Executives' Legal Expertise and Corporate Innovation

• Published date: 01 November 2024
• Author: Yunhao Dai,Xinchu Tong,Xiao Jia
• Date: 01 November 2024
• DOI: http://doi.org/10.1111/corg.12578

Corporate Governance: An International Review, 2024; 32:954–983

https://doi.org/10.1111/corg.12578

Corporate Governance: An International Review

ORIGINAL ARTICLE

Executives' Legal Expertise and Corporate Innovation

YunhaoDai1,2 | XinchuTong1 | XiaoJia 1

1School of Economics, Hua zhong University of Science and Technolog y, Wuhan, China | 2Re search Center for Contemporary E conomics, Huazhong

University of Science a nd Technology, Wuhan, China

Correspondence: Xi ao Jia (jiaxiao@hust.edu.cn)

Received: 8 June 2023 | Rev ised: 12 January 2 024 | Accepted: 23 Janua ry 2024

Funding: Dai was supported by the Nat ional Natural Science Foundation of C hina (Grant Nos. 71991473 and 723720 48), the Young Top- Notch Talent

Cultivation Prog ram of Hubei Province, and the Hua zhong University of Science and Tech nology Double First- Class Funds for Humanities and So cial

Sciences. Jia was s upported by the National Natura l Science Foundation of China (Grant No. 720 02077) and the Fund amental Research Fund s for the

Central Universities H UST (Grant No. 2172021WKY XQN011).

Keywords: corporate gover nance | corporate innov ation | legal expertise | pat ent litigation

ABS TRAC T

Research Quest ion: This study investigates whether and how executives with legal ex pertise impact corporate innovation.

Research Find ings: Using a sample of listed firms in China, we have the following findi ngs: (1) Firms that hire executives with

legal expertise are associated with more corporate innovation. (2) These firms talk about potential legal risks and legal advisors

more often in their annual reports and have lower chances of being sued in patent litigations. (3) The innovation- promoting effect

is stronger when the firms are state- owned enterprises, have more overseas revenue, operate in high- tech industries, have prior

patent litigation experience, and are in strong legal env ironments.

Theoretica l/Academic Implication s: The findings indicate that executives with legal ex pertise bring more attention to legal

risks and help the firm to shape a stable envir onment, which can effectively promote innovation activities. Also, the innov ation-

promoting effect of law yer executives complements the role of in- house legal counsels and the external legal environ ment. This

paper adds to the literature on the value of executives w ith legal background.

Practit ioner/Policy Implicat ions: Our results emphasize t he important role played by executives w ith legal expertise in cor-

porate innovation. Given the continuing shortage of legal talents and the g radual improvement of the legal system in China, firms

need to employ more legal talents to avoid potential legal risks and ma intain sustainable growth.

1 | Introduction

Innovation is v ital for both economic growth and a f irm's com-

petitive advantage (Porter1992; Romer199 0; Schumpeter193 4).

A grow ing number of studies document the wide range of fac-

tors that af fect fi rm innovation, and an i mportant dimension

is the per sonal traits of t he managers, such a s over- confidence,

generalist skills, and foreign experience (Custódio, Ferreira, and

Matos 2019; He and Tian2018; Hirshleifer, Low, and Teoh2012;

Yuan and Wen2018). However, the role of executives with legal

ex per ti se i n co rpo rat e in nov at ion a ct iv iti es is sti ll un der ex plor ed .

Executives w ith legal expertis e, that is, t op executive team

members who have legal professional experience, are becoming

increasingly importa nt for firms. For instance, the Chinese tech

companies Alibaba and ByteDance both hi re executives with

professional law yer experience.1 As executives with legal ex-

pertise have a comprehensive understanding of the practice of

law, they can easily identify legal risks and i ncorporate these

concerns into the strategies of the fir m, especially when the in-

house counsels have weak positions in the c orporate hierarchy.

Exist ing literatu re has shown th at higher ex- a nte litigation ri sks

would increase investment uncertainties, drive managerial my-

opia, a nd reduce corporate innov ation (Hassan, Houston, a nd

Karim 2021; Mezzanotti 2021). Therefore, the empirical ques -

tion we aim to answer is whether and how the presence of exec-

utives with legal experti se promotes corporate innovation.

© 2024 John Wi ley & Sons Ltd.

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Due to its special institutional backgr ound, China provides an

ideal setting for th is t opic. Fir stly, the legal environment in China

has greatly improved si nce the national judicial reform in 200 4,

witnessing h igh numbers of patent applicat ions and litigations;

litigation an nouncements have signif icant and negat ive effects

on the stock price and performance of the defendants (Firth, Rui,

and Wu2011; Wu eta l.2020). Second ly, the in- house leg al coun-

sel2 in Chinese companies is featured w ith an inferior position

within the corporate hierarchy, unlike the in- house counsels

in the United States who have a key role in c orporate decision-

making. While existing studies mostly foc us on the strong role

of in- house c ounsels in US fir ms (Black etal. 2021; Ha m and

Koharki20 16; Hopkins, Maydew, and Venkatachalam2015), the

institutional characteristics in China allow us to investigate the

complementary role of executives w ith legal expertise when the

in- house counsel has in ferior skill and position inside the firm.

