Reputation Penalties for Poor Monitoring of Executive Pay: Evidence from Option Backdating

We study whether outside directors are held accountable for poor monitoring of executive compensation by examining the reputation penalties to directors of firms involved in the option backdating (BD) scandal of 2006–2007. We find that at firms involved in BD, significant penalties accrued to compensation committee members (particularly those who served during the BD period) both in terms of votes withheld when up for election, and in terms of turnover, especially in more severe cases of BD. However, directors of BD firms did not suffer similar penalties at non-BD firms, raising the question of whether reputation penalties for poor oversight of executive pay are large enough to affect the ex ante incentives of directors.