When companies fail – because of misjudgment, misdeeds, or even bad luck – leaders’ names and reputations stand to be indelibly smeared. They get fired and have a hard time finding work elsewhere. Those who do get rehired tend to do so in lesser capacities or at smaller firms. It is difficult to imagine Dennis Kozlowski of Tyco or Jeffrey Skilling of Enron ever working again. Even executives who have been labeled as simply bad managers, such as Jill Barad of Mattel, become marginalized.

For CEOs who get branded with the Scarlet F – for failure – it’s all part of the “settling-up” process. Settling-up is an essential, but often overlooked, premise of agency theory developed by University of Chicago finance professor Eugene Fama. Corporate owners (principals) can rely on the fact that managers and directors (agents) 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 prior performance. Executives who perform well build good reputations and get better jobs and higher pay in the future. Meanwhile, the markets disseminate word about the failings of those who perform poorly, and their prospects are accordingly diminished.

“When a company fails, those whose professional identities are closely tied to the organization are affected – particularly its officers and directors.”

But the settling-up process for corporate elites can be exceedingly imprecise. Peter Lynch, the investment guru and vice-chairman of Fidelity Management and Research Company, was a director of two of the most visible corporate collapses of the 1990s – 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. And sometimes corporate leaders are penalized far out of proportion to their culpability. Lloyd Ward served as CEO of Maytag for only 15 months. He was replaced in November 2000, after being blamed for the 59 percent drop in Maytag’s share value; he lost prestigious corporate directorships and has not found a comparable position. But Ward served at Maytag during very difficult times for the appliance industry. And Maytag’s performance was worse under some other CEOs who somehow avoided stigmatization.

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 career?

It turns out there are many factors – economic, social, and psychological – that influence the amount of professional devaluation that a corporate director or executive will face. We have constructed a model to describe the process. In this model, failure evokes a stigmatization process, whereby opinion-shapers discredit the professional identities of corporate elites. The discrediting, in turn, triggers tangible economic loss. The greater the stigmatization of corporate elites, the more unwilling companies will be to associate with them and the greater the professional devaluation they will encounter. But the amount of stigmatization the person encounters is shaped by a host of factors. These include indicators of a person’s responsibility for failure, cognitive biases that amplify or diminish the assignment of blame, emotional biases, and the amount of social capital the person possesses.

How Stigma Starts

The process starts after a precipitating event, a major corporate failure. This loss may be abrupt or gradual. 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.

When a company fails, those whose professional identities are closely tied to the organization are affected – particularly its officers and directors. Professional identities are 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. 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.

When a firm experiences failure, a social negotiation process is mobilized through which elites’ professional identities are revised. The elites leading the firm are often themselves branded as failures. 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.

The media plays a particularly substantial role in the stigmatization process. The business press frequently glorifies leaders whose companies are performing well, but then disparages the same leaders if their companies stumble. It is common for press accounts of company failures to emphasize the role of the firm’s leaders in corporate fiascos. The stigmatization of leaders can be driven by other voices: investor advisory services and newsletters; watchdog groups, such as the Council of Institutional Investors; and academics, who often focus their attention on a company’s leaders when performance declines.

The business community may join in the stigmatization process as well. Peers and business acquaintances may withdraw their contact because of the negative portrayals from other quarters. Company employees may speak vigorously to the press about the deficiencies of the firm’s leaders in order to deflect blame and to reassure outsiders that the source of the firm’s problems is gone.

Professional Devaluation

Stigmatization is emotionally painful, but it can be financially painful as well. And the greater the stigmatization of a corporate elite, the greater will be his or her subsequent professional devaluation. Stigmatization leads to substantive devaluation through three interrelated conduits. First, the presence of a stigma is a signal of a person’s inferior abilities. Since labor markets consider all available information about candidates in arriving at appropriate wages, public information about inadequacy would have a negative effect on the elite’s employability and compensation. Second, firms tend to feel social pressure not to hire the stigmatized – especially for leadership positions. Third, stigmatized individuals are likely to anticipate the reluctance of companies to make them favorable offers, and so they may be unwilling to present themselves as candidates for future leadership positions.

