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A Google Groups thread has discussion around a site that was hacked and because of it, now has many broken (dead) hyper links. The question then came up, would Google penalize a site that had broken links?
The simple answer is no, you generally will not be hurt by broken links. Googler, JohnMu said, "In general those broken links will not negatively affect your site's crawling, indexing and ranking."
But it really depends on many variables. In general, if you have a small number of broken links on your site, it should make no difference in your rankings at Google or any other search engine. However, if your site navigation and linking structure is in complete disarray, then you can expect your site to have major issues ranking well for your content. Does this mean your site will be "penalized?" No, not at all. But it does mean the search engines will have a rough time crawling your site and understanding your content.
Ben covered this topic back in 2005 under the title Do Search Engine Penalize for Dead Links? Yes, it still makes for a good read.
Forum discussion at Google Groups.
