When governance fails: Naming directors in class action lawsuits

This paper examines one type of failure in the governance system, the case where directors do not protect shareholders from securities fraud. We find that shareholders can influence large changes in governance and compensation by targeting the full board of directors, but it is more costly in terms of legal fees. Naming directors in a class action lawsuit based on securities fraud, on average, leads to increases in CEO incentive pay, but decreases in director incentive pay. Additionally, naming directors results in a greater change in board composition. These changes in compensation and corporate governance appear to lead to enhanced performance in the years following the lawsuit.