There is a current fondness for arguing that GCs should claim their place at the top table of the World’s corporations. There are a variety of plausible reasons for making the claim -it may solidify the importance of good governance, it’s a sign of the (in-house) profession’s ascendancy, and/or, it’s a simple necessity for large organisations to have legal brains influencing the major decisions. There is also one central doubt. That doubt is that a place on the Board may negate the willingness of GCs to do the job they were appointed to do. We could define that job in a number of ways but today let’s keep it to this: they are their to better manage the company’s legal risk.
It is of course really difficult to test out what it really means when a GC get’s promoted to the top table: for them, for their company and for their legal risk culture. So it was with great interest that I read, The association between corporate general counsel and firm credit risk. It’s a study based on analysis of 9,878 businesses between 1994 and 2013. The essential question asked is whether credit risk ratings and credit default swap spreads (prices) change when GCs are appointed to senior management positions. Put another way, do credit risk analysts (as ‘experts’) think the appointment of a lawyer to the senior management team reduces or increases credit risk?
This is what they conclude:
Using changes analyses for a sample of ﬁrms during the 1994–2013 period, we ﬁnd that credit rating agencies and CDS investors perceive an increase in GC ﬁrms’ credit risk relative to non-GC ﬁrms upon appointment of a GC to senior management. We also show that bond market participants respond to appointments in the one- and two-year periods immediately following a GC appointment, suggesting that these participants do not perceive GC ﬁrms’ credit risk as increasing slowly over time, but rather relatively quickly.
Their analysis controls for various matters: things like size of firm; leverage; tangible property; changers in income; book value; expected litigation risk; and the like. This is important because, they find that:
GC ﬁrm industries exhibit higher credit risk via credit ratings but not CDS spreads. In addition, GC ﬁrm industries are composed of ﬁrms that are larger, have more leverage and tangible assets, higher proﬁtability, higher stock return and cash ﬂow volatility, a greater (lower) propensity for reporting losses (year-over year increases in income), and a higher entrenchment index. We also include the average annual cumulative abnormal stock return in our industry sample and conclude that GC ﬁrm industries exhibit more positive abnormal stock returns compared to non-GC ﬁrm industries. Collectively, this descriptive evidence suggests that GC ﬁrm industries are comprised of ﬁrms with somewhat lower ﬁnancial stability, but greater stock return potential.
So part of the reasons that GC’s might get appointed to boards is the more volatile nature of the businesses that they are promoted within, but this – on the data – does not appear to be the only explanation because they control for this kind of industry variation in their analysis. The question is why do those assessing credit risk downgrade credit risk on appointment of a lawyer to the senior management team and why do credit default spreads increase afterwards? The claim of the authors is that the lawyer’s presence at the business’ top table may reduce their appetite for risk control in favour of business facilitation:
…GCs have begun to assume advisory and entrepreneurial responsibilities within the ﬁrm. Recent survey evidence suggests a keen understanding of business management, project management, sales, and marketing are necessary attributes of contemporary GCs (Association for Corporate Counsel, 2015). Ganguin and Bilardello (2005) expand upon this notion by highlighting that ﬁrms’ credit risk can be impacted by a reliance on GCs who excessively focus on capital raising, ﬁrm restructuring, and ﬁrm strategy, as well as GCs who allow the ﬁrm to become overly aggressive in dealings with suppliers, customers, and other stakeholders. As the GC takes on these new responsibilities, he/she is likely to place less of an emphasis on the gatekeeping functions and more of an emphasis on the facilitating functions, thereby potentially reducing the effectiveness of the GC’s internal monitoring.
I confess to being a bit sceptical (in, I should add, a totally uninformed way) of the idea that credit risk raters and buyers of credit default swaps might be sensitive to the appointment of lawyers to senior management. But,the authors of the study cite, “the rating agencies [that] caution that an over reliance on lobbyists or lawyers can create a corporate culture that is overly aggressive.” They also point to other studies suggesting in-house lawyers can be incentivised towards poorer practice by promotion and the like. I’d be interested in hearing views.
It is worth emphasising also though the authors acknowledged limitations of their study:
we employ an admittedly crude proxy to capture the changing role of GCs within ﬁrms, [and so] our measure could suffer from considerable noise. Second, our results may be capturing selection effects rather than treatment effects because the decision to appoint a GC to senior management is a ﬁrm choice.
So the results are consistent with the weakening of gatekeeping in favour of risky business facilitation, but other things may be going on. Those other explanations may be alternatives or additional. It is possible, for instance, that a GC promotion is not the moment s/he turns native. Rather it may be a signal (or is read as a signal by credit risk analysts) that there is trouble coming down the pipe or that the business is expanding into choppier waters.