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Risky Business: Promoting general counsel to the C-suite

Monday, April 1, 2019

C-suite GCs

Rewarding a high-performing manager or mid-level executive with a promotion to the C-suite is a common practice in many corporations, ideally producing a positive impact on the bottom line and perceived financial stability among stakeholders. But what about promoting those who have been trained in law rather than business?

According to research published in the Journal of Accounting and Economics co-authored by Kevin Koharki, an associate professor of accounting in Purdue University’s Krannert School of Management, the changing role of corporations’ general counsel (GC) and their increasing ascendance into senior management positions can produce less desirable outcomes.  

“The association between corporate general counsel and firm credit risk,” co-written by Koharki and Charles Ham, an assistant professor of accounting in the Olin Business School at Washington University, found that among the sample of S&P 1500 firms analyzed, the number of GCs holding a C-suite position increased from about 20 percent in 1994 to nearly 50 percent in 2012.

“The promotion of a GC to the C-suite can potentially impact a number of corporate activities,” Koharki says. “They have traditionally served as internal monitors and gatekeepers who ensure that firms and their employees act legally and responsibly.

“As the ‘best practices’ of their respective businesses continue to evolve, however, the responsibilities of a GC become more complex and often include more advisory and entrepreneurial roles that require an understanding of business, project management, marketing and other key functions.”

According to Koharki, the trend becomes dangerous when there are incentives for a GC to abdicate his or her key responsibilities as a gatekeeper to become more of a partner to the CEO in generating growth and gaining a competitive edge.

“There are tradeoffs and costs associated with GCs in the C-suite that represent potential conflicts of interest,” he says. “Although there may be positive outcomes that offset such tradeoffs, our study focuses on the debt market, particularly credit rating agencies and how they determine a firm’s risk and likelihood of repaying their debts.”

Specifically, Koharki and Ham found firms that appoint a GC to the C-suite experience increased overall credit risk, as measured by worsened credit ratings and increased credit default swap spreads. These changes predominantly occur in the one- and two-year periods immediately following such appointments, which suggests their findings are not a result of changes in credit risk over time. 

“This could have far-reaching implications,” Koharki says. “If a firm’s credit rating gets downgraded because of the risk that credit rating agencies feel is inherent with a potential tradeoff between the GC and the CEO, their borrowing costs go up. Depending on where the bonds are trading and how they are rated, certain institutions may no longer be able to own them.”

Indirectly, this could have negative implications for individual shareholders and bondholders, he says, as well as for investors whose retirement portfolios or pensions include mutual funds made up of numerous securities.

Although some concerns about lapses in the gatekeeping role of GCs were addressed with passage of the Sarbanes-Oxley Act (SOX) after the failure of Enron, WorldCom and other notable firms in the early 2000s, the study’s findings suggest that this was only a partial fix.

“The limitations of assigning personal liability to GCs and other senior managers through SOX are significant,” he says. “Instances of corporate negligence or malfeasance will continue to occur despite the best efforts of regulators.”

Source: Kevin Koharki

Writer: Eric Nelson

An abstract and downloadable PDF of “The association between corporate general counsel and firm credit risk” is available at https://doi.org/10.1016/j.jacceco.2016.01.001.