The Law-Abiding Executive

The law can be a manager’s best friend or worst enemy. One attorney maintains that b-schools must make sure their students achieve the legal literacy necessary to keep them on the right side of the law.
 
The Law-Abiding Executive

According to some estimates, CEOs spend approximately 20 percent of their time dealing with legal issues; yet their formal business education typically leaves them ill prepared to deal with matters related to the law. Doing business without understanding the legal system is like driving a car without understanding all the rules of the road. You could be buckled up, obeying the speed limit, and paying the utmost attention to safety—but you’re still headed for disaster if you’re driving on the wrong side of the white line.

Today more than ever, executives need a basic education in legal literacy, because the law touches virtually every decision a manager makes. The wrong decision—or the right decision made too late—can cause a small problem to mushroom to a crisis. Meanwhile, more regulation, more personal liability, more criminalization of civil wrongs, and more multibillion dollar verdicts significantly raise the overall cost of doing business.

In the U.S., for example, the Sarbanes-Oxley Act is a recent regulatory buzz saw that has ripped through publicly traded companies. The law was adopted in an effort to restore investor confidence in the wake of the Enron and WorldCom scandals. Yet, rigorous deadlines for compliance with SOX and the high costs associated with it have left some executives so battle-fatigued they just want to leave all legal issues to the lawyers. But they can’t; managers, not lawyers, are the frontline decision makers.

The best course of action is to incorporate legal literacy into the business’s decision-making process. Legal literacy lets managers avoid predictable surprises and control legal costs that could otherwise detract from their bottom line. Best of all, it lets them manage the company’s legal risk instead of being managed by it. This leverages the law into a strategic competitive business advantage.

It Starts with Education

Traditional business educators focus on so many issues vital to commerce—accounting, finance, marketing, operations management—but ignore the legal risks that can derail their students’ success in all these business areas. Even worse, I have seen professors sometimes treat these legal issues with disdain.

Take, for example, the finance professor who tells his students that insider trading laws undermine market efficiency. While that conclusion may have some mathematical merit, it fails to respect the fact that markets serve society, and society values fairness. The use of inside information is unfair. To keep markets equitable, we have laws and regulations that set the standard for acceptable behavior.

Another example is the accounting professor who says it’s pointless to have laws discouraging accountants from preparing the books they will later audit because no firm would damage its reputation by acting improperly and risking a conflict of interest. That comment, which I heard prior to the Enron-Arthur Andersen debacle, ignores the realities of decision-making psychology. In the case of Andersen, the members of the accounting team were motivated to keep the client happy because they were experiencing the loss aversion associated with the fear of losing millions of dollars in revenue. They developed a decision-making blind spot that ultimately led to Andersen’s demise.

Too many managers are focused on one area of business—the balance sheet or the marketing challenges—to notice that they might be in legal trouble in some broader area like employee relations.

I’ve also seen the law disregarded in a class where the professor discusses what happens when business negotiations break down. Instead of focusing on the substance of negotiation and why it’s important to understand differing points of view, this professor disparages lawyers in general. Unfortunately, his attitude leaves students with the impression that the law and lawyers are inconvenient roadblocks.

Such attitudes—especially those that paint lawyers as redundant or even detrimental to business—unwittingly promote overconfidence in business students and lead them to believe that the ends justify the means. Worst of all, students who take on these same attitudes tend to engage in aggressive business practices once they become managers. They are prone to take extra legal risks—triggering legal liabilities ranging from negligence to brazen malfeasance—because they fail to recognize until it’s too late the avoidable opportunity costs the legal system imposes on them.

If these managers continue to pursue aggressive at-risk business behaviors, their bad habits eventually will catch up with them. Their pricing strategies will run afoul of antitrust laws, their accounting will invite regulatory scrutiny, or their employment practices will result in class action lawsuits. At that point they’ll be learning about legal risk management the hard way, through expensive trial and error—or worse, error and trial.

