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Stigmatization and Devaluation of Elites Associated With Corporate Failures: An Enhanced Model of “Settling Up”

Batia M. Wiesenfeld Stern School of Business New York University 44 West 4th St. (7-52) New York, NY 10012 Ph: (212) 998-0765 [email protected]

Kurt Wurthmann Columbia Business School Columbia University 3022 Broadway New York, NY 10027 Ph: (212) 854-2836 [email protected]

Donald C. Hambrick Smeal College of Business Administration The Pennsylvania State University University Park, PA 16802 Ph: (814) 863-0917 [email protected]

February 11, 2004

The authors wish to thank Caroline Bartel, Tim Pollock and the members of Wharton’s M2 group for their helpful comments on an earlier draft of this paper.

1 Stigmatization and Devaluation of Elites Associated With Corporate Failures: An Enhanced Model of “Settling Up”

Abstract

We develop a theoretical model for explaining the amount of professional devaluation, or

“settling up” (Fama, 1980), that a corporate elite member – an executive or director – will face following his or her association with a firm failure. Failure evokes a stigmatization process, whereby opinion-shapers assign blame and discredit the person’s professional identity. The greater the stigmatization, the more unwilling companies will be to have an association with the person, and the greater the professional devaluation. The amount of stigmatization the person encounters is shaped by four factors: 1) indicators of the person’s responsibility for the failure;

2) cognitive biases, which may exacerbate the assignment of blame; 3) emotional processes in assigning blame; and 4) the amount of social capital the person possesses.

2 In this age of free-flowing information, the top executives and directors who oversee major firms may understandably experience a form of vertigo. If their companies fail – because of misjudgment, misdeeds, or even bad luck – their communities and the entire business world are informed, and the leaders’ identities – their names and reputations – stand to be indelibly smeared. Although other organizational constituents will also suffer from the company’s failure, it will be those at the helm – the corporate elites – who will be stigmatized, in the spotlight of scorn, with no place to hide, and their careers in grave jeopardy. And according to many conceptions of leadership, this is as it should be. The captain goes down with the ship.

“Settling-up” is an essential, but often overlooked, premise of agency theory (Fama,

1980). According to this concept, corporate owners (principals) need not be overly concerned with closely monitoring the behaviors of the managers and directors (agents) they put in charge of their enterprises, nor even be worried about designing compensation plans that correctly recognize current performance; instead owners can rely on the fact that managers and directors will be motivated to do their very best by the prospect of future adjustments to their compensation – adjustments, or settling-up, that will be based on their prior performance. Such adjustments can be made at the focal firm or, more importantly, they can occur in external labor markets. For those managers and directors who have performed well, they can expect the labor market to confer positive identity and reputations, as well as increased opportunities for future appointments and greater rewards. For those who have performed poorly, the markets disseminate word about their failings, and their prospects are accordingly diminished. But how precise is the settling up process? When and why might punishment (or reward) in the labor market not correspond with the agent’s performance?

3 Empirical evidence suggests that corporate executives and directors experience professional devaluation when their companies perform poorly. They tend to be fired; they tend not to get rehired elsewhere; and those who do get rehired tend to do so in lesser capacities or at lesser firms (Cannella, Fraser, and Lee, 1995; Houston and James, 1993; Gilson, 1989, 1990;

Wiesenfeld, 1993). The notoriety that has recently befallen some of America’s corporate leaders reinforces the view that failed leaders face their day of reckoning. It is difficult to imagine such figures as Dennis Kozlowski of Tyco or Jeffrey Skilling of Enron – both of whom have been accused of ethical misdeeds that brought their firms down – ever working again (if they stay out of prison). Even executives who have been labeled as simply bad managers, such as Jill Barad of Mattel and Christopher Galvin of Motorola, seem to be largely derailed and shunted to the margins of the business world.

At the same time, however, there is anecdotal evidence that the settling-up process for corporate elites is exceedingly imprecise. Some figures that would seem to warrant sanction never skip a beat. For example, the investment guru and vice-chairman of Fidelity Management and Research Company, Peter Lynch, was a director of not one, but two, of the most visible corporate collapses of the 1990’s – Morrison Knudsen and W.R. Grace. Yet his name was rarely invoked in conjunction with these failures, and he went on to enjoy great acclaim after their occurrence.

Conversely, there are instances in which corporate leaders seem to be singled out as scapegoats and penalized far out of proportion to their culpability for their companies’ problems.

For instance, Lloyd Ward served as CEO of Maytag for only 15 months before being replaced in

November of 2000, amidst allegations of blame for the 59 percent drop in Maytag’s share value during his brief tenure (COMPUSTAT; ProQuest). Since his dismissal, Ward has not found a

4 comparable position and has lost his prestigious directorships at both Maytag and General

Motors. But Ward served at Maytag during very difficult times for the appliance industry, and the firm’s performance under his watch was actually not as bad as it was during the tenures of some other Maytag CEOs who somehow avoided stigmatization. For example, Maytag CEO

Daniel Krumm oversaw a drop in share value of 62 percent in 14 months in 1989-1990

(COMPUSTAT), yet he continued as CEO of the firm until his retirement in 1992 and then remained on the board (and other boards) for years thereafter.

Given the centrality of the corporate system in our modern economy (Berle and Means,

1938; Jensen and Meckling, 1976) and the expectation that settling up in labor markets will resolve corporate agency problems (Fama, 1980), there is a need to understand how the settling- up process occurs for elites who are associated with corporate failures. How do the apparent failings of elites become translated into diminished compensation and professional opportunities? What are the factors that cause settling-up to deviate from the straightforward calculus envisioned by agency theorists (e.g., Fama, 1980)? How is it that some elites who are associated with failures avoid paying much professional price, while others – who, on the surface, seem no more or less blameworthy – face the end of their careers? If, as Fama argued, settling-up is an essential ingredient in maintaining a viable separation of ownership and control in our system of collective capitalism, then these questions warrant close examination.

In this paper, we develop a theoretical model for explaining the amount of professional devaluation that a specific corporate elite member – an individual executive or director – will face following his or her association with a firm failure. Our model envisions that failure evokes a stigmatization process, whereby opinion-shapers (including the press, investment analysts,

5 academics, and the business community itself) discredit the professional identities of corporate elites, assigning blame and heaping scorn upon them.

