The accepted wisdom is that a lawyer who represents herself—by acting as both a lawyer and a director—has a fool for a client. In our working paper, Lawyers and Fools: Lawyer-Directors in Public Corporations, my co-authors, Lubomir Litov and Simone Sepe, and I explain why the accepted wisdom is outdated. The benefits of lawyer-directors in today’s world significantly outweigh the costs. Beyond monitoring, they help manage litigation and regulation, as well as structure compensation to align CEO and shareholder interests. On average, a lawyer-director increases firm value by 9.5 percent, and when the lawyer is also a company executive, the increase rises to 10.2 percent. During our sample period, 2000-2009, the result was an almost doubling in the percentage of public companies with lawyer-directors.
Our paper is the first to analyze the rise of lawyer-directors. It makes a variety of other empirical contributions, each of which is statistically significant and large in magnitude. First, it explains why the number of lawyer-directors has increased. Among other reasons, businesses subject to greater litigation and regulation, and firms with significant intangible assets (such as patents), value a lawyer-director’s expertise. Second, our paper describes the impact of lawyer-directors on corporate monitoring. Among other results, it shows that lawyer-directors have a positive effect on board structure and takeover protections that could otherwise cause a decline in firm value. Finally, our paper analyzes the significant reduction in risk-taking and the increase in firm value that results from having a lawyer on the board.
The paper’s approach to the board differs from the standard framing common in much of corporate law scholarship. That model focuses on the internal costs that arise from separating ownership and control and the various means (such as board monitoring) to minimize them. Our study looks outside the corporation to external factors—the business environment in which the firm operates—that can also affect firm value and, in turn, the board and its composition. In addition, we look at the experience and skills that lawyer-directors bring to managing the business. The results suggest that an “ideal” board is likely to reflect external circumstances that are particular to each firm. By filling substantive gaps in how the company is managed, board composition can increase firm value. Interfering with the ability of shareholders and directors to order their own affairs potentially imposes a less-efficient, less-flexible model on organizations with different needs and characteristics.
Our findings fly in the face of requirements that focus predominantly on director independence. Board composition—and the training, skills, and experience that directors bring to managing a business—can be as or more valuable to the firm and its shareholders. Our intuition is that a lawyer-director brings a special perspective based on her training and experience with the law and legal issues and an appreciation of doing things “by the book” that likely comes with it. Thus, lawyer-directors have a risk-reducing effect on the overall level of risk a firm will assume. That outcome appears to be as much the product of efforts by lawyer-directors to enhance internal governance as it is a response to litigation and regulation. The result is greater firm value, but based on the particular management skills and experience that directors bring to the job rather than independence.
The full working paper is available here. Questions and comments are welcome.