Ethics Versus Law

Many business school administrators believe they are already addressing the issue of aggressive, overconfident managers. In the post-Enron environment, schools have placed a renewed emphasis on ethics, but most of these courses fail to explore the overlap between law and ethics. Even more rarely do they tap into the spectrum of legal tools available to achieve superior business performance.

I know of only one top business school—the Wharton School of Business at the University of Pennsylvania—that includes law as one of its five required core disciplines. Other schools typically offer business law as an elective or not at all. In those electives, the school focuses on institutional issues such as the branches of government, the court system, and basic business law concepts. The rudimentary approach explains key concepts but affords students little opportunity for applying them strategically.

Sometimes business schools will supplement their curricula with courses from the law school that focus on corporate governance and organizational structure issues. These issues impact long-term strategy, but ignore routine day-to-day business transactions—where many managers can get into trouble.

Ironically, at most schools, business students are not allowed to enroll in first-year law courses, such as contracts and torts, that would be more relevant to their careers. But even if they were, classes offered in classic law school style would be of little help. Law students use the Socratic method to deconstruct appellate legal decisions, studying what doesn’t work to figure out what might work. This system isn’t of much use to business managers who are trying to look forward and manage latent legal risk in their enterprises.

If the law school case method is unsatisfying for business students, and typical ethics courses don’t teach them what they need to know, how should they learn about managing a business’s legal risks? I believe the best solution is a cross-functional, integrated legal literacy course that combines elements of both business and law.

Crafting a Course

When designing a legal literacy course, a school must strike the right balance between helping students reach an intellectual understanding of core concepts and giving students the tools to apply them. A school might offer one course that spans two semesters, a one-semester course, or a combination of introductory and upper-level business law courses. Generally speaking, a successful legal literacy course has three components: the right content, the right presentation, and the right teachers.

Content. Business and law speak different languages. When studying legal literacy, business students first must build their legal vocabularies. But a word of caution: A vocabulary data dump can quickly turn into “buzzword bingo” if the data is not enriched by context—if the legal concepts are not explained in terms of how they can affect an executive’s day-to-day decision making.

Case studies that allow students to see the concepts in action help drive home key points. Take, for example, the concept of joint and several liability. In a joint venture situation, all of the joint venture partners are on the hook for all of the liability incurred by any one of them. Most people assume that liability among partners is proportional. Common sense suggests that an individual is only responsible for his own actions.

Joint and several liability, however, is imposed by operation of law. It allocates the responsibility automatically for everyone whether they know it or not—and therein lies the problem. A case study could present a joint venture in which one partner is a wheeler-dealer with a high risk tolerance. Scenarios could show how quickly cash flow projections are invalidated when he makes one false move and everyone else becomes responsible for his actions.

Once the hidden risk of joint enterprise is unmasked, business professors can use the case to show how ignorance of the law might drive a business into bankruptcy. Such context also gives the professor an opportunity to teach risk management techniques such as contractual indemnity provisions and due diligence. Best of all, students learn the ability to minimize risk while maximizing opportunity.

Given that the MBA curriculum is already a crowded roster, most schools do not have the luxury of offering a wide variety of business law courses. That’s why they need to make the few courses they do have count. Securities law and the specifics of insider trading may be sexy, but not every business is publicly traded. Spending precious classroom time on a legal subject with marginal value dilutes the legal literacy experience. Instead, a legal literacy course should include concepts that the majority of students will encounter and that affect the widest range of industries.

Presentation. A legal literacy course should show students how legal issues are part of the chaotic mix of day-to-day business and how these issues are attached to decisions that executives make every day. It should give students the ability to notice what’s going on around them that could potentially cause trouble. Too many managers are focused on one area of business—the balance sheet or the marketing challenges—to notice that they might be in legal trouble in some broader area like employee relations.

In a famous Harvard psychology experiment, volunteers were told to view a short film of a basketball game and count the number of passes the players made. Partway through the film, a man dressed in a gorilla suit walked into the room, tried to distract the volunteers by beating his chest, and then walked out. Half of the volunteers were so intent on watching the basketball players that they did not notice the gorilla. The corollary lesson is that when managers concentrate too hard on one area of business, they miss issues related to another area. They can’t afford such a narrow focus.

