Financial Fraud, Director Reputation, and Shareholder Wealth

TLDR

We investigate the reputational impact of financial fraud on outside directors using a sample of firms that faced shareholder class action lawsuits. Following a fraud lawsuit, outside directors do not experience abnormal turnover on the sued firm’s board but lose other board seats, especially when allegations are severe or the director bears greater monitoring responsibility, while interlocked firms sharing directors see valuation declines at filing and fraud‑affiliated directors are more likely to leave firms with stronger governance, with their departure associated with valuation increases for those firms.

Abstract

We investigate the reputational impact of financial fraud for outside directors based on a sample of firms facing shareholder class action lawsuits. Following a financial fraud lawsuit, outside directors do not face abnormal turnover on the board of the sued firm but experience a significant decline in other board seats held. This decline in other directorships is greater for more severe allegations of fraud and when the outside director bears greater responsibility for monitoring fraud. Interlocked firms that share directors with the sued firm exhibit valuation declines at the lawsuit filing. Fraud-affiliated directors are more likely to lose directorships at firms with stronger corporate governance and their departure is associated with valuation increases for these firms.