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Charles K. Whitehead
Among old adages about lawyers, one often heard is that those who would represent themselves have a fool for a client. And, on a related note, there’s a common view that lawyers should not serve on boards of directors—lest they run into conflicts about making strategic decisions versus giving legal advice.
But the very real trend of attorneys serving as directors would seem to belie that view: their numbers nearly doubled from 2000 to 2009. And a new working paper by a trio of finance and law academics argues that the benefits of “lawyer-directors” far outweigh the costs—not only because they lower certain risks, but because they boost the overall value of a company by nearly 10 percent.
“A lawyer-director increases firm value by 9.5 percent, and when the lawyer is also a company executive, the increase in firm value rises to 10.2 percent,” according to the Cornell Law School research paper “Lawyers and Fools: Lawyer-Directors in Public Corporations.” It’s written by Cornell Law professor Charles Whitehead, University of Arizona assistant professor of finance Lubomir Litov, and University of Arizona associate law professor Simone Sepe.
What first caught the researchers’ attention was the sheer increase in lawyer-directors over the last decade. The authors examined companies in the S&P 1,500 (excluding financial services firms, which are their own kettle of fish, apparently), counting 340 lawyer-directors in the year 2000 and 541 lawyer-directors in 2009.
During that same period, the percentage of public companies with lawyer-directors shot up from 24.5 percent to 43.9 percent.
Next, the authors wondered under what circumstances, and in what kind of companies, lawyers were more likely to be on the board. Companies from industries more subject to litigation and those more heavily regulated increased the odds. So did a company’s size and complexity—the bigger and more complex the operation, the greater the chance of seeing a lawyer-director on the board. Having more patents or intangible assets also increased the probability. These companies are “going to benefit by having greater certainty over ownership,” says Whitehead, a former general counsel of Nomura Securities International.
What difference, then, did having a lawyer on the board make? Controlling for variables such as the industry, changes in regulation, and the existence of outside directors, the authors aimed to isolate the specific effects of lawyer-directors.
“When a lawyer is on the board you tend to see a shift in the way a company is managed,” says Whitehead. Overall, he adds, there’s a “reduction in risk-taking by the firm.”
Among the findings, they determined that when a lawyer-director is present, CEO compensation goes up, on average. At the same time, however, a CEO’s financial incentives tend to be structured in a way that reduces their interest in risk-taking. “They do get paid more, but the composition of what they get paid is more associated with shareholder interests,” Whitehead explains.
When it comes to litigation, says Whitehead, “If there’s a lawyer on the board, you’re going to see the risk associated with lawsuits drop,”
In other words, companies tend to be more financially stable when facing litigation if there’s a lawyer on the board. “For example, lawyer-directors decrease the effect of accounting malpractice litigation on bankruptcy risk from a 35 percent increase to a 13.5 percent increase,” the paper states. “Similarly, having a lawyer-director reduces the effect of securities law litigation on bankruptcy risk from a 28.4 percent increase to a mere 5.8 percent increase.”
Finally, the paper finds that the lawyer-director’s influence in the areas of executive compensation and litigation risk really pays off: “Our results tell us is that, on average, a lawyer-director increases firm value by 9.5 percent, an increase that rises to 10.2 percent when the lawyer-director is also a corporate officer,” the authors say. “She does so primarily through her effect on CEO compensation and litigation, both of which cause a reduction in firm risk-taking to more efficient levels . . .”
These numbers go to another central argument in the paper: that in addition to monitoring a company’s senior officers for potential bad acts, outside directors can also make a company run better. In this case, says Whitehead, lawyer-directors bring the “substantive skills” of their profession to bear.
“There’s a real value associated with having the perspective, the training, the judgment—judgment is key—that having a lawyer brings with it to the business,” he says.