Business educators can help put students on the right side of the law by teaching them to appreciate the central role law plays in business sustainability.

The best learning experiences simulate real-world corporate pressures. For example, when Andrew Grove was CEO of Intel, he wanted to ramp up his employees’ knowledge of antitrust law. Recognizing that perfunctory rules and training would not be enough, he used hands-on training to embed antitrust compliance deep into the corporate psyche.

The way other companies would practice fire drills, Intel practiced antitrust compliance, conducting random audits and collecting the kinds of documents the Department of Justice or the Federal Trade Commission might demand in a subpoena. Mock depositions were conducted as part of the simulation to duplicate the experience of what it’s like to be grilled by a hostile lawyer. Firsthand experience is a powerful teacher, and this was reported to be among Intel’s most effective tools. Once managers have watched opposing counsel lob a grappling hook into their documents, they are much more cautious about what they say and how they say it.

Other companies use the same technique to practice their crisis management skills. Typically only the CEO and the general counsel have advance notice of the crisis management fire drill. After all, dealing with the unexpected is the whole point. During a monthly staff meeting, for example, a staffer might bring the senior vice president a note about an urgent customer matter or a sexual harassment complaint. Will the manager’s response contain the liability, or will the situation escalate? Will the company’s written crisis management plan even be consulted?

Live simulations can be extremely effective in the classroom, too, as Duke University has proved in its Corporate Education division. In a leadership course, student teams are assigned to disassemble and reassemble certain parts of real race cars. This exercise tests decision making and leadership skills in a way no abstract lecture or written case study ever can. It forces students into active learning and creates a memorable experience with much more staying power than any lecture.

Thus, simulations or hands-on exercises are excellent ways of reinforcing the importance of legal literacy in the minds of business students. They expose deficiencies and help hone decision-making skills. They increase the likelihood of law being an integral part of the knowledge base when real-world pressures conspire to keep executives from seeing the gorilla in the room.

Instructors. Ideally, business law instructors should have one foot planted in the academic world and one planted in the real business world—although the edge may go to those with broad hands-on business experience. Many law school professors have not practiced law beyond the level of a third- or fourth-year associate at a prestigious firm. As a result, they have not been privy to partner-level client discussions and the strategizing that lies at the heart of preventive law. On the flip side, law professors who practiced law long enough to attain partner status might have been too specialized in their careers; they might not have the necessary breadth of experience to teach a legal literacy course.

The legal literacy course really calls for a corporate generalist, who most often can be found within an organization’s in-house legal department. Such generalists have close ties to management and a better understanding of the business issues managers wrestle with every day. A lawyer with an MBA or business management experience often can integrate law into business seamlessly. One of the highest compliments I ever received came from a student who said he didn’t think of me as a lawyer, but as a businessperson who happens to be a lawyer.

If a school has trouble locating an academic with practical legal experience, administrators could design a course that is team taught by an academic and a practitioner. Of course, team teaching requires a high level of mutual respect and partners who pull their respective weight. The disdainful finance professor mentioned earlier need not apply to team teach such a course; neither should the stereotypical, arrogant lawyer. The team needs a collaborative mindset to successfully prepare business students for the legal challenges they will face in the working world.

Signposts to Success

Business educators can help put students on the right side of the law by teaching them to appreciate the central role law plays in business sustainability. If students develop legal literacy, they gain a tool that they can use as a competitive business advantage when they’re executives. A well-designed interdisciplinary course provides a legal road map for new graduates who are just learning how to navigate the road to running a business.

Hanna Hasl-Kelchner is a corporate lawyer whose career spans private, government, and in-house practice. She is a former adjunct professor at Duke University’s Fuqua School of Business, where she taught legal leverage in full-time and executive MBA programs. She is currently associate general counsel and national counsel for trademark enforcement at Lorillard Tobacco Company. A frequent guest speaker on the subject of preventive law, she is also the author of the 2006 book The Business Guide to Legal Literacy: What Every Manager Should Know About the Law. She writes a blog about the topic on www.legalliteracy.com.