Managerial leverage is limited by the extent of the market: hierarchies, specialization and utilization of lawyers' human capital

This paper examines the role of hierarchies in the organization of human‐capital‐intensive production. We develop an equilibrium model of hierarchical organization and provide empirical evidence based on confidential data on thousands of law offices. The equilibrium assignment of individuals to hierarchical positions varies with the degree of field specialization, which increases as the extent of the market increases. As individuals’ knowledge becomes narrower but deeper, managerial leverage—the number of workers per manager—optimally increases to exploit this depth. Consistent with our model, the share of lawyers who work in hierarchies and the ratio of associates to partners increase as market size increases and lawyers field specialize. Other results provide evidence against alternative interpretations that emphasize unobserved differences in the distribution of demand, or firm‐size effects, and lend additional support to the view that, in legal services, hierarchies help exploit increasing returns associated with the utilization of human capital.