Dissecting Organizational Stigma: The Case of Lehman 'Orphans'

In September 2008, Lehman Brothers and Merrill Lynch had similar business strategies and exposure to toxic assets, and both faced insolvency. However, while Lehman was allowed to fail, Merrill was rescued. For Lehman employees without board positions (Lehman "Orphans"), bankruptcy was thus random and unrelated to their actions. This quasi-natural experiment allows us to disentangle the effect of organizational stigma from their ability and role in the firm's distress. We show that Lehman Orphans are subsequently (1) paid less, (2) less likely to hold top positions, and (3) have lower-powered incentives in future compensation packages relative to former Merrill employees. However, firms hiring Lehman Orphans as directors do not exhibit worse performance or higher risk. We conclude that the labor market irrationally stigmatizes organizations according to random negative outcomes rather than causes of negative performance.