Paying for Failure: Director Compensation, Oversight Lapses, and Network Effects

We examine how director compensation functions both as a mechanism for board accountability and as a strategic tool to divert shareholder attention from high pay packages following major oversight failures. Analyzing various corporate incidents, we find that the consequences are contingent on the nature of the failure. For events with diffuse responsibility, such as major environmental breaches, the entire board experiences a significant compensation reduction. In contrast, for failures with clear accountability, like financial misstatements, pay cuts are precisely targeted at directors on the responsible committees. We also provide evidence of a network governance channel: environmental failures, perceived as systemic risks, trigger preemptive pay reductions on connected boards that share a director with the violating firm. Importantly, these pay cuts are not merely strategic gestures; they are followed by substantive improvements in environmental performance at both the focal and connected firms, demonstrating that risk perceptions transmitted through director networks can drive meaningful governance and operational changes.