Banking on the Lawyers

Abstract

This Article is the first to analyze an unexplored but critical change in how modern banks are governed: the rise of lawyers as bank directors. That rise has been precipitous, raising the question of why lawyer-directors now sit on most bank boards.

Using novel empirical evidence, we show that lawyer-directors at banks are associated with efficient changes in risk management and significant increases in bank value. In particular, banks with lawyer-directors assume more risk in ordinary (non-crisis) circumstances and less risk when a crisis arises, in each case in a way that makes banks more valuable. Lawyer-directors do this by drawing on advocacy skills to critically analyze opposing points of view, an essential quality in managing the risks banks face today. They are also more likely to make complex information, sourced from multiple experts, more accessible to a bank’s board as part of its decision-making process. Finally, lawyer-directors are skilled at assessing litigation and regulatory risks, which have grown significantly in recent years.

Risk management failures were a primary cause of the 2008 financial crisis, prompting two principal regulatory responses: stricter capital requirements and enhanced governance. Their effectiveness remains hotly debated. Our findings have two important implications. First, we challenge the notion that stricter regulation is sufficient for efficient risk management. Rather, to manage a bank, directors must have the skills to think critically about risk. Second, we underscore the value of director expertise, showing that more is needed than simply the director’s independence now mandated by law.

Keywords: bank governance, risk management, lawyer-directors, financial crisis, corporate governance

JEL Classification: K2, K22, K23, G01, G18, G21, G22, G23, G24, G28, G32