Monday, September 29, 2008

What Is The Net Present Value of a JD?

What's the real value of a law degree?

Is law school a good value? That’s the question I ask my students to figure out, hoping to teach them a bit about finance. Using crude numbers, the answer looks like a resounding “yes.” As they say in the investment business, it looks like a “three bagger.” Even if you have to put $230,000 in, you get over $700,00 back! Sweet! Hey Deans, maybe we should raise tuitions (and law professor salaries)!

What crude numbers, you may ask? Well the Wall Street Journal reported recently on salary statistics. While the median salary for persons holding just a BA has slipped to $47,240, those of us with professional degrees have gone up to $89,602. Even better, recent Labor Department numbers show the median salary for lawyers at $106,120. So, as I say to my students, think of your law degree as an annuity. It represents a payment stream that lasts for a career (say 40 years) that equals the spread between what you would have earned without your law degree versus what you can with it. Using the median salary numbers, that spread is almost $60,000. Discounted at 8%, the annuity has a present value of over $700,000. The present value of three years of tuition (at $40,000 a year), books and foregone salary (at the median) is about $230,000. So, as your stockbroker used to say about Lehman bonds, a “no brainer!”

I'm unconvinced. This analysis seems far too simplistic. With so much variation in lawyer pay -- particularly given the bimodal distribution of starting salaries, working with averages doesn't really tell you very much. The same is true for salaries of people with bachelor degrees. The expected salary for having a four-year degree is highly dependent upon what your undergraduate major was.

To get a much better feel for how well law school really pays off, I'd love to put together an agent-based model or program a Monte Carlo Simulation to account for undergraduate major, law school ranking (top 14 vs. lower ranked schools), law school grades, tuition rates, etc. Either technique should yield a distribution of likely outcomes that would be much more informative than looking at averages. Another important piece of information to take into effect is expected number of hours worked. Is a legal job that pays $100,00/year but requires 60-70 hours of work per week really better compensated than an engineering job that pays $75,000/year but only requires 40-50 hours per week?

My expectation is that law school is only worthwhile if you have below average expected earnings with your undergraduate degree, go to a top-14 law school, and/or are in the top 10-20% of your class. For everyone else, I recommend an MBA. Or better yet -- major in economics or engineering as an undergrad.

(HT Tax Prof Blog)

No comments: