Warning: Giving General Counsel bottom line responsibility may be risky for firm’s credit health
A firm’s General Counsel (GC) has traditionally been a gatekeeper, serving as an internal monitor to ensure that executives and employees follow “best practices” and act legally. Over the past several decades, the role of the GC has evolved. A significant change is the appointment of attorneys in the GC position to senior executive leadership posts. In this new role, the GC not only serves as a legal advisor to the CEO, but also becomes an integral member of a firm’s top management team.
When a GC takes on a new role in a firm, there is evidence that the legal gatekeeper responsibilities of the position are de-emphasized in favor of efforts to facilitate company growth and economic success.1 New research from Olin examines, for the first time, how the new role of the GC in company management is viewed by debt market participants and what effect it may have on a firm’s credit risk. The debt market offers a unique setting to examine this relationship because debt market participants are highly skilled at incorporating “soft” information, such as the makeup and perceived integrity of senior management, in formulating risk assessments.
The Olin study is based on a large data set of nearly ten thousand annual firm-level credit rating observations between 1994 and 2013, and more than three thousand annual credit default swap (CDS) spread observations between 2001 and 2013. The researchers test the hypothesis that there is a positive association between appointing a GC to senior management and the debt market’s perception of the firm’s management as reflected in credit ratings and other credit risk data.
Although Sarbanes-Oxley partially reduced the credit risk associated with appointing a C-Suite GC, we find that it did not completely alleviate bond market participants’ concerns. This is significant as it highlights regulators’ limitations in assigning personal liability to corporate officers and provides some evidence as to why periods of corporate malfeasance occur despite regulatory changes.
Previous research by Professor Ham found that the number of S&P companies with a GC in senior management increased from 21 percent in 1994 to 47 percent in 2013. As companies weigh the costs and benefits of appointing the GC to a senior leadership position, the results of this study could have a significant impact on the decision.
First, the study found that firms with a GC serving in a senior management position were perceived by debt market participants as bearing greater overall credit risk, as reflected in these firms’ assigned credit ratings and CDS spreads. Next, the research documented that market participants adjust ratings relatively quickly in order to incorporate the appointment of the GC to senior management. In fact, debt market participants responded, on average, within one and two years following such an appointment. Finally, after the passage of the Sarbanes-Oxley Act of 2002—legislation that included measures to strengthen the penalties on corporate executives for malfeasance—the impact of GC appointments on credit ratings was only partially alleviated.
KEY TAKEAWAYS FOR MANAGERS
- A firm whose General Counsel serves in a senior management position is perceived as exhibiting greater overall credit risk.
- Debt market participants adjust credit ratings and CDS spreads relatively quickly in order to incorporate “soft information” related to the appointment of a firm’s General Counsel to senior management.
- Passage of the Sarbanes-Oxley Act of 2002 has not fully alleviated the perception of increased risk that goes along with appointing the General Counsel to senior management.
The findings imply that bond market participants perceive GC appointments to senior management as potentially impairing these individuals’ gatekeeping responsibilities, resulting in greater overall credit risk for their firms. Professor Koharki explains that “the debt markets are cognizant of the fact that general counsels may reduce their gatekeeping functions when appointed to senior management, so the conflict of interest may cause them to become an adversary to the CEO or the board instead of being an independent watchdog of the company.” Additionally, the results imply that credit-rating agencies continue to view GC appointments as somewhat riskier even after new regulations were enacted to mitigate these risks. Thus, the authors conclude that in weighing the net benefits and costs of appointing a GC to senior management, managers should consider the overall impact and potentially lasting effects of this perception on risk evaluations.
“The Association Between Corporate General Counsel and Firm Credit Risk”
Kevin Koharki, Assistant Professor of Accounting, and Chad Ham, Visiting Assistant Professor of Accounting, Olin Business School, Washington University in St. Louis
Journal of Accounting and Economics, 10 May 2016.
1 Association for Corporate Counsel, 2013. Skills for the 21st century general counsel. Association for Corporate Counsel, 2015. Chief legal officers 2015 survey.
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