The discrediting and denigration of leaders’ professional identities, in turn, triggers tangible economic loss. The greater the stigmatization of corporate elites, the more unwilling companies will be to have an association with them, and the greater the professional devaluation

(in terms of restricted access to positions and rewards) they will encounter. Stigmatization is thus the critical link between firm failure and the tangible devaluation, or settling up, the individual leader experiences. Our model thus differentiates between social stigmatization

(discredited identity) and professional devaluation (reduced access to positions and resources). In doing so, we depart from some psychological research that considers stigma a combination of social stain and tangible exclusion (Crocker & Major, 1989), primarily because we do not assume an exact correspondence between the two. Indeed, as we shall discuss, the two processes

-- social denigration and professional devaluation – involve somewhat different, but overlapping, parties.

We propose that the amount of stigmatization the person encounters is shaped by four factors: 1) indicators of the person’s responsibility for the failure (in the rational vein that agency theorists would anticipate); 2) cognitive biases, which may exaggerate (or diminish) the assignment of blame; 3) emotional biases exaggerating blame, notably a desire to see some elites humbled; and 4) the amount of social capital the person possesses. Thus, the model extends beyond the seemingly rational side of settling-up, as envisioned by Fama, to the social and psychological – in an attempt to develop a full and accurate portrayal of how elites are punished for their associations with failures.

6 The Stigmatization – Devaluation Process

The precipitating event in our model is a corporate failure which, in keeping with the economist’s conception of the impetus for settling-up, we define as an instance in which a company incurs a major loss in its market value. This loss may be abrupt or gradual; it may be attributed to acts of omission (e.g., failure to adapt) or acts of commission (e.g., excessive risk- taking); it may be attributed to business misjudgment or to ethical misdeeds that impair the firm’s legitimacy; it may be large enough to send the firm into bankruptcy or simply enough to wipe out a significant percentage of its value. Although we hesitate to specify how large a market loss must be in order to qualify as a failure (and we will later discuss the implications of the size and nature of the loss), in general we envision our model applying to situations in which the company loses over one-half of its market value (net of changes in the overall stock market).

The model pertains primarily to major publicly-held firms, but may also have relevance for comprehending settling-up following the failure of smaller or private companies.

The professional identity of corporate elites

The mediating mechanism in our model is the elite member’s professional identity as a corporate leader. Identity refers to the way that people define themselves and are defined by others, along with the value and status associated with such definitions (Deaux & Martin, 2003;

Stryker, 1980; Tajfel, 1981). An elite’s professional identity as a corporate leader is multi-layed but specific to the professional context (Deaux & Ethier, 1998). At the narrowest level, professional identity refers to attributes descriptive of the person, such as ‘charismatic’,

‘decisive’ or ‘intelligent’. At the relational level, professional identity refers to roles in interpersonal interactions, such as ‘liaison’ or ‘spokesperson’. At the collective level,

7 professional identity refers to category memberships, such as ‘board member’, ‘executive’, or

‘CEO’.

Identities are important for a variety of reasons. They provide the identity holder with a set of schemas and scripts that minimize uncertainty and guide thoughts, feelings and behaviors

(Hogg & Abrams, 1990). One’s identity also shapes the way that others interact with the person

(McCall & Simmons, 1978). The content and status of a person’s identity is thus a basis for self- esteem and self-definition (Tajfel, 1981); but it may have social and economic currency, as well.

As both a guide for behavior and a source of organizational status and legitimacy, a corporate elite’s professional identity is a barometer of his or her economic value in the managerial and director labor markets.

The professional identity of a corporate elite is a social accomplishment, achieved through a social negotiation process whereby the person and audience (or interaction partners) interactively claim and grant identity through words and actions both symbolic and substantive

(Bartel & Dutton, 2001; Deaux & Ethier, 1998). For example, a corporate leader’s identity claims are often apparent in internal communications, interviews with the press and analysts, and documents such as letters to shareholders. The resources and attention that leaders (and their public relations representatives) put into reinforcing their reputations provides evidence of how important it is to leaders to continually burnish their professional identities. Ultimately, however an elite’s claim to an identity may be either supported or rejected by others, including the press, employees, business peers, and others.

The stigmatization of failed corporate elites

When a company fails, those whose professional identities are closely tied to the organization are affected – particularly its leaders, or elites (Meindl, Ehrlich, and Dukerich,

8 1985). These elites include the company’s officers, who are the agents responsible for formulating and executing company strategy as well as for maintaining the overall health of the firm (Barnard, 1938; Selznick, 1957; Mintzberg, 1973); they also include the company’s directors, who are the owners’ paid delegates (or “supra-agents”) for overseeing management.

When a firm experiences failure, a social negotiation process is mobilized through which elites’ professional identities are revised. The elites leading the firm -- whose identities are tied to the firm’s identity and fortune -- are often themselves branded as failures (Sutton & Callahan, 1987;

Wiesenfeld, 1993). This process bears the hallmarks of stigmatization, whereby an individual is discredited and denigrated because a negative attribute is associated with his or her social identity (Crocker, Major & Steele, 1998).

As a social phenomenon, stigmatization is “sent” by interested parties to stigmatized targets in a process of social derogation (Goffman, 1963; Leary & Schreindorfer, 1998). In contemporary society, the observers of corporate leaders are numerous and have great reach, with the media playing a particularly substantial role in the stigmatization process. Chen &

Meindl (1991) described how the media glorifies leaders whose companies are performing well, but then will disparage the same leaders if their companies stumble. The media savors the extreme, and it attracts audiences by making the extreme as colorful and as laden with “the human factor” as possible (Gans, 1979; Gitlin, 1980; Katz and Dayan, 1986; Hayward, Rindova, and Pollock, in press). Therefore, it is common for press accounts of company failures to emphasize the role of the firm’s leaders in bringing about the problems. Moreover, because media outlets feed ideas to each other, this focus on the failed leaders may be repeated and embellished many times over (Berger and Luckmann, 1966; Salancik and Pfeffer, 1978).

9 The stigmatization of leaders can be driven by voices emanating from diverse channels not limited to the media, because stigmatization is based in the consensually shared values of an array of social observers (Crocker, et al., 1998; Kurzban & Leary, 2001). Supplementing the media in the stigmatization process are several other vocal forces, including investor advisory services and newsletters, such as Investor’s Business Daily; watchdog groups, such as the

Council of Institutional Investors; and academics, who often focus their attention on a company’s leaders when performance declines (Meindl, et al., 1985; Finkelstein, 2003).

