Do Lawyers Make Better CEOs Than MBAs?
Bad news is coming for Wells Fargo. A nearly $150 million settlement is pending in the bank’s fraudulent account scandal last year, and a new scandal has emerged: It was recently alleged that thousands of customers were unknowingly signed up for insurance. In pipeline litigation, regulatory oversight intensified. Meanwhile, Bank of America, one of Well Fargo’s main competitors, experienced a scandal-plagued first half of 2017 with impressive results and profit results. What explains the difference in the fortunes of the two largest US banks?
One possibility is the tone above. For the past few years, Wells Fargo has been run by MBAs, and since 2010 Bank of America CEO Brian Moynihan has a law degree from Notre Dame. Can these differences in knowledge affect the CEO’s behavior in setting the course and cutting the corporate screen? After all, there are subtle differences in how these two disciplines teach us to understand and manage risk: Legal education focuses on the downsides of certain actions, while business education can increase shareholder value by increasing risk.
We are interested in how lawyers influence CEO firm decisions and whether they differ from CEOs without a law degree. I collaborated with Irena Hutton, Danling Jiang, and Matt Pierson to compare the behavior of CEOs with those who have a bachelor’s degree, MBA, or other degree with a law degree. We looked at nearly 3,500 CEOs, about 9% of whom have a law degree. From 1992 to 2012, the S&P 1,500 was associated with nearly 2,400 publicly traded firms.
More litigation or less?
The most obvious impact expected from a lawyer CEO depends on the amount of litigation his company has. In those 20 years, we have litigated more than 70,000 cases brought by our firms in federal court. We focus on nine common types of corporate litigation: antitrust, employment civil rights, contract, environmental, intellectual property, labor, personal injury, product liability, and warranty.
The results are clear: Firms run by CEOs with legal experience are involved in multiple lawsuits. Compared to the average firm, attorney-managed firms experience between 16% and 74% more lawsuits, depending on the type of litigation. Employment civil rights, antitrust, and securities litigation decreased the least, and the smallest (but still significant) decrease in litigation CEO contract attorney. The result is economically meaningful, because the reduction is in some cases a few less suitable per year.
This result, of course, can be explained by many factors other than the education level of the CEO. Perhaps attorney generals are more common in small firms for a number of reasons, and small firms don’t sue as often for other reasons. If so, the observed correlation is just a coincidence.
We attempt to account for the same factors to isolate CEO influence by legal level. Our analysis controlled for various company characteristics commonly used in corporate statistical analysis: industry, company size, leverage, revenue, book-to-market ratio, earnings, volatility, time period, industry exposure, and other factors that may affect host litigation. Because we tried to isolate the effect of CEO legal education, we controlled for CEO characteristics that may have led to less litigation. This includes the CEO’s age and seniority, as well as alternative measures of high academic achievement, such as an MBA, PhD or MD degree, or a degree from an Ivy League institution. We found that none of these factors had any effect on the litigation as a legal status.
A final factor that may explain our results is the presence and influence of other judicial gatekeepers, such as legally trained directors or senior and highly paid in-house general counsel. The attorney general hires or promotes other attorneys in the hierarchy, and these attorneys are responsible for reducing the caseload. Or a board full of lawyers, instead of the CEO, doing the sailing. Although we found that CEOs with a legal background are associated with a higher future number of CEOs with legal experience, our results are robust when we account for other legal experts. In other words, CEOs, rather than board members or general counsel, are responsible for reducing litigation.
Can we see why?
Having determined that attorney generals are associated with fewer cases, we next need to determine whether they result in lower legal rates. After all, there are two explanations why firms run by attorney CEOs have fewer lawsuits: either (1) these CEOs make strategic decisions that lead to fewer lawsuits against their companies, or (2) they are more likely to litigate. low possibility of Hiring the Attorney General. Although these explanations are not necessarily mutually exclusive, we have found that some cases, or at least a significant proportion, are consistent with CEO active risk management. Lawyer CEOs behave differently from non-lawyer CEOs when it comes to risk-taking and other behaviors that can lead to litigation.
First, we look at the comparison between the type of firms and CEOs. We haven’t seen the obvious choice side of the CEO hiring industry. Lawyers at the helm of banks, biotech companies, high-tech firms, Internet startups and retail outfits, as well as utilities and pharmaceuticals. And we see no evidence that firms in risky industries prefer MBAs and firms in more conservative industries prefer lawyers. At a high level, we do not see lawyers open to risk-averse firms.
Second, we examine firm behavior by CEO type. Firms managed by lawyers differ from non-lawyer firms in several measures of risk-taking. CEOs with a legal background tend to apply more cautious earnings management policies, especially in industries with high litigation risk, such as pharmaceuticals. One measure used is current accruals, where managers accelerate the recognition of revenues and delay the recognition of expenses. Lawyers have been less aggressive in their settlement by sector level.
In addition, firms with attorney CEOs were more likely to use less litigation related strategies and their firms experienced lower volatility. Areas where attorneys general have been most successful in reducing litigation—for example, civil rights work—are areas of law school where legal risks can be identified and corrections implemented more easily.
Finally, we use econometric methods to isolate the effect of CEOs on litigation itself. In one experiment, we examine the market reaction to firms with non-lawyer CEOs and those with lawyer CEOs at the time the Sarbanes-Oxley Act was passed. The law has increased compliance requirements for firms and thus increased legal risk. We hypothesize that the market will reward firms with lawyer CEOs who are better at navigating the new regulatory environment. Consistent with our hypothesis, we found that firms with lawyer CEOs experienced a positive market reaction in key cases of Act passage, while firms without lawyer CEOs experienced the opposite. This reflects the increasing importance of having a CEO with legal experience at a time of high compliance standards and stricter law enforcement.
Do Lawyer CEOs affect company performance?
We found that attorneys general not only have more cases, but trial experience is also associated with better case management. So the companies run by lawyers do better, spending less on litigation if they go to trial—they often settle and lose when litigants are sued. But if the company is run by lawyers CEOs litigate less and litigate better, why CEOs with JD degrees represent less than a tenth of the pool of CEOs?
To answer this question, we examine the performance of all firms in our data set. We find that CEOs with a legal background are associated with higher firm value, but only in a subset of firms, particularly high-growth firms and firms with high litigation volume. However, the influence of CEOs outside this setting on firm value, which is legal value, was negative. That is, pharmaceutical companies and airlines do better when run by lawyer CEOs, all else being equal, while printing and publishing companies do worse. This is because the benefit of less litigation in lower cases is offset by overly cautious firm policies that can negatively affect CEOs’ cash flow and growth.
Our research leads to two conclusions. First, CEOs with legal experience manage the risk of litigation by setting the firm’s specific risk policy. Second, this action only increases value when the company operates in an environment with high litigation risk or high demands. Otherwise, this action may harm the company.
Ideally, of course, the CEO will have the best of both worlds: minimizing litigation through rational decision-making, while at the same time knowing how to take risks to maximize value for the firm.