Stigmatization will be tempered by referent comparisons that shape observers’ expectations. Failures in healthy industries are unexpected. As a result, they provide strong signals of leader ineffectiveness and contribute to greater stigmatization. In contrast, failures that occur in hostile contexts can be largely assigned to environmental factors and therefore result in less leader blame.

Social psychological research suggests that stigmatization is greater to the extent that observers perceive that the individual was able to control or prevent the offending attribute. And so individual-level factors such as an elite member’s position, tenure, and actions will influence attributions of control and blameworthiness.

For example, executives at failed firms experience greater stigmatization than do outside directors. Outside directors’ professional identities are not strongly invested in the company on whose board they serve. Because their contact with the organization and their access to information is limited, outside directors are not held to the same standard of in-depth understanding about company affairs as executives.

Among executives, the higher you are, the harder you fall. Senior-most executives (CEOs, COOs, and CFOs) who are associated with failed firms experience greater stigmatization than do lower-level executives of the firms. Increasing hierarchical position in an organization brings increasing access to information, formal decision-making authority, and individual power. Leaders with greater access to information are better able to foresee the consequences of their decisions and actions. And those with greater authority and individual power have greater control and ability to overcome resistance by less powerful opponents within the organization.

Tenure matters, too. The longer an elite’s tenure at a failed firm, the greater the stigmatization he or she will experience. When executives and directors are relatively new to a firm, the degree of control they are able to exert over organizational outcomes is constrained. 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.

And it’s better to be incompetent than corrupt. Elites accused of ethical misdeeds that lead to firm failure will experience greater stigmatization than will those accused of business misjudgment. Ethical misdeeds – insider trading, fraud, misleading and dishonest actions, sexual misconduct, and abuse of power – 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.

Cognitive Biases

Observers are not fully rational in how they view the influence of leaders on organizational outcomes. Observers frequently 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, even accidents – observers tend to blame leaders.

The assignment of blame is an interpretive process rather than a black-and-white calculation. And like other stigmatizing stereotypes, the act of blaming leaders is subject to bias. We anticipate that there are two prevalent mental short-cuts, or heuristics, that shape observers’ stigmatization of elites.

The first is the availability heuristic. People tend to view information that comes most easily to mind, such as vivid and recent information, as the most reliable and relevant. As a result, it will be more available in the sensemaking process. Social psychologists, for instance, have observed that people may be stigmatized merely by their proximity to a negatively evaluated object or person – even if there is no apparent relationship between them.

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

And so elites who are present at the firm during the visible phase of a failure will experience greater stigmatization than those who departed earlier. Since these leaders have to explain the failure event in speeches, on television, in newspaper articles and formal announcements, and sometimes even in formal testimony, they will be perceived to be much more closely associated with the failing firm than leaders who have already departed. By contrast, leaders who depart prior to a perceived failure 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. For example, Gerald Levin, the CEO of Time Warner, engineered the eventually discredited merger with AOL. But he announced his resignation seven months before a 59 percent 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 former AOL CEO Steven Case.

In addition to timing, size matters. Failures of large firms affect many people – employees, customers, and suppliers. Large corporate failures are vivid because they are relatively rare and surprising. When big companies fail, observers are likely to conclude that serious errors in leadership must have occurred. And that increases 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. The losses at Global Imaging received relatively little attention. But Xerox CEO Richard Thoman was widely and vehemently criticized in the press and forced to resign after only a year in office.

Representativeness Bias

Another heuristic associated with stereotypes is representativeness. Observers make judgments, in part, by taking into account the degree to which a specific event corresponds to a broader category of occurrences in their minds. 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.