The business community may join in the stigmatization process as well. As Sutton and

Callahan (1987) found, failed executives feel shunned by their peers and business acquaintances, who may withdraw their contact because of all the negative portrayals from other quarters, or who may be acting out of their own embarrassment for their peer or their desire to avoid contamination via “courtesy” stigmatization (Page, 1984). Members of the focal organization may join in the stigmatization process, by speaking vigorously to the press and others about the deficiencies of the firm’s leaders (or of a specific leader). They will do this in order to deflect blame from themselves, as well as to reassure outsiders that the source of the firm’s problems has been spotted and is now gone – i.e., to convey the message that the organization is now cleansed.

Professional Devaluation: The Settling-Up

Although most research on stigmatization emphasizes the cruelty of social denigration, some recent work has noted that stigmatization also plays an adaptive function in legitimating and maintaining a social system (Kurzban & Leary, 2001; Jost & Banaji, 1994). Namely, stigmatization leads to the marginalization and exclusion of actors who are genuinely dangerous

(Kurzban & Leary, 2001).

10 Stigmatization is in itself emotionally painful, but it engenders substantive loss as well.

When elites’ identities are spoiled, the resources and compensation they can command subsequently are diminished, which of course is the “settling-up” anticipated by Fama (1980). As a result of stigma, the person could experience various forms of substantive loss, including job dismissal, loss of board seats, inability to secure new employment or board seats, and extreme demotion in the size or prestige of business affiliations – any of which would cause a reduction in the person’s earnings and a substantive career loss. Empirical evidence indicates that stigmatized elites tend to pay a price in future wages, in both the managerial and director labor markets (Gilson, 1989; Cannella, et al., 1995; Yermack, in press).

Stigmatization leads to substantive devaluation through three interrelated conduits. First, the presence of a stigma is a signal of a person’s inferior abilities. According to agency theory

(Fama, 1980), managerial and director labor markets consider all available information about candidates in arriving at appropriate prices for their services. Accordingly, public information about inadequacy, as conveyed by a stigma, would have a negative effect on the elite’s employability and compensation. Second, and perhaps playing an even more important role in the devaluation process, is the social pressure on firms not to hire the stigmatized – especially for leadership positions. Organizations must convey signs of legitimacy and normalcy, in order to maintain favorable terms with their constituencies (Meyer & Rowan, 1977; DiMaggio & Powell,

1983). Hiring a visibly tarnished person as an executive or director would clearly be at odds with the requirement for legitimacy, and few firms would be willing to take that risk. Therefore, even if a company were to believe that a person had been unfairly or excessively stigmatized

(and perhaps that it could secure his or her capable services for a modest wage), the firm would feel extreme social pressure not to engage that individual. Third, stigmatized individuals are

11 likely to anticipate the reluctance of companies to make them favorable offers. Out of a desire to avoid this unpleasant reality, as well as out of a sense of shame and embarrassment, failed elites may be unwilling to present themselves as candidates for future leadership positions – employing a “covering” strategy, whereby those with visible stigmas attempt to make their stigmas as unobtrusive as possible (Goffman, 1963). To the extent that stigmatized elites who withdraw from labor markets would have preferred to continue their careers, this “voluntary” withdrawal still represents a form of professional devaluation.

We thus posit our baseline proposition:

Proposition 1: In the context of corporate failure, the greater the stigmatization of a corporate elite, the greater his or her subsequent professional devaluation.

We now turn to the factors that influence the amount of stigmatization a given individual will experience. We start with the rational evidence of the person’s responsibility for the failure.

Indicators of the Person’s Responsibility: Signs of Blameworthiness

The idea that observers and labor markets hold executives and directors accountable for firm failures is consistent with the agency theoretic premise that information processing in markets is generally rational and efficient (Fama, 1980). According to this view, we can readily anticipate that elites will be stigmatized in proportion to the severity and extraordinariness of the failures with which they are associated. The greater the severity of the loss, the greater the blame that must be apportioned. But we can anticipate that stigmatization will be tempered by referent comparisons which shape observers’ expectations. Failures that occur within healthy industries are unexpected, provide strong signals of leader ineffectiveness, and therefore result in great stigmatization. In contrast, failures that occur in hostile contexts can be largely assigned to

12 environmental factors and therefore result in less leader blame. Namely, we anticipate that two important, but somewhat obvious, attributes of the corporate failure itself will significantly affect the degree of stigmatization experienced by the firm’s elites: a) the amount of loss and b) the degree of discrepancy between the loss and the performance of other firms in the industry.

Although the professional identities of all elites associated with a failed firm will suffer to some extent, we anticipate that observers will make some distinctions among them, stigmatizing each individual in accordance with assessments of his or her level of blameworthiness. This prediction is based on social psychological research that suggests that stigmatization is greater to the extent that observers perceive that the individual was able to control or prevent the offending attribute (Crandall, 1994, 1995; Crandall & Biernat, 1990; Crocker, Corwell, and Major, 1993;

Pullium, 1993; Rodin, Price, Sanchez, & McElligot, 1989; Weiner, Perry, & Magnusson, 1988).

Thus, the degree of stigma befalling an elite will exist somewhere along a continuum ranging from minor stigma (for elites whose roles in their firms suggest that they had little or no control or responsibility for the failure) to substantial (for elites whose roles suggest that they had total control and responsibility for the failure). Among the individual-level factors expected to influence attributions of control and blameworthiness and, hence, the degree of stigma suffered, are: the elite member’s position, tenure, and actions, particularly with regard to fulfilling ethical responsibilities.

Position: Director versus executive. Principals delegate decision-making authority to a group of agents, including the CEO and other executives; but they also delegate oversight responsibility to a group of paid supra-agents, the directors of the firm. These two categories of agents have different types of control over company outcomes which may rationally be factored into assessments of individual accountability for failure.

