The bad news keeps coming for Wells Fargo. A nearly $150 million settlement is pending for the fake-account scandal that roiled the bank last year, and a new scandal has emerged: Recently it has been alleged that thousands of customers were signed up for insurance without their knowledge. A bevy of lawsuits is in the pipeline, and regulatory scrutiny is intensifying. Meanwhile, one of Well Fargo’s chief competitors, Bank of America, has been relatively scandal free, with impressive revenue and proﬁt results for the ﬁrst half of 2017. What explains the divergence in the fortunes of two of the U.S.’s largest banks?
One possibility is the tone at the top. For the past several years, Wells Fargo has been run by MBAs, while Bank of America’s CEO since 2010, Brian Moynihan, has a law degree from Notre Dame. Might this diﬀerence in education inﬂuence how CEOs behave when it comes to setting a course and trimming corporate sails? After all, there’s a subtle diﬀerence in how these two disciplines train people to understand and manage risks: Legal training focuses on the downside of particular actions, while business training may emphasize the upsides for shareholder value from risk taking. We were interested in how lawyer CEOs might inﬂuence ﬁrm decision making more broadly — 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 law degrees with those who earned a bachelor’s degree, MBA, or other degree. We looked at about 3,500 CEOs, about 9% of whom have law degrees. They were associated with nearly 2,400 publicly traded ﬁrms in the S&P 1500 from 1992 to 2012.
More Litigation, or Less?
The most obvious impact a lawyer CEO might be expected to have is on the amount of litigation their company is involved in. We looked at over 70,000 lawsuits ﬁled against our sample of ﬁrms in federal courts during those 10 years. We focused on nine common types of corporate litigation: antitrust, employment civil rights, contract, environmental, intellectual property, labor, personal injury, product liability, and securities.
The result was clear: Firms run by CEOs with legal expertise were associated with much less corporate litigation. Compared with the average company, lawyer-run ﬁrms experienced 16% to 74% less litigation, depending on the litigation type. Employment civil rights, antitrust, and securities lawsuits were reduced the most, while contract saw the smallest (but still signiﬁcant) reduction with a lawyer CEO. The results were economically meaningful, since the reduction was several fewer suits per year in some cases.
This result could, of course, be explained by many things other than the educational background of the CEO. Perhaps lawyer CEOs are more common at smaller ﬁrms for some reason, and smaller ﬁrms are less likely to be sued for some other reason. If this is the case, then the correlation we observed is merely a coincidence.
We attempted to account for factors such as this in order to isolate the impact of a CEO with a law degree. Our analyses controlled for a wide range of the ﬁrm characteristics typically used in the statistical analysis of companies: industry, ﬁrm size, leverage, proﬁtability, market-to-book ratio, returns, volatility, particular time periods, industry eﬀects, and a host of other factors that might inﬂuence litigation. Since we were trying to isolate the impact of the CEO’s legal training, we also controlled for CEO characteristics that might lead to less litigation. These included CEO age and tenure at the top, as well as alternative measures of high academic achievement, such as having an MBA., PhD, or MD degree or a degree from an Ivy League institution. We found that none of these factors had as large an impact on litigation as having a law degree did. A ﬁnal factor that could explain our result is the presence and inﬂuence of other litigation gatekeepers, such as directors with legal training or high-ranking and highly-paid in-house general counsel. Perhaps lawyer CEOs simply hire or elevate other lawyers in the hierarchy, and these lawyers are responsible for the reduction in litigation. Or maybe a board full of lawyers, rather than the CEO, is doing the sail trimming. While we do ﬁnd that CEOs with legal training are associated with the greater future presence of directors with legal expertise, our results are robust when we account for these other lawyers. In other words, CEOs, not board members or general counsel, are driving most of the litigation reduction.
Do We See Causation?
