Government regulators may reduce corporate fines for criminal behavior if the fines threaten the firm’s survival, thus posing harms to employees and society. In a recent paper, Nathan Atkinson explores the frequency with which government regulators reduce fines and evaluates if these reductions are justified or if regulators are undermining their own capabilities to deter bad behavior and fully compensate harmed parties.

In 2005, semiconductor firm Hynix pled guilty to a decade of price-fixing. Under federal sentencing guidelines, Hynix should have faced a criminal fine of up to $537 million. Instead, prosecutors imposed a $185 million penalty, which they allowed Hynix to pay interest-free over five years. Their rationale? A larger fine “would have exceeded the Defendant’s ability to pay.”

This case exemplifies an understudied but common practice of United States government officials reducing corporate penalties over fears of “collateral consequences,” including job losses and harm to the public more broadly. In a recent paper, I explore the frequency of these reductions in penalties and evaluate if these regulatory fears of collateral consequences are justified or if government officials are unnecessarily undermining deterrence against criminal behavior and reducing compensation for harmed parties. I find that reductions often lack justification given the financial health of the guilty firms.

Regulators across the U.S. federal government have broad legal authority to reduce penalties if they might lead to insolvency or other unintended harm. For example, the United States Sentencing Guidelines for Organizational Defendants explicitly instructs prosecutors to consider collateral consequences and provides mechanisms to adjust fines downward to “avoid substantially jeopardizing the continued viability of the organization.” The Environmental Protection Agency gives reductions when liability would “result in plant closings, bankruptcy, or other extreme financial burden, and there is an important public interest in allowing the firm to continue in business.” And the Federal Trade Commission takes into account factors including a corporation’s “ability to pay [and the penalty’s] effect on [the corporation’s] ability to continue to do business.”

Looking across dozens of departments, agencies, and commissions, I find that over 96% of fines imposed at the federal level since 2000 are governed by policies that instruct officials to consider the effect of the fine on factors including “innocent employees,” “customers,” “competition,” “ability to pay,” “ability to continue in business,” “others not proven personally culpable,” and “the public generally.”

Officials appear to adhere to these policies and reduce fines quite often. For criminal cases, I find that 20.6% of solvent firms and 54.2% of financially distressed firms (which together represent 67% of all cases) have had their fines explicitly reduced because of concerns about financial distress.

However, a closer look at high-profile cases of fine reductions reveals that those officials often lower fines unnecessarily, overstating risks to employees and shareholders.

Consider again the fine paid by Hynix in 2005. The Department of Justice’s settlement agreement explained the large downward adjustment was because the full fine “would have exceeded the Defendant’s ability to pay.” Moreover, the fine was further reduced “due to the inability of