Boards of directors are ostensibly put in place to monitor executives, yet recent research found that directors trust executives and do not consider monitoring as a critical aspect of their duties. We posit that monitoring and the vulnerability to manipulation become more salient to outside directors when a peer firm’s managerial opportunism becomes widely and publicly discussed as organizational misconduct, such as that observed at Theranos. Integrating research on organizational categories and corporate governance, we develop a novel theoretical framework to better understand how a public breach of trust between outside directors and executives at a perpetrator firm can spillover to other firms in the same industry (i.e., bystander directors), harming the trust between outside directors and executives, generating feelings of vulnerability among outside directors, and prompting outside director exit. We further propose that the salience of vulnerability will be less effective in prompting action for some outside directors than for others. Support for our theory in empirical examination on a matched sample of outside directors has implications for research on corporate governance, organizational misconduct, and director turnover.
