011: Is a Law Degree a Good Investment Today?:

There continues to be an active debate on the question of whether or not law school is a good investment. I prefer to think of the question not in terms of “whether,” but in terms of “when.” In this essay, I conduct an analysis for three current undergraduates who are considering attending private law schools. I demonstrate how such individuals should take all known costs and all expected benefits into account in making their “investment” decision. As the calculation necessarily differs dramatically from one potential law student to another, my conclusions are far less important than my methodology.

[I]n terms of lost salary, the opportunity cost of law school attendees will vary greatly from one potential attendee to another. To reflect this variation, I will undertake an analysis for each of three very different but hopefully somewhat typical potential attendees. My first such potential law student is a college graduate whom I will name Also Ran. Also Ran achieves above average grades in a relatively nonmarketable major from a middle-of-the-pack undergraduate institution; he could have earned a mere $35,000 in a non-legal job. Also Ran manages to claw his way into a third-tier private law school (with a blended US News and World Report rank of 88th) and has only a poor prospect, which I will set equal to 5% in the current market, of landing an NLJ 250 job (i.e., a “Biglaw” job). My second potential law student is a college graduate whom I will name Solid Performer. Solid Performer achieves relatively good grades in a somewhat more marketable major from a better institution; he could have earned $42,500 in a non-legal job. Solid Performer makes his way into a second tier law school (with a blended US News and World Report rank of 50th) and has a better prospect than Also Ran, but still a relatively small prospect, of landing an NLJ 250 job. Specifically, I will assume that there is an 8% chance that Solid Performer ends up starting at Biglaw. My third potential law student is a college graduate whom I will name Hot Prospect. Hot Prospect earns strong grades in a relatively marketable major from a highly-ranked undergraduate institution; she could have earned $50,000 in a non-legal job. Hot Prospect attends a first tier law school (with a blended US News and World Report rank of 19th) and has a relatively strong chance, which I will set equal to 25% for purposes of my analysis, of ending up in an NLJ 250 entry-level position.

Chart G

Chart J

Chart K

These numbers are bleak. What they say, in plain English, is that with the benefit of twenty-twenty hindsight, two-thirds of the graduates from Also Ran’s institution, four-fifths of the graduates from Solid Performer’s institution, and two-thirds of the graduates from Hot Prospect’s institution will know, as they are receiving their diplomas, that they made what has turned out ex post to be a bad investment!

Finally, it is interesting to turn the mode of calculation on its head, and thus directly confront the question of how much a legal education is worth. ...

Chart Z

[L]aw school is a very risky (and expensive) investment; it should not be entered into lightly. However, as I have already mentioned, and worth repeating again, each potential student’s calculus will be based on a host of factors unique to him or her. For some, like an English major (relatively low opportunity costs) who gets some scholarship assistance (somewhat lower out-of-pocket costs) to attend Harvard Law School (relatively high pay-off), the investment in a legal education is almost surely a no-brainer. Moreover, even for individuals facing a more challenging calculus, it may be the case that a legal education confers benefits beyond the incremental compensation that I have used to analyze the pure investment decision. For example, a law degree opens up many more avenues of potential employment, including importantly self-employment, than does a typical undergraduate degree; lawyers are found in all parts of the workforce performing all manner of jobs. Does this imply, perhaps, that some option value should be added to a law degree’s payoffs? If so, how would one measure such option value? And lastly, of course, a law degree is a professional degree; it confers considerable prestige. But alas, as I first pointed out two years ago, you cannot eat prestige.

For the 2009 numbers, see here. (The title, of course, brought to mind my article, Tax Myopia, or Mamas Don't Let Your Babies Grow Up to be Tax Lawyers, 13 Va. Tax Rev. 517 (1994).)

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All of this is very depressing. I guess my only option as an unemployed third year student is to compete with more experienced attorneys - lowering the price of legal services in my local area.

Posted by: BNS | Nov 25, 2011 2:07:46 PM

Ohwilleke, if you are analyzing law school as a new investment, 12% isn't that high. My company is using an 11% hurdle rate for the safest of new investments. It can be higher based on the country risk and business risk (new business, complementary, etc...). Comparing law school to where to invest already earned capital isn't the proper analysis.

The options are either A) borrow $0 by doing nothing (leave university with a bachelor degree doing whatever) - the next best alternative. Or be, borrow $200K to $250K to invest in a business venture - law school. Given that school debt is likely not fully tax deductible at best, and with absolute recourse that not even bankruptcy can wipe out, the hurdle rate should be fairly high.

Posted by: SAN | Nov 23, 2011 7:42:00 PM

Law is a path-dependant career, however. If you don't get off to a good start, success may very well never materialize and there will be no later years in which to receive a disproportionately high return. For the graduates who have now gone 2-3 years post graduation without a job, it is increasingly unlikely that they will ever have a legal career at all. The argument about the value of a legal degree over a lifetime, which I see popping up regularly now, assumes that a career is launched at all. This is not happening for many.

Posted by: Fred Smith | Nov 23, 2011 9:54:47 AM

To Ohwilleke, you mention something I've been told my whole life: "Anything can be taken away from you, except for your education."

And the fact of the matter is that my J.D. will be worthless when I graduate! I haven't learned anything that'll make me a good lawyer. Concurrently, law firms don't want to train graduates like me at all. So what do I do?

I would happily give up my J.D. if it meant that my student loans would vanish. But that's not going to happen, no matter how shitty this degree is!

Posted by: JohnD. | Nov 22, 2011 10:34:56 PM

A twelve percent discount rate seems very high in an economy where risk free returns pay interest rates of 1-2%, the stock market has broken even over the last decade, and junk bonds have yet to break even this year. The truth is that there is no alternative investment where a recent college graduate can put a quarter million and reliably expect much more than a 3%-4% rate of return.

Also, a law degree has much to be said for it as an asset protected investment. Unlike other assets, no one can take your degree from you by any means (although disbarring you after various due process steps can reduce its economic value).

At a more sensible discount rate, the case of law school looks much better, particuarly given that the returns from a law degree are disproportionately in the later years of one's career.

Posted by: ohwilleke | Nov 22, 2011 12:15:14 PM

Good stuff Mr. Schlunk.

Posted by: anon | Nov 22, 2011 11:47:22 AM

Good thing I have a low discount rate! (thank's German ancestors)

Posted by: Matt | Nov 22, 2011 9:10:26 AM