Profitable Misconduct, Corporate Governance, and Law Enforcement

Abstract

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 to be effective policies designed to deter corporate misconduct must account for interactions between external governance, such as laws and their enforcement, and internal governance mechanisms such as managerial compensation. The analysis offers insights into how to improve the deterrence of corporate misconduct.