13 Outside directors are the most direct representatives of a corporation’s owners. They have incentives to build reputations as expert monitors (Fama, 1980; Fama & Jensen, 1983). However, their professional identities are not strongly invested in a particular organization on whose board they serve, because their involvement with the firm is less intense than that of executives, and their board affiliations are often diversified across more than one organization. Outside directors’ contact with the organization and their access to information is limited to what is given to them by the firm’s executives and also by the limits of the time they can devote to board responsibilities (Lorsch and MacIver, 1989). While senior managers generally formulate and implement the firm’s strategic direction (Hambrick and Mason, 1984), outside directors’ roles in strategy formation largely involve offering advice, review, and approval (Herman, 1981; Lorsch and MacIver, 1989; Mace, 1986; Mueller, 1979; Patton and Baker, 1987; Vance, 1983; Whistler,

1984; Wolfson, 1984). The board’s primary internal role is that of monitoring and disciplining management by setting executive compensation, hiring and firing senior executives, and restricting policies that would adversely affect shareholder value (Fama and Jensen, 1983;

Hermalin & Weisbach, 1998; Mace, 1986; Vancil, 1987). Thus, outside directors are not held to the same standard of in-depth understanding about company affairs as executives.

Empirical evidence supports this distinction. Research has found some evidence that senior executives influence firm performance (see Finkelstein and Hambrick (1996) for a review), but evidence of outside directors’ influence on firm performance is sparse and weak.

For example, firm performance is not consistently related to such board features as the percentage of outsiders (Bhagat and Black, 1999), the separation of the chairman and CEO positions (Baliga, Moyer, and Rao, 1996), or the stockholdings of outside directors (Bhagat,

Carey and Elson, 1999). Indeed, the relationship between boards and firm performance may most

14 likely be mediated by the board’s influence in setting executive compensation or limiting management entrenchment (Zahra and Pearce, 1989). Thus, observers are expected to hold company executives more accountable for firm failures than they do outside directors.

Proposition 2: Executives who are associated with failed firms experience greater stigmatization than do outside directors of the firms.

Position: Hierarchical level. With increasing hierarchical position in an organization comes increasing access to information, formal decision making authority, and individual power

(Finkelstein, 1992). Leaders with greater access to information are better able to foresee the consequences of their decisions and actions. Also, leaders with greater authority and individual power have greater control and ability to overcome resistance by less powerful opponents within the organization. Thus, while the most senior executives in the firm (CEO, COO, CFO) differ in their domains of responsibility, they are all the ultimate arbiters for their particular areas, with the CEO at the apex. Lower level executives (e.g., vice presidents) might have significant amounts of responsibility, but they are monitored and can be overruled by their senior counterparts. Consequently, overall firm performance provides a clearer signal of CEO and other senior executive identity than it does of lower-level executive identity and ability.

This view is consistent with the agency theoretic view that “higher managers are affected more than lower managers” when labor markets use firm performance to determine outside wage opportunities (Fama, 1980: 293). It is also consistent with empirical evidence of the “managerial accountability hypothesis,” wherein labor markets hold top-tier managers more accountable than their subordinates for firm outcomes (Cannella et al., 1995). Thus, if the market for managerial services functions in a rational manner, the senior-most executives of the firm should be held more accountable for firm failures than lower-level managers.

15 Proposition 3: Senior-most executives (CEOs, COOs, and CFOs) who are associated with failed firms experience greater stigmatization than do lower-level executives of the firms.

Tenure. When executives and directors are relatively new to a firm, the degree of control they are able to exert over organizational outcomes is constrained both by lack of information and lack of influence (Yermack, in press). With time, executives and directors accumulate the information they need to empower them to make important decisions. Greater tenure also puts them at the helm over an extended decision-making period, giving them more influence over both strategy and performance outcomes (Hambrick & Fukutomi, 1991). Longer-tenure executives and directors are also likely to be entrenched, which is an indication of both control and accountability in the case of corporate failure.

Proposition 4: The longer an elite’s tenure at a failed firm, the greater the stigmatization he or she will experience.

Ethical misdeeds. Agency theory justifies disciplining managers and directors, not only when poor performance is a sign of the leaders’ lack of ability, but also – and especially – when poor performance appears to be due to leaders pursuing their own interests rather than those of the firm’s principals. The ways that agents might pursue their own self-interests, and thus sacrifice those of owners, range from shirking (failure to expend sufficient effort in the fulfillment of their roles) to acts of commission, including insider trading, fraud, misleading and dishonest actions, sexual misconduct, and abuse of power. All of these actions can be described as ethical misdeeds whereby executives and directors fail to fulfill their obligations to shareholders.

Ethical misdeeds will be even more stigmatizing than simple lack of ability, because a willful misdirection of effort is far more controllable than is a mere lack of skill; as noted,

16 research has shown that stigmatization is greatest when the stigmatizing attribute is judged to be controllable (Weiner, et al., 1988). For these reasons, elites who are accused of ethical misdeeds will be held to be more blameworthy for firm failures than will those who are accused of poor business judgment.

Proposition 5: Elites who are accused of ethical misdeeds that lead to firm failure will experience greater stigmatization than will those accused of business misjudgment.

Cognitive Biases and Attributions of Blame

So far, we have argued that observers rely upon objective indicators of an individual’s responsibility for a corporate failure and then rationally stigmatize the person in proportion to his or her apparent culpability. However, it is well known that observers are not fully rational in how they view the influence of leaders on organizational outcomes (Meindl, et al., 1985).

Stemming from a desire to be reassured about the role of human volition (as opposed to the role of random forces) in life’s outcomes, observers engage in a “romance of leadership.” Even though corporate failures may stem from any number of factors – including environmental jolts, long-institutionalized structures and systems, isolated missteps of employees, and outright accidents – observers tend to blame leaders. Conversely, when things go very well, for whatever reasons, leaders are credited and their professional identities are burnished (Meindl, et al., 1985;

Hayward, et al., in press).

Thus, the assignment of blame to leaders is an interpretive, sensemaking process, rather than a black-and-white calculation. Like other stigmatizing stereotypes, the act of blaming leaders is subject to cognitive and attributional biases (Crandall, 1994). We anticipate that two prevalent cognitive heuristics feed into romantic conceptions of leadership, shaping observers’ stigmatization of elites who are associated with firm failures. These are the heuristics of

17 “availability” (whereby people assign disproportionate weight to information that is most obtrusive – i.e., vivid, recent, and easily retrieved from memory) and “representativeness”

(whereby people generalize from a specific event or instance to a broader category that it seems to represent).

The Availability Bias

The availability heuristic is a cognitive bias that reduces complex probabilistic judgments into simpler ones, influencing how people process the information they use to create attributions.

Information that comes most easily to mind, such as vivid and recent information, will be judged as most reliable and relevant, and hence will be more available to observers in the sensemaking process (Tversky & Kahneman, 1974).