Once we determined that lawyer CEOs were associated with less litigation, we needed to determine whether having a law degree caused the reduction. After all, there are two explanations for why ﬁrms run by lawyer CEOs experienced less litigation: Either (1) these CEOs made strategic choices that resulted in less litigation against their companies, or (2) companies with an already low propensity for litigation simply chose to hire lawyer CEOs. While these explanations need not be mutually exclusive, we found that less litigation was, at least in signiﬁcant part, consistent with active risk management by the CEO. When it came to risk taking and other behaviors that could generate litigation, lawyer CEOs appeared to act diﬀerently from non-lawyer CEOs.
First, we looked at the matching between ﬁrm types and CEOs. We did not observe an obvious selection bias in which industries hired lawyer CEOs. Lawyers are at the helms of banks, biotech companies, high-tech ﬁrms, internet startups, and retail outﬁts, as well as utilities and pharmaceuticals. And we saw no evidence that companies in riskier industries choose MBAs and ﬁrms in more conservative industries choose lawyers. At a high level, we did not see any obvious sorting of lawyers into risk-avoiding ﬁrms.
Second, we examined ﬁrm behaviors across CEO types. Companies run by lawyers behaved diﬀerently in several dimensions related to risk taking than those run by non-lawyers. CEOs with legal training tended to implement more-cautious earnings management policies, especially in industries with high litigation risk, like pharmaceuticals. One measure we used was current accruals, where managers accelerate recognition of revenues and delay recognition of expenses. Lawyers were much less aggressive in accrual accounting relative to industry levels.
In addition, ﬁrms with lawyer CEOs seemed more likely to deploy strategies that are associated with less litigation, and their ﬁrms experienced lower volatility. The areas where lawyer CEOs were the most successful at reducing litigation — employment civil rights cases, for example — were ones in which legal training can identify potential legal risk and implement ﬁxes relatively easily.
Finally, we used econometric techniques to isolate the impact CEOs themselves had on litigation. In one test we examined the stock market reaction to ﬁrms that had lawyer CEOs versus nonlawyer CEOs around the passage of the Sarbanes-Oxley Act. The Act increased compliance requirements for ﬁrms, and therefore increased legal risk. We predicted that the market would reward ﬁrms with lawyer CEOs, who would be better able to navigate the new regulatory environment. Consistent with our hypothesis, we found that during the key events of the Act’s passage, ﬁrms with lawyer CEOs experienced a positive market reaction, while ﬁrms without lawyer CEOs experienced the opposite. This suggests that during periods of high compliance standards and more-stringent legal enforcement, the value of having a CEO with legal expertise increases.
Do Lawyer CEOs Affect Firm Performance? We found that lawyer CEOs were not only associated with less litigation but, conditional on experiencing litigation, were also associated with better management of litigation. So companies run by lawyers, if sued, spent less on litigation and did better — they settled less often when sued and lost less often when cases went to court. But if companies run by lawyer CEOs get sued less and perform much better when sued, why do CEOs with JD degrees represent less than one-tenth of the CEO pool?
To answer this question, we examined the overall performance of the ﬁrms in our data set. We found that CEOs with legal training were associated with higher ﬁrm value, but only in a subset of ﬁrms, speciﬁcally, in high-growth ﬁrms and ﬁrms with large amounts of litigation. Outside of this setting, however, the eﬀect of CEOs with legal training on ﬁrm value was negative. So companies in, say, the pharmaceuticals and airlines industries performed better when run by lawyer CEOs, all else being equal, while companies in, say, printing and publishing performed worse. This is perhaps because in low-litigation industries the beneﬁts of less litigation are oﬀset by lawyer CEOs’ overly cautious ﬁrm policies, which can negatively aﬀect cash ﬂows and growth.
Our research produces two conclusions. First, CEOs with legal expertise are eﬀective at managing litigation risk by, in part, setting more risk-averse ﬁrm policies. Second, these actions enhance value only when ﬁrms operate in an environment with high litigation risk or high compliance requirements. Otherwise, these actions could actually hurt the ﬁrm.
Ideally, of course, a CEO would be the best of both worlds: able to reduce litigation through prudent decision making while also knowing when to take risks to enhance value for the ﬁrm.