As a result, 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. Observers will perceive leaders who have been associated with past failures to be representative of the category of causes for firm failure. If a failed company is accused of using dubious accounting stratagems that resemble (even somewhat) the accounting stratagems of already notoriously failed firms – like Enron – then the focal company and its leaders are readily placed in the same category as the earlier offenders.

In addition to the cognitive biases, there are critical emotional processes that cause stigmatization of elites to deviate from what might rationally be expected. For corporate leaders, we can expect that schadenfreude – or pleasure in others’ misfortune – will exert an emotional influence on stigmatization. After all, schadenfreude is motivated by observers’ desires to feel better about themselves by comparing themselves to less fortunate others. And observers may obtain a feeling of justice in seeing the lofty brought down to earth.

The more that an elite’s previous success and status is viewed as undeserved, the more likely his or her pain will trigger schadenfreude. And so the more an elite leader has been portrayed as ruthless or arrogant, the greater the stigmatization he or she will experience upon firm failure. For example, Al Dunlap openly acknowledged his take-no-prisoners style of leadership, including drastic layoffs at Scott Paper and at Sunbeam; he wrote a book about his experiences entitled Mean Business. Once Sunbeam’s performance began to decline, those who observed the indifference he seemed to have about firing people were eager to help speed his fall from grace.

Additionally, corporate elites who are seen as selfish and greedy are likely to inspire resentment. 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. Observers may grudgingly tolerate high executive compensation when firm performance is good. However, once performance falters, the appearance of unfairness will inspire anger and indignation. Observers will take great pleasure in seeing such elites cut down to size.

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. In periods of widespread economic trouble, many social actors will be dissatisfied with their own lot, and comparing themselves to less fortunate others may be among the few available ways for people to derive a (perverse) form of happiness. As the old adage goes, “misery loves company.”

Social Capital

Some corporate executives and directors possess much more social capital than do others. They may sit on multiple, influential boards, or maintain close personal friendships with lots of influential people, or have prestigious educational and military credentials. These aspects of social capital can also function as a stigma buffer. The greater the social capital of an elite associated with a failed firm, the less the stigmatization he or she will experience.

Executives and directors who have high levels of prestige tend to be perceived as competent, credible, and trustworthy. Observers are reluctant to view 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. What’s more, fellow elite members often make the decisions through which tangible devaluation occurs. When they feel bound by the bonds of loyalty and friendship, these elites will be motivated not to ostracize failed elites; and they may be unwilling to impose the devaluation that otherwise seems warranted.

Individuals who possess social capital are also able to grant favors to those upon whom they depend. These favors create a diffuse, generalized commitment among individuals through norms of reciprocity. Such obligations may be “called in” when an individual with social capital requires them, such as when his or her career is at risk – thus providing another countervailing force against the effects of stigmatization.

Our elaborated model of settling-up has widespread practical implications. People need to be aware that they are likely to face considerable career loss if associated with a company failure. And they will seek either compensation or insurance for this risk. Thus, some portion of the high pay that executives and directors receive can be thought of as compensation for bearing extreme career risk. Similarly, the fact that elites may seek some form of insurance for the event of their stigmatization helps to explain the large severance agreements that executives have been seeking in recent years.

Beyond building social capital, there are things an executive can do to mitigate his or her eventual risk of stigmatization and devaluation. A person may intentionally adopt a style of humility, and even carry this philosophy over to his or her pay package.

Ultimately, however, the fact that cognitive and affective biases play such an important role in the stigmatization and devaluations process throws into question the market efficiency of settling up. If some elites are not sanctioned to the full extent they should be – say, simply because they are associated with relatively obscure companies, or because they have a lot of social capital – 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, then some talented individuals may be unwilling to become executives and directors of companies. If leaders are unduly timid and risk-averse because they fear failure and the stigmatization it brings, then investors and society will ultimately pay the price.

Batia M. Weisenfeld is associate professor of management at NYU Stern.

Kurt Wurthmann is a doctoral student at Columbia University Business School.

Donald C. Hambrick is professor of management at the Smeal College of Business Administration at Pennsylvania State University.