The availability heuristic is known to play a major role in stigmatization. Social psychologists, for instance, have observed that people may be stigmatized merely by their proximity to a negatively evaluated object (Hebl & Mannix, 2003). For example, a bystander may experience derogation merely by being physically near a stigmatized person, even if there is no apparent relationship between them; the cognitive availability resulting from physical proximity triggers stigmatization. Similarly, friends, family, and associates of the stigmatized can suffer stigmas simply by virtue of their relationships with the scorned (Page, 1984).

The availability bias can be expected to affect perceptions of the blameworthiness of corporate leaders. The leaders of a firm who announce a corporate failure have to explain the failure event in speeches, on television, in newspaper articles and formal announcements, and sometimes even in formal testimony. Through this process, these individuals become a highly salient category of information that observers draw upon to make sense of the failure; it is these

18 leaders’ names in the headlines and attached to the quotes, their pictures in the papers and their voices on television. They are perceived to be much more closely associated with the failing firm than leaders who have already departed, even though it may have been departed leaders’ policies and behaviors that actually caused the decline (Hambrick & D’Aveni, 1988). It is the current leaders – those who are present as the firm is visibly failing – who are vividly available in observers’ minds; they will be blamed and stigmatized by the failure event (Slovic & Fischhoff,

1988; Wiesenfeld, 1993). For example, Gerald Levin, the CEO of Time Warner, helped to engineer the eventually discredited merger with AOL, but he announced his resignation seven months before a 59% collapse of the combined company’s market value, and thus received far less criticism and stigmatization than did the other top executives who were present at the collapse (notably Steven Case and Robert Pitman) – even though it was Levin’s shareholders who were the larger losers in the deal (Wall Street Journal, 1/13/03).

Leaders who have departed prior to a perceived failure are shielded from attributions and stigma by two complementary forces. First, they do not serve as the human face of the firm in public forums in which the failure is examined, making them less available in observers’ minds.

The more time that has elapsed since their departure, the less able observers will be to recall their association with the firm. Second, the departed leaders may have developed new associations with different organizations. These new associations help to obscure the person’s relationship with the failed firm, because it is difficult for observers to assimilate, or reconcile, information about a company failure with information about a former leader whose primary association is now elsewhere. Thus, those elites who departed prior to the perceived failure are less likely to receive blame and to be stigmatized when failure occurs.

Proposition 6: Elites who are present at the firm during the visible phase of a failure will experience greater stigmatization than those who departed earlier.

19 Just as some leaders are more cognitively available for stigmatization than others, so too do company failures differ in their vividness for observers. Some corporate failure events receive much more attention from the press and public, and therefore are more likely to spur attributions according to the logic of availability, than are other failures. Large and well known companies that fail particularly receive a great deal of attention. Failures of large firms affect many people (including employees, customers, and suppliers) and hence are more noteworthy than failures of smaller firms. Furthermore, large corporate failures are vivid because they are relatively rare and surprising (Hambrick & D’Aveni, 1988); large firms have abundant access to resources and great legitimacy (Pfeffer and Salancik, 1978), and they are not expected to fail.

When they do fail, observers are likely to conclude that exogenous forces were not the cause of the failures, but rather that serious errors in leadership must have occurred. The lack of an available external attribution for large corporate failures, coupled with the greater public attention that large firms receive, will increase observers’ tendency to attribute blame to corporate elites. For example, both Xerox and its much smaller competitor, Global Imaging

Systems, Inc., lost 52 percent of their market value between May of 1999 and May of 2000.

While the losses at Global Imaging received relatively little attention, Richard Thoman, the CEO of Xerox, was widely and vehemently criticized in the press and forced to resign after serving for only one year (COMPUSTAT; ProQuest).

Proposition 7: The larger the firm that fails, the greater the stigmatization of elites associated with the firm.

The Representativeness Bias

Another heuristic associated with stereotypes is representativeness, whereby observers make judgments, in part, by taking into account the degree to which a specific event corresponds

20 to a broader category of occurrences in their minds (Kahneman & Tversky, 1972). Those instances that are representative of a broader category of events will lead observers to perceive that all of the features of the broad category apply to the new instance, far out of proportion to the actual degree of correspondence (Kahneman & Tversky, 1972; Tversky & Kahneman, 1971).

This bias may apply to the phenomenon of blaming elites for corporate failures in two different ways. First, some leaders may be associated with, hence representative of, other prior failures.

Second, some instances of corporate failure may be similar to, hence representative of, other visible corporate failures. Stigmatization of corporate elites may become exaggerated as a result of such representativeness biases.

Observers are more likely to perceive a correspondence between a leader and a corporate failure when that leader has been associated with other failures in the past. (As noted earlier, not every executive and director associated with a corporate failure will be prevented from working again elsewhere.) Especially when there is only limited or ambiguous evidence regarding causes of failure, observers will perceive leaders who have been associated with past failures to be representative of the category of causes for firm failure. Attributions of blame are generalized to those associated with this category, whether there is tangible evidence of their blameworthiness for the new event or not.

Proposition 8: Elites who have been previously associated with other failed firms will experience greater stigmatization upon a firm failure than will those without such prior associations to corporate failure.

When observers develop a schema of failure events attributable to leadership missteps, the category is likely to include specific features from recent well-known failures. For example, if a failed company is accused of using dubious accounting stratagems that resemble (even somewhat) the accounting stratagems of already notoriously failed firms, then the focal company

21 and its leaders are readily placed in the same category as the earlier offenders; they may receive more stigmatization than would have occurred if their offense was unique or idiosyncratic. Thus, corporate failures that resemble other recent, visible failures increase attributions of blameworthiness through the representativeness heuristic.

In the context of corporate failure, the representativeness heuristic may be exacerbated by the interaction of the romance of leadership and the availability heuristic. As discussed above, observers tend to attribute company failures to the deficiencies of leaders. In turn, the cognitive categories that get created tend to center around types of failed leaders, or categories of villains, rather than around types of failed companies. So, returning to the example above, observers will not so much develop a cognitive category of “companies that use dubious accounting methods,” as much as they will develop a cognitive category of “executives and directors who use dubious accounting methods.” The press and others will portray the failure this way, making the failure vivid; and a cognitive category of inept leadership will be established.

Proposition 9: The more that a firm failure resembles other recent, visible failures, the greater the stigmatization of elites associated with the firm.

