In the corporate governance literature, there’s little about the corporate secretary, an information intermediary for the board, who attends all board meetings and serves a role inextricably linked to the risk of litigation. Corporate secretaries (CSs) advise the board and facilitate communication between the board and various stakeholders. Additionally, they document the board’s deliberations ensuring that the decision-making process can withstand legal scrutiny. Given the nature of these responsibilities, many CSs also serve as chief legal officers (CLOs) of the corporation. However, while this governance structure ensures that CSs have a deep understanding of the firm’s legal environment, their dual roles may give them conflicting incentives that could increase the risk of litigation. In a new study, we focus on these conflicts by examining whether firms where the corporate secretary also serves as the chief legal officer (“CLO duality”) are more likely to face legal problems.
Drawbacks of CLO Duality
Since CLOs are typically hired by and report to the CEO, they may view the CEO as their primary supervisor. As a result, in their capacity as CSs, they may cast their communications with the board in overly positive terms or, in extreme cases, intentionally mislead the board to protect or curry favor with the CEO. Consider the case of Apple’s former CS and CLO, Nancy Heinen, who falsified documents and misled the board to cover up the backdating of stock options granted to herself and other executives. Conflicts of interest are especially relevant when they relate to legal issues because the board oversees the legal strategy based on information provided by the CS/CLO who ultimately developed the strategy. These conflicts may expose firms to greater legal risks. We refer to this as the “conflicted” explanation.
Benefits of CLO Duality
The CLO is responsible for identifying and mitigating legal risks and challenges facing the firm as it executes its operating strategy. They are well positioned to inform and advise the board and ultimately avoid or remediate potential legal issues. Furthermore, as legal experts, they know how to develop processes and documentation to defend against potential legal claims. This firm-specific legal expertise could reduce litigation risk. We refer to this argument as the “expert” hypothesis.
Empirical Analyses and Findings
In our study, we first identify the determinants of CLO duality, focusing on characteristics associated with litigation risk. CLO duality firms are more likely to operate in a high litigation-risk industry, have a higher standard deviation of returns, be smaller, and have greater board independence than firms without CLO duality. Importantly, the first two of those four determinants suggest that firms with CLO duality would be more likely to face shareholder litigation than non-CLO duality firms, while the latter two would suggest the opposite.
To test whether the conflicted or expert hypothesis dominates, we examine the relation between CLO duality and the likelihood of shareholder litigation, regulatory violations, and penalties levied for regulatory violations. We examine these outcomes because the CLO has legal expertise, and legal risks can impose significant financial and reputational costs. Furthermore, managing legal risks is a priority for corporate boards, as they may be subject to civil and criminal liabilities for failing to properly exercise their fiduciary responsibilities.
Based on a sample size of approximately 12,000 observations, our initial tests show that firms with CLO duality are less likely to be targets of shareholder litigation and commit regulatory violations; they also pay 50 percent fewer penalties for those violations. We find similar results (except for the likelihood of a violation) in multivariate tests where we control for CLO compensation, firm size, industry risk, sales growth, stock returns, stock return skewness and volatility, and firm age. Overall, these results are consistent with the “expert” hypothesis as CLO duality is associated with a lower likelihood of facing legal issues.
We next explore whether our results are driven by firms switching from CLO duality to non-CLO duality (separating the roles). We find that 105 firms in our sample combine the CLO/CS roles, while only 57 separate the roles. In addition, in our regression analyses, we find that the results are generally concentrated among firms that combine the CS/CLO roles. Overall, our results show that firms switching to combined CS/CLO roles are less likely to violate regulations and receive lower penalties when they do so.
Next, we consider the impact of board independence since independent boards are likely to be more effective monitors. Our results are concentrated among firms with a high proportion of independent directors, suggesting a complementary relationship between CLO duality and board independence. This suggests that firms with an “expert but conflicted” CS (regarding legal issues) that include a high proportion of outside directors are less likely to have legal problems.
Lastly, since the second most common pairing of a CS with another officer is with the Chief Financial Officer (CFO) we examine whether the expert hypothesis also applies to joint CS/CFO roles (“CFO duality”). Specifically, we examine the relation between CFO duality and the likelihood of a financial restatement and find that firms with CFO duality issue 1.5 percent fewer restatements. Further, we find that this result is driven by revision (“little r”) restatements, indicating that firms with a financial reporting expert as CS require fewer financial statement revisions.
Collectively, across various tests and settings, we find that CLO duality is associated with fewer incidents of shareholder litigation and lower regulatory penalties. We also find that firms with a combined CS and CFO issue fewer restatements. Our results are broadly consistent with the CS serving an important governance role in modern corporations.
This post comes to us from Jagadison K. Aier at George Mason University, Justin Hopkins at the University of Virginia’s Darden School of Business, and Syrena Shirley at Columbia Business School. It is based on their recent article, “An Examination of Legal Risk When the Corporate Secretary is the Chief Legal Officer,” available here.