Friday, July 27, 2012

Law, Economics, and Corporate Crime

There was an interesting discussion of corporate crime in The Economist with the clever title: Fine and Punishment. The author was examining the notion that the fines being levied on corporations caught in criminal activities were too small to have a deterrent effect. It was suggested that the US Department of Justice was beginning to recognize this and had been ratcheting up the level of its fines for a number of years. The following chart was provided to indicate that for antitrust violations the penalties had increased significantly. The question is, has any of this had a deterrent effect?

The author relies on the "law and economics" approach to crime and punishment. This point of view holds that criminals are the same "rational, self-interested actors" that are assumed in some economic theories. Let us refer to such individuals as homo economicus.

"The economics of crime prevention starts with a depressing assumption: executives simply weigh up all their options, including the illegal ones. Given a risk-free opportunity to mis-sell a product, or form a cartel, they will grab it. Most businesspeople are not this calculating, of course, but the assumption of harsh rationality is a useful way to work out how to deter rule-breakers."

Given this assumption, an economist can come up with a scheme for disincentivizing a rational criminal.

"In an influential 1968 paper on the economics of crime, Gary Becker of the University of Chicago set out a framework in which criminals weigh up the expected costs and benefits of breaking the law. The expected cost of lawless behaviour is the product of two things: the chance of being caught and the severity of the punishment if caught. This framework can be used to examine the appropriate level of fines, and to see if there are ever reasons to exempt companies from fines."

Using this approach, the author concludes that fines will have to be much higher if they are going to have the necessary deterrent effect.

The author’s conclusion is rather obvious given that fines are levied as punishment and crime continues. Of more interest is the implied notion that corporations can be considered as having the same motives and ethical responses as individuals.

Lynn Stout addresses some of these issues from a different perspective in her book Cultivating Conscience: How Good Laws Make Good People. She is not a fan of the homo economicus view of humanity. She believes it is an absurd assumption in economics, and particularly so as applied to law.

"If this is true, Economic Man is a being without conscience. He will happily lie, cheat, steal, renege on his promises, even murder, whenever doing so advances his material interests....The resulting portrait of human nature is anything but implies we are psychopaths."

Psychiatrists have a collection of characteristics they use to identify psychopaths. There is a nice overlay with those of homo economicus.

"Antisocial Personality Disorder (APD) is the formal psychiatric label for psychopathy. The hallmarks of APD are extreme selfishness and lack of consideration for others, along with tendencies ‘to lie, cheat, take advantage, [and] exploit’."

"Luckily, very few people act like this. The American Psychiatric Association estimates that only 1-3 percent of the U.S. population suffers from APD, and many of these individuals are safely locked away in prison."

While Stout does not hold with the homo economicus view of individuals, she does consider the possibility that corporations, being other than human, may be capable of generating such aberrant behavior. The issue is social context. The thesis of her book is that humans have evolved as "prosocial" animals. They have innate behaviors molded by the requirement that society must have individuals who are cooperative, law-biding, and considerate of others if society is to be successful. Individuals, except for the few psychopaths, are predisposed to have those characteristics. However, humans can change their behavior if inserted into different social contexts. For example, a person who willingly pays his taxes will be tempted to cheat if he discovers that he is surrounded by neighbors who cheat on their returns.

Stout believes that people imbedded in a corporate environment are unlikely to become homo economicus, but might become what she refers to as a cousin: "corporation man." An environment that fosters a "them versus us" attitude and focuses only on financial gains as a metric of success is one that can alter behavioral patterns. As discussed in The Legal Basis for Corporate Irresponsibility, lawyers, economists, and legislators are telling corporation man that his only responsibility is to make money—not a message likely to generate ethical concerns.

Is there such a thing as corporation man? It is definitely possible. Antitrust violations are too easily explained as commercial exuberance and it is hard to envisage them as pathological behavior. However, consider some of the actions of the pharmaceutical corporations. The $3 billion fine levied on GlaxoSmithKline involved admitting criminal behaviors including failure to tell regulators about safety data for one of its drugs. Can it be that corporation man, outside of his business environment, would not think of harming another human, but within the corporate context is capable of reckless behavior that could endanger the health of many individuals? One can look at the frequency with which these antisocial actions are taken by corporations and conclude that there is a corporate culture that encourages such behavior.

If one then believes in corporation man, how does one disincentivize his behavior? Corporate fines don’t seem to have the desired effect. As Stout indicates, most true psychopaths end up locked away in prison. Since corporation man is not a true psychopath, but merely a cousin, perhaps a form of "three strikes" would be appropriate: first offense yields a corporate fine; second offense adds a fine for the CEO; third offense adds fines for all the board members. If the criminal actions are life-threatening, the second and third offense penalties can by switched to prison terms.


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  2. This is a very interesting article! I never realized that economists could manipulate corporate crime so much. It's hard to know what loopholes will be exploited and when, but I'm sure there is action being taken all the time. I just wish there was less corporate crime to mitigate. Thanks for this post!


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