Emotional Bias in Assigning Blame: Schadenfreude

In addition to the cognitive biases discussed above, there are critical affective processes that cause stigmatization of elites to deviate from what might rationally be expected (Kunreuther

& Slovic, 2002). For corporate leaders, we can expect that schadenfreude (Nietzche, 1887/1967)

– or pleasure in others’ misfortune – will exert an emotional influence on stigmatization (Smith,

Turner, Garonzik, Leach, Urch-Druskat & Weston, 1996). In contrast to normatively appropriate reactions to others’ suffering, such as pity or sympathy, schadenfreude establishes an antagonistic relationship between the object of stigma and the observer (Heider, 1958; Smith,

22 2000). Schadenfreude is at once a positive emotion (pleasure) but malicious, and has been viewed as pervasive in social relations (Nietzche, 1887/1967; Leach, Spears, Branscombe &

Doosje, 2003). With respect to the stigmatization of corporate elites, schadenfreude is the desire to see the mighty humbled.

Recent psychological research suggests that schadenfreude is associated with envy, resentment, and a wish to cut down another person (Brigham, Kelso, Jackson & Smith, 1997;

Feather & Sherman, 2002; Smith, et al, 1996). Two relevant mechanisms may underlie the feeling of schadenfreude toward failed corporate elites. First, schadenfreude is a downward social comparison (Smith, 2000), motivated by observers’ desires to feel better about themselves by comparing themselves to less fortunate others. Second, observers may obtain a feeling of justice in seeing the lofty brought down to earth (Feather & Sherman, 2002). In the context of corporate failure, we anticipate that these mechanisms, and in turn schadenfreude and stigmatization, will be triggered by the attributes of people who are the potential objects of stigma (corporate elites) as well as by attributes of the context in which the stigmatization takes place.

Attributes of the Stigma Object

The more that an elite’s previous success and status is viewed as undeserved, the more that he or she will inspire resentment, and the more likely his or her pain will be to trigger schadenfreude in observers (Feather & Sherman, 2002). When evaluating whether an executive’s success is undeserved, observers may look for discrepancies between the person’s success and evidences of his or her character. When there are signs that the person’s success has come at others’ expense, or because of ruthlessness or unfairness, observers may view his or her success

23 as undeserved and therefore worthy of retaliation. Such retaliation takes place at the first sign of weakness, as poor outcomes draw attention to how those outcomes were obtained (Brockner &

Wiesenfeld, 1996; Brockner, Wiesenfeld & Martin, 1995). For example, Al Dunlap openly acknowledged his tough, take-no-prisoners style of leadership, including drastic layoffs, at Scott

Paper and at Sunbeam (summarized in his book, Mean Business). Those who observed the indifference he seemed to have about firing people were eager to help speed his fall from grace and to heap great scorn upon him, once Sunbeam’s performance began to decline.

Proposition 10: The more an elite leader had previously been portrayed as ruthless or arrogant, the greater the stigmatization he or she will experience upon firm failure.

Additionally, corporate elites who are seen as selfish and greedy are likely to inspire resentment in observers. It is well known that executive compensation varies widely among firms and that CEOs and directors have substantial influence over their pay (summarized in

Finkelstein & Hambrick, 1996). Those who receive pay well above peers in other companies will be seen as greedy and undeserving. Observers may grudgingly tolerate the apparent inequity when firm performance is good, out of reluctance to disturb a system that is yielding positive outcomes. However, once performance falters, the appearance of unfairness will inspire anger and indignation (Folger, 1993). Observers will take great pleasure in seeing such elites cut down to size, and fairness restored, once their companies stumble.

Proposition 11: The greater an elite’s compensation (relative to peers and to others in the focal firm), the greater the stigmatization he or she will experience upon firm failure.

24 Attributes of the Broader Context

When times are bad, sources of satisfaction for the general populace are in short supply.

In periods of widespread economic trouble, many social actors will be dissatisfied with their own lot, and downward social comparisons – along with the positive feelings they engender – may be among the few available ways for people to derive a (perverse) form of happiness. As the old adage goes, “misery loves company”; it is comforting for people to know that others are as miserable as they are, even though taking comfort in others’ misery is schadenfreude (Smith, et al., 1996). During periods of broad economic malaise, a high proportion of observers are

“miserable” and thus likely to experience schadenfreude.

Cognitive biases may also play a role in schadenfreude. When times are bad, negative information may be highly salient, because it can be easily assimilated with other perceptions of the situation (Kiesler & Sproull, 1982). This process makes downward social comparisons more cognitively salient than upward comparisons, creating fertile ground for schadenfreude. In this vein, Meindl, et al. (1985) found that the general press contained more references to corporate leaders in bad economic times than in more favorable times, presumably because of criticisms of existing leaders (as well as calls for better leaders).

As noted earlier, the leaders of a firm that fails within a troubled industry may be spared severe stigmatization. But if the overall economy is troubled, and the general populace and its various institutions (including the press) are on edge and in search of villains, then schadenfreude will prevail. In their own pain, observers will relish the pain of the once-lofty.

Proposition 12: Elites who are associated with failed firms during periods of macroeconomic malaise will experience greater stigmatization than those associated with failed firms during periods of macroeconomic vitality.

25 The Mitigating Effects of Social Capital

Recent research emphasizes the adaptive functions of stigmatization by highlighting the need for societies to maintain order and facilitate exchange by forming cooperative coalitions among those who contribute, while ostracizing those who disrupt the social system or are perceived to be unlikely to provide future social benefits (Kurzban & Leary, 2001). This research additionally identifies the important stigma-buffering effect of social capital, which serves as an indicator of a person’s fitness as an interaction partner.

Some corporate executives and directors have much more social capital, or ability to secure benefits by virtue of their social ties (Portes, 1998), than do others. Some corporate elites sit on multiple, influential boards (Davis, Yoo, & Baker, 2003); some are close personal friends with large numbers of influential others (Westphal, 1999); some have prestigious educational and military credentials, and their accompanying ties and cachet (D’Aveni, 1990); while others have few or none of these social resources to draw upon in the event of company failure.

We argue that social capital functions as a buffer protecting the individual corporate elite in two ways. First, it reduces stigmatization by attenuating attributions of blame. Second, social capital mitigates the relationship between stigmatization and devaluation, because norms of reciprocity serve to decouple stigmatization from the willingness of key actors to impose sanctions upon fellow elites.