Usin g a dataset of Chines e listed firms fr om 2008 to 2016, we sho w

that firms employing executives with legal expertise have an aver-

age of 17% more awa rded patents th an those without executives

with legal expertise. We also find evidence on how the presence

of executives w ith legal expertise promotes corporate innovation:

Firms t hat have executives w ith legal expertis e make more anal-

yses on legal risks i n the following- year annual reports, mention

more about the internal and exter nal legal experts, and have a

lower likeli hood to be sued in patent litigations. Overa ll, execu-

tives with legal expertise can provide a more stable environment

for the firm's investments and thus promote corporate innovation.

The above results may be subject to endogeneity concern s. For

example, there could be omitted variables that cause fir ms to

generate more patents and at the same time cause firms to hi re

executives with legal expert ise. To mitigate these concerns,

we conduct the following identif ication tests. First , we use

Heckman two- stage selection model to explore the determi-

nants of fi rms' decisions in hiri ng lawyer executives, ex ploiting

firm and regional characteristics that capture both the demand

and the supply for legal talents (F. Chen etal.20 21; Ellis , Fee,

and Thomas2 018) and then reexamine the baseline results after

accounting for the self- selection model. Second, we constr uct a

control group with a propensit y score matching approach using

firm and regional characteristics as matching variables to test

the robustness of our inferences. A ll results remain consistent.

We further examine the mechanism of how executives with legal

expertise promote corporate innovat ion. B ased on the textual

analy sis of annual repo rts, we find th at the presence of exe cutives

with legal expertise is associated with more mentions of legal

ris ks, as we ll as inte rnal and ex terna l legal advis ors.3 Usi ng paten t

lit igat ion da ta, we furt her fi nd tha t the pr esenc e of exe cuti ves wi th

legal expertise significantly reduces the firm's likelihood of being

sued in patent litigation. We infer that lawyer executives signifi-

cantly improve the awareness of potential legal risks, incorporate

legal concerns i nto firm strategies, and reduce the firms' risks of

bein g sued. By enablin g a stable env ironme nt throug h these activ-

ities, the fir ms can carry out more investments in innovation ac-

tivities. Our f indings are consistent with the ex isting studies that

show defendant fir ms become financial ly constrained and reduce

innovation activity (Cohen, Gurun, and Kominers2016; Lee, Oh,

and Suh2021; Mezzanotti20 21).

We a lso fi nd that the innovation- promoting effect of law yer

executives complements the role of in- house legal counsel and

the ext ernal leg al environ ment. Spec ifical ly, the relatio nship is

more pronounced when the firms are state - owned enter prises,

have more overseas revenue, operate in high- t ech industries,

and have prior patent litigation experience. The relationship

is als o more pronounced for the f irms that are cross- l isted in

the Hong Kong St ock Exchange an d are located in c ities with a

stronger level of intellectual proper ty protection, lega l aware-

nes s, and ma rketi zation . In add ition, executi ves who are sen ior

(i.e., chief executive officer or vice chief executive officer) or

worked as a lawyer or an off icer in a corporate legal depart-

ment have a more significa nt impact on cor porate innovation

than others.

Our study contributes to the literature in three ways. First,

this paper contributes to the g rowing literature on the deter-

minants of corporate innovation. We show that executives'

legal expertise reduces uncer tainties a rising f rom litigation

risks a nd thus promotes corpor ate innovation activ ities. The

finding is incremental to the studies on the relationship be-

tween corporate innov ation and managerial pers onal traits,

such as over- confidence, milita ry experience, liability, for-

eign exper ience, and hometown identity (e.g., B enmelech and

Frydman 2015; Galasso and Simcoe 2011; Guan etal. 2021;

Hirshleifer, Low, and Teoh 2012; Ren etal. 2021; Yuan and

Wen2 018).

Second, this paper contributes to the evolving line of research

on the economic con sequences of hiring executive s with legal

expertise. Prior literatu re focuses on lawyer CEOs a nd the re -

lated economic outcomes, such as strategic disclosures of litiga-

tion losses and higher stock liquidity (F. Chen etal.2021; M. H.

Pham 2020). Although this paper focuses on the top manage -

ment team, our re sults suggest executives w ith legal expertise

matt er for sh aping a st able inv estme nt envi ronment and promo t-

ing innovation activities.

Finally, our finding complements the studies on the role

of general counsels or Chief Legal Of ficers (CLO) (Black

eta l. 2021; Ham and Koharki 2016; Hopkins, Maydew, and

Venkatachalam 2015; Jagolinzer, Larcker, and Taylor 2011).

By highlighting the in stitutional characteristics of Chinese

firms, we show that when the in- house counsels have a weak

position in the firm and inferior legal credentials, the execu-

tiv es wit h legal exper tise c ompleme nt the ro le of gene ral co un-

sels and inc orporate legal r isks into fi rm strategies . Thus, this

paper identifies the role of legal executives when the status of

in- house counsel is low.

2 | Institutional Background

2.1 | The In- House Counsels in the United States

and China

In t he United St ates, in- house counsels a re lawyers who are

employees of private busi ness corporations. Since the 1980s,

in- house counsel h as gradually gained a key role in the

decision- making process of companies, a nd the transforma-

tion is known as the “in- house counsel movement.” According

to legal studies, several reasons lead to the proliferation of

in- house lawyers in the United States. The foremost reason

is that legal service is business- specific and information cost

constitutes a form of transaction cost that can be internalized

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