Time and Money: Discovery Leads to Hourly Billing

Abstract

Although many clients and lawyers now condemn hourly billing, there is heavy irony about this. Starting in the 1950s, both groups demanded the switch from fixed-fee billing to hourly billing. This paper explains why. Our economic model shows that societal changes, particularly the expansion of pretrial discovery in the 1938 Federal Rules of Civil Procedure, led inevitably to hourly billing. Hourly billing both efficiently shifted new risks away from lawyers and made legal services cheaper than under fixed fee billing.

Our model suggests that, if litigation costs are relatively certain, then the efficient contract is a fixed-fee contract. Although such a contract imposes a cost risk on attorneys, the contract reduces moral hazard, that is, the incentive for an attorney to waste time. If instead cost uncertainty increases greatly and lawyers are more risk averse than their clients, then it becomes efficient to switch to hourly billing. Hourly billing will reduce risk for the attorney. If cost uncertainty is large enough, then the savings from risk reapportionment, which the lawyer and the client can share, will more than offset the cost of the waste from hourly billing's moral hazard.

Before 1938, the standard fee arrangement was a fixed fee. Broadened discovery then increased the uncertainty of litigation costs, especially as states copied the Federal Rules over the next two decades. Starting in the mid-1950s, as our model predicts, litigators, spurred by their institutional clients, switched to hourly billing. By the late 1960s, society's increasing complexity had increased cost uncertainty for transactional lawyers. As our model predicts, the bar soon also shifted to hourly billing for transactional work. Many personal injury cases continue to be litigated under contingency agreements in part because, as the model shows, clients in these cases are often more risk averse than other clients. The model suggests why clients and lawyers have recently experimented with forms of fixed-fee billing. Because the conditions that made hourly billing efficient may now have changed, economic pressures are now building for a return to forms of fixed-fee billing.

JEL Classification: K41