Social Capital Reduces Blame

Individuals who have high levels of social capital have high prestige and status, which alters the ways that observers react to them. In particular, executives and directors who have high levels of prestige tend to be perceived as good interaction partners – competent, credible, and trustworthy (Geis, 1977; Giordano, 1983; D’Aveni, 1990). Observers are reluctant to view

26 such individuals as inept, careless, or self-serving. Furthermore, high-status leaders will be more likely to be excused for having many important things on their minds that might justifiably absorb their attention (Carson, 1980); and they will have stored up more “idiosyncrasy credits,” which they will be able to exchange for greater tolerance of their mistakes (Hollander, 1958).

These several mechanisms are expected to attenuate attributions of blame and thereby reduce stigmatization of high-status, well-connected leaders who are associated with failed organizations (Wiesenfeld, 1993).

Proposition 13: The greater the social capital of an elite associated with a failed firm, the less the stigmatization he or she will experience.

Social Capital Moderates the Effect of Stigmatization on Devaluation

Many of the actors involved in the stigmatization of corporate elites (e.g., the press, academics, and governance think tanks) are not directly involved in the decisions by which tangible devaluation occurs. Instead, it is fellow elite members – other top executives and directors – who make these decisions. When they feel bound by the bonds of loyalty and friendship, they will be motivated not to ostracize failed elites; and they may be unwilling to impose the devaluation that otherwise seems called for (Wiesenfeld, 1993). That is, a failed leader’s social capital may intervene to diminish the relationship between stigmatization and the actions fellow elite members take to tangibly devalue him or her.

Individuals who possess social capital in the form of prestige and network ties are able to grant favors to those upon whom they depend. Although these favors can function as quid pro quo, they are generally not explicitly sought, nor formally specified, but rather create a diffuse, generalized commitment among individuals through norms of reciprocity, whereby people feel obligated to repay the favors and gifts they receive (Pfeffer, 1992). Such obligations may be

27 “called in” when an individual with social capital requires them, such as when his or her career is at risk.

These norms of reciprocity are thus a countervailing force against the effects of stigmatization, encouraging an individual’s friends and others who are bound in their web of interrelationships not to devalue him or her. They will not remove the person from their boards, and they might even be willing to hire him or her as an executive or director. The more social capital an individual elite possesses, the more friendship and network resources that are available to step in to buffer him or her from the devaluing effects of stigmatization. Since information that leads to action is most likely to move through chains of personal contacts (Katz, 1957;

Coleman, Katz, and Menzel, 1957; Lee, 1969; Khurana & Cohn, in press), and the best jobs –

“the ones with the highest pay and prestige” – are likely to be filled through personal contacts

(Granovetter, 1995:22), greater social capital is likely to result in greater access to the best appointments, even after one’s association with a failure event. Such an expectation is consistent with empirical findings that invitations to join boards of directors move along networks of long- term friendships and personal contacts (Mace, 1986; Useem, 1984; Zajac, 1988).

In sum, then, the more social capital an individual possesses, the less effect stigmatization will have on his or her continued access to top jobs, due primarily to the countervailing pressures of norms of reciprocity.

Proposition 14: The greater the social capital of elites associated with a failed firm, the weaker the association between stigmatization and the devaluation they experience.

Discussion

Economic research on agency theory and settling up in managerial and director labor markets is primarily focused on professional devaluation, but is relatively silent with regard to

28 how such devaluation comes about. Our model specifies a differentiated set of actors whose actions lead to the devaluation of corporate elites, as well as the cognitive, emotional, and social processes that shape those actions. More importantly, we explicitly acknowledge the role of stigmatization – the identity derogation that precedes the tangible losses that elites experience.

As a deterrent to potential agency problems, it is possible that fear of professional identity loss may be just as influential as the fear of economic losses to corporate elites, who invest so much psychological energy in their public personas.

We describe a prototypically organizational stigmatization process – one that links individual to organizational outcomes and plays a crucial intervening role in the economist’s conceptualization of the forces required to maintain our system of public corporations (Fama,

1980). We draw upon a range of relevant theoretical perspectives to identify the key antecedents of stigmatization, providing an enhanced and realistic model of the effects of firm failure on corporate elites. Most prior research in this area has invoked one or another of these theoretical traditions, with findings narrowly consistent with expectations. For example, economic research has repeatedly found evidence of settling up and has explained it in terms of market efficiency

(Yermack, in press); sociological research, by comparison, has observed the stability and ‘small world’ nature of corporate elites and explained it in terms of the buffering effects of social networks and elite status (Davis, Yoo & Baker, 2003). In contrast, we see rational, cognitive, emotional, and social processes as inextricably intertwined predictors of the stigmatization of corporate elites. By elucidating these antecedent factors, it is possible to anticipate the simultaneous but sometimes divergent operation of economic, social and psychological forces in the stigmatization process.

29 Our model differentiates stigmatization from devaluation, acknowledging that the actors involved in each process overlap but are not identical. Indeed, we suggest that stigmatization and devaluation may at times be quite discrepant. For example, while stigmatization may have a substantial effect on the devaluation of elites who have little social capital, its effect may be greatly attenuated for leaders who have higher status, prestige, and network resources. The distinction between stigmatization and devaluation may also contribute to psychological research on stigma by helping to reconcile perspectives that focus on stigma as a diminished social identity (e.g., Crocker et al., 1998) and those that focus on stigma as exclusion (e.g., Leary &

Schreindorfer, 1998).

Further contributions to social psychological research on stigmatization may emerge from the study of stigmatized elites. For example, because most research on stigma has focused on low-status targets (e.g., racial minorities, women, the mentally ill and the handicapped), emotions such as anxiety and disgust have been emphasized (Archer, 1985; Devine, Evett &

Vasquez-Suson, 1996). When stigma targets are high-status elites, however, the role of schadenfreude may be more clearly seen. The role of social capital is also brought to the fore when corporate leaders are considered as the objects of stigma.

The distinctions we draw between stigmatization and devaluation may help to integrate differing perspectives on social capital. For example, the elite who achieves social capital by bridging ‘structural holes’ in sparse networks may be buffered from stigmatization following failure, because information about the person’s failings are not easily transmitted without his or her own involvement as conduit (Burt, 1997). In short, the stigmatization process cannot gather steam. In contrast, the elite who has social capital by virtue of many strong bonds of friendship in dense networks may be buffered from stigmatization by a very different mechanism –

30 specifically the unwillingness of well-placed friends to allow stigmatization and devaluation to occur. Our model suggests how these two forms of social capital may work in very different ways to influence stigmatization and devaluation.

