Time and Money: Discovery Leads to Hourly Billing

It is ironic that many clients and lawyers now condemn hourly billing. Starting in the 1950s, both groups demanded the switch from fixed-fee billing to hourly billing. This article explains why. Using a new economic model, Professors Cloud and Shepherd show 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. The economic model indicates that clients and lawyers balance two concerns when choosing a type of contract. First, they seek to reduce moral hazard, the incentive for an attorney to devote too much or too little time to a case. Second, they attempt to shift the risk of uncertain litigation costs to whomever of the client or lawyer is less risk averse. 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 by reducing the lawyer's incentive to overbill. However, if cost uncertainty increases greatly, as it did after the 1938 changes in the Federal Rules, and lawyers are more risk averse than their clients, then it becomes efficient to switch to hourly billing. Although hourly billing increases moral hazard, it reduces 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 moral hazard. The switch to hourly billing reduces clients' legal fees. History confirms the model's predictions. Before 1938, the standard fee arrangement was a fixed fee. Broadened discovery