Are Corporate General Counsels in Top Management Effective Monitors? Evidence from Stock Price Crash Risk

Abstract

We find that firms with a top management counsel (TMC) have lower stock price crash risk than other firms. We further show that firms with a TMC issue more negative relative to positive earnings guidance and use more negative relative to positive words in their annual report filings, compared to firms without a TMC. TMCs are more effective in mitigating crash risk when they serve on the board. Our findings support the monitoring role of TMCs in mitigating bad news hoarding, which, in turn, contributes to the reduction in crash risk.

Keywords:

• Corporate general counsel
• Discretionary accruals
• Opaque financial reports
• Stock price crash risk

JEL codes:

• M41
• M51
• G34
• G14

Acknowledgments

We gratefully acknowledge helpful comments from Mary Ellen Carter (Editor of European Accounting Review), two annonymous referees, Renee Adams, Avanidhar Subrahmanyam, Michael Theobald, Andreas Andrikopoulos, Cameron Truong, and participants at the PhD symposium associated with the 2017 Financial Markets and Corporate Governance conference, 2018 Financial Markets and Corporate Governance conference, 2018 Multinational Financial Society Conference and seminar series of La Trobe University. Balasingham Balachandran acknowledges the funding support from La Trobe University Social Research Assistance Platform grant.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Data Availability

Data are available from the public sources cited in the text.

Notes

1 The Association of Corporate Counsel (2015) documents that 60% of CGCs have shown strong interest in helping CEOs concerning key strategic business decisions.

2 See, for example, Hutton et al. (2009) and Kim et al. (2011a) for evidence of bad news hoarding via earnings management and tax avoidance, respectively, as a means of instigating crash risk.

3 In 2017, the U.S. District Court in Tampa, Florida, jailed former WellCare Health Plans, Inc., general counsel Thaddeus Berede for engaging in a $35 million health care fraud scheme. Similarly, in 2013, Joseph Collins, a corporate lawyer representing Refco, Inc., was sentenced to two years in prison for his role in a $2.4 billion fraud.

4 We also find similar results using a caliper of 0.01. However, we present the results using a tighter caliper (0.005), since it leads to greatly reduced bias and improves the performance of the PSM (Lunt, 2013).

5 We also use several other alternative definitions of TMCs to minimize the concern of the inclusion or exclusion of CGC in defining a firm as having a TMC and discuss the results in Appendix C. Our results hold for these alternative measures of TMCs.

6 For example, in 2003, approximately 13.91% of firms had TMCs serving on the board. By 2009, approximately 32% of our sample firms had TMCs serving on the board. We also find that the percentage of TCMs serving on the board in our sample increased from 2009 onward.

7 Our results should be interpreted with caution because of potential multicollinearity issue since we observe a coefficient of correlation of 0.3382 between CEOINCENT and CFOINCENT at the 1% significance level.

Additional information

Funding

This work was supported by La Trobe University Social Research Assistance Platform grant.