Profitable Misconduct, Corporate Governance, and Law Enforcement

This paper analyzes interactions between corporate governance and law enforcement practices, focusing on cases where deterrence is weak and harmful misconduct is profitable. We show how managerial compensation contracts, including stock-based compensation and insurance that shields managers from liability, systematically undermine enforcement efforts aimed both at the corporation and at managers. We also show that common enforcement policies such as discounting penalties when corporations voluntarily self-report or implement compliance programs can actually lead to more social harm by increasing the profitability of misconduct. Our results suggest that when enforcement is weak, relying on inducements for cooperation with corporations might appear beneficial but may make matters worse. Deterring corporate misconduct should take into account the many ways external and internal governance interact.