Our model also contributes to research on the ‘romance of leadership’ (Meindl, et al.,

1985). We relate the romance of leadership to the social negotiation process by which corporate leaders’ identities are constructed. By identifying some of the emotional processes that enter into observers’ conceptions of leaders (notably schadenfreude), we suggest that observers’ self- related concerns may cause them to take pleasure in seeing powerful elites humbled. Attributes of leaders (e.g., their arrogance and ruthlessness) and attributes of the context (e.g., general economic malaise) may influence the degree to which elites serve as lightning rods for these emotional responses. Our model helps to integrate the ‘romance of leadership’ perspective with other perspectives on leadership. For example, by raising issues such as ethical misconduct, our model allows us to predict when the romance of leadership becomes the vilification of leadership.

Future Directions

Investigating the stigmatization and devaluation of corporate elites raises several issues that would be fruitful areas for future research. Unlike people who are stigmatized entirely by their category membership (e.g., race), the corporate elite goes from being admired to being stigmatized in a dynamic process that unfolds over time. Future research may investigate the dynamic, reciprocal and interrelated forces – at psychological, social and economic levels – that shape this stigmatization and devaluation process. Considering this dynamic process may also help to reveal the dimensionality of stigma. For example, stigmatization may vary by the length

31 of time that a stigma is in effect, with stigmas that last for longer periods having different effects than more transitory stigmas. Similarly, stigmatization may be confined to relatively few audiences, or it may diffuse across audiences; future research may productively address how stigma is communicated across observers.

Another area for research would be to focus on the experience and reactions of the professional identity holder – the stigmatized elite (Sutton & Callahan, 1987). Our model focuses on observers, because they generate stigma. However, social identities are the products of a social negotiation process between the targeted individual and social interaction partners. When the stigma target is an elite member, his or her ability to proactively manage the social predicament of stigma (Crocker, et al., 1998) may be triggered. Elites may offer blame- deflecting attributions (e.g., in letters to shareholders) and attempts at obfuscation (e.g., editing board minutes). The person’s social status and social capital may furnish a wide range of options that might be exercised when the threat of stigma is in the air. On the other hand, the elite’s very public stature may constrain his or her use of the identity-protective strategies that lower-status stigma targets utilize. Furthermore, the elite’s attempts to cope with the social predicament of identity threat will influence the climate and culture of his or her organization (Wiesenfeld,

Brockner & Thibault, 2000).

Another promising area for future research is to examine the processes that begin where our model leaves off. In particular, there are anecdotal examples of various forms of redemption

– a social re-valuation that can follow the stigmatization and devaluation that our model depicts.

For example, through charitable acts and community involvement, Michael Milken, the former junk bond king, has restored some of his reputation. Qualitative research has begun to address how people construct new identities and shed less desirable ones (Ebaugh, 1988). The study of

32 stigmatized corporate elites may be an excellent forum in which to examine the social redemption process.

Our model also points to the need for future research on the influence of national culture on stigmatization and devaluation. A purely rational model of settling up in the context of corporate failure is highly generalizable; it should apply wherever managerial and director labor markets exist. However, our conceptualization of the stigmatization and devaluation of elites includes social, cognitive and emotional processes, and therefore leaves abundant room for cultural moderators. Some of the processes we have introduced may take different forms in other cultures. For example, research has found that cultures vary in their tendency to succumb to attributional biases (Markus & Kitayama, 1991). In cultures where ‘face’ is crucial, the broader community may coalesce to protect or restore the reputation of people who are associated with failure; empathy may be a more likely response than schadenfreude when observing others’ misfortune. Similarly, the structure and function of elite social networks may vary in different cultural contexts, influencing the degree to which social capital buffers elites from stigmatization and devaluation.

Practical Implications and Summary

Our elaborated model of settling-up for corporate elites who are associated with company failures has widespread practical implications. We will briefly note some of the implications for individual elites and then address the implications for our overall corporate system.

The individual elite, above all, needs to be aware that he or she is likely to face considerable career loss if associated with a company failure. For this risk, he or she will seek either compensation or insurance. Thus, some portion of the high pay that executives and

33 directors receive can be thought of as their compensation for bearing extreme career risk – a risk they bear simply by being at the top of their firms; this is an idea that researchers of executive compensation have yet to address. Similarly, elites may seek some form of insurance for the event of their stigmatization, which helps to explain the large severance agreements that executives have been seeking in their employment contracts in recent years. In keeping with our model, the bigger and more visible the firm, and the more precarious its position, the larger these up-front severance packages can be expected to be.

Additionally, the individual elite who wishes to mitigate his or her eventual risk of stigmatization and devaluation may engage in certain behaviors – some positive, some negative.

On the positive side, for example, the person may concertedly adopt a style of humility, even carrying this philosophy over to his or her pay package. Jim Collins (2001) has written recently about the virtues of the “humble leader,” but he has not addressed the idea that humble leaders will face far less vilification and career loss – in the event of firm failure – than will arrogant or flamboyant leaders. On the negative side, the elite who senses impending trouble at the firm may be able to resign in time to avoid being stigmatized – as perhaps Gerald Levin of Time Warner succeeded in doing. While there is no evidence of how common these “blame-avoidance departures” might be, they may actually occur quite regularly, and investors might learn to become aware of them.

Our model has broader implications as well. Fama (1980) asserted that a reliable settling- up mechanism is essential for the viable separation of ownership and control in a capitalist economy. But if settling-up is not very reliable; if – as our model portrays – there are often major discrepancies between the amount of professional devaluation an elite member should reasonably incur and the amount actually experienced, then the capitalist system will become

34 frayed. If some elites are not sanctioned to the full extent they should be – say, simply because they are associated with relatively obscure companies, or possess a great deal of social capital, or depart before their mistakes show up – then other elites in similar situations will implicitly be allowed to engage in unsound behaviors. On the other hand, if some elites are punished more harshly than their behaviors warrant – perhaps because they are simply the ones on the scene when the collapse occurs, or for the other reasons we have laid out, including simple schadenfreude – then some talented individuals who might be very capable leaders will be unwilling to become executives and directors of companies. And those who do take on such jobs may be far more conservative and risk-averse than they should be, in an effort to avoid missteps at all costs. If leaders are unduly timid and risk-averse, for fear of failure and the stigmatization that goes with it, then investors and society still come out as losers.

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