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 non-lawyer 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.

Original Article