[Srinivasan Sankaraguruswamy is an Associate Professor of Accounting at the NUS Business School, National University of Singapore and Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore]
A significant challenge confronts legal departments of companies. On the one hand, the demand for legal services from external counsel continues to skyrocket given the increasing complexity of the legal environment in which companies operate and the onerous nature of compliance requirements. On the other hand, in-house legal teams have come under intense pressure from management to bring about drastic reductions to legal costs. Both the global financial crisis in the late 2000s and the pandemic more recently have focused the attention on practices of companies in the procurement of external legal services, compelling them to be more creative about arrangements with external counsel to extract greater value at competitive prices.
These developments necessitate that legal procurement by companies be “increasingly data-and-metrics driven” and reliant on “evidence-based rationales for major reductions in legal spending”. The role of data analytics in modern legal engagement cannot be understated. At what stages during their lifecycles do companies spend extensively, if at all, on legal fees? What types of companies incur greater legal spending? Do larger companies necessarily spend more than smaller ones? Do companies with greater exposure to global markets spend more than those without? Do companies in certain industries spend more than companies in other industries?
Despite the criticality of these questions in the sphere of corporate legal procurement, there are numerous obstacles to obtaining data on specific fee arrangements between corporations and law firms representing them due to the private nature of their relationship. Available studies regarding legal fees in various markets are either anecdotal, survey-based or limited to specific time-spans. In our recent paper, “Which companies pay more (or less) in legal fees? An empirical study of India”,[1] we seek to fill this gap through our empirical study using a comprehensive dataset of legal fees that corporations in India have incurred annually over a 30-year period from 1990 to 2020. To our knowledge, there is no prior academic work that analyzes legal fees incurred by corporations across multiple variables over such a long time-horizon.
The study of the legal expenses in India is interesting for at least two reasons. First, India is unique in that data on legal spending are available over a sufficiently extensive period to enable a meaningful empirical analysis regarding the trends and determinants of legal fees that corporations expend. Second, India’s economic liberalization in 1991 caused its product and investment markets to open up, thereby enabling its corporate legal sector to grow exponentially. This presents us with an interesting setting to explore the various determinants of legal fees in such a market.
Through our study, we show that several characteristics relating to the legal environment in India have been exhibiting an increasing trend over time. For example, the total legal fees spent in the economy each year have been increasing during the period of our study. However, during this time the size of the Indian economy has also been growing and, hence, we examine the average legal fees spent by a company each year, which has also been increasing over time. In terms of transactional legal work, there has been a considerable growth in investments (both foreign and domestic), capital raising, and other similar corporate transactions, all of which signify a growing demand for legal services. Mergers and acquisitions (M&A) tend to appear in waves, and hence do not demonstrate consistent time trends. In sum, the legal environment has been rapidly expanding in India.
Our study is based on a sample that consists of 174,921 firm-year observations of limited liability companies from the Prowess database, which meet the data requirements. The company specific determinants of legal fees spent by corporations are company size, export and import status, state of incorporation, significant corporate events, and industry membership. Company size is the most important determinant of legal fees, in that larger companies spend more on legal fees than do small company. We proxy for company size with the total assets of the company, and whether a firm is a multi-segment firm or not. Companies that export goods and services to other countries, or import goods and services from other countries, contend with laws in India as well as in the importing (or exporting) country and hence spend more on legal fees than companies which sell to or buy from only the domestic market. Four states, being Delhi, Maharashtra, West Bengal, and Tamil Nadu are the most industrialized states in India and their courts have original jurisdiction over civil and commercial matters beyond a specified monetary value. The companies incorporated in these states spend more on legal fees than do companies incorporated in other states in India.
Companies engage in significant corporate events like issuing securities, either in an initial public offering (IPO) or in a secondary equity offering. Companies also issue debt and commercial paper in the capital markets. External law firms play an important role in drafting and filing documents with regulators, vetting the prospectus related to the securities issuance and in advising the company on related legal issues. We find that companies that engage the capital markets to issue securities spend more on legal fees than companies who do not have any significant corporate events in a given financial year. A second type of significant corporate event is a merger or acquisition (M&A). Companies can be either acquirers or targets in an M&A transaction. Companies that are a party to an M&A have to structure the transaction, conduct due diligence, prepare and enter into contracts involving reams of documents, and file some of these documents with regulators, all of which are usually handled by external law firms who specialize in the legal aspects related to an M&A. Hence, we expect, and find, that both acquirers and targets spend significantly more on legal fees than do companies who do not have any significant corporate event in a financial year. Since significant corporate events are undertaken by specific types of companies, we use a propensity score matching process to obtain the above-described results.
Extant accounting literature classifies the litigation risk of a company based on the industry of which it is a member. For example, one study codes high litigation risk companies as those which are in the biotech, computer, electronics, and retail industries. We find that technology companies and companies in the energy sector in India spend higher legal fees on average than do companies in other industries.
We contribute to the literature in two significant ways. First, our paper is the first to describe the cross section of legal fees across companies in a single market over a sustained period of time. Such an analysis of legal fees is significant given the intense fee-sensitivity displayed by the legal market, the need for further data analysis for purchasers and providers of legal service, and the unavailability of public information regarding fees at the level of each engagement or even each purchaser-provider relationship for legal services. Second, we show empirically that larger companies spend more on legal fees. Companies who engage the stock market to issue equity or debt securities also spend more on legal fees. Both acquirers and targets in an M&A also spend higher amounts on legal fees. Companies in high tech and the energy industries spend more on legal fees, presumably because they face higher legal, contracting and regulatory risk.
At one level, critics may argue that the findings in our paper are consistent with obvious expectations, but our effort herein is to empirically test the validity of conventional wisdom and available anecdotal evidence. Our findings regarding the determinants of legal fees would not only enable market players to calibrate these factors in structuring their engagements for legal services, but they would also provide the opportunity for researchers to analyze legal fees in other markets (subject to the availability of data) or to undertake further in-depth studies across one or more determinants of legal fees. Our paper would also contribute to the broader literature surrounding the legal profession, including any regulation surrounding the quantum and design of legal fees in India, and generate appropriate discourse in other related jurisdictions as well.
– Srinivasan Sankaraguruswamy & Umakanth Varottil
[1] The published article is behind a paywall. We do have some free copies made available by the publisher. If any of the readers requires one (subject to availability), please email us at v.umakanth@nus.edu.sg.
A preprint of the article prior to peer review is available on SSRN.