When Governance Fails: Naming Directors in Class Action Lawsuits

Abstract

This paper examines one type of failure in the governance system, the case where directors do not protect shareholders from securities fraud. We study the breakdown of the agency relationship in which shareholders not only sue the company, but also name the directors. We find that naming directors in a class action lawsuit based on securities fraud leads to significant changes in both the directors' and CEOs' compensation structure. Additionally, naming directors results in a greater change in board composition. When a financial institution is the lead plaintiff in the lawsuit, these changes are magnified.