A fascinating U.S. study by Charles Whitehead, Lubomir Litov and Simone Lepe has suggested that having lawyers as non-executive directors may improve corporate governance; increase the value of those companies and their ability to borrow.
Increased litigation and regulation alongside a perception of increased risk appears to be driving an increase in lawyer participation at board level. In the US at least, lawyer-directors they are often outside directors. The study models empirical evidence to suggest companies with lawyer-directors may reduce the risk-appetite of CEOs by realigning the CEO’s remuneration incentives to increase pay but reduce risk appetite. Risk-taking behaviour by those Companies is also claimed to reduce. Interestingly, “lawyer-directors who are insiders (for example, lawyer-CEOs who are also directors) are more likely to reduce corporate risk than outside lawyer-directors”. The same is true where it is a lawyer director who chairs the risk management committee or who is the Chief Financial Officer.
Risk is measured through insolvency risk and ; volatility. Interestingly, where there were lawyer-directors litigation (e.g. patent litigation) seemed to reduce other risk measures, suggesting some litigation had benefit to the client beyond the outcome of the litigation itself. Indeed, patent litigation increased the value of the company. Even where such litigation posed risks to the company the risks posed by accounting malpractice, securities and class action litigation reduced where there were lawyer directors. The reduction in risk and increased financial stability was linked to reduce borrowing costs and higher leverage.
It is worth quoting the summary of key findings on litigation risk:
- Lawyer-directors increase the effect of patent litigation on firm value by 13.2 percent.
- Accounting malpractice litigation reduces firm value, but the result is reversed when there is a lawyer-director. In that case, there is a 308 percent increase in the effect of accounting malpractice litigation on firm value compared to when no lawyer is on the board.
- Securities law and class action litigation reduces firm value, but the result is also reversed when there is a lawyer-director. In that case, there is an almost 155 percent and 65 percent increase in the effect of such litigation on firm value compared to when no lawyer is on the board.
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. 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 as indicated by the rise in Tobin’s Q. Her influence on board structure and takeover protections may also add to firm value. The influence of a lawyer-director is even greater if she has a prominent position on the board.
The authors suggest that it is not litigation generally that is the source of improvement but a more general improvement in governance that results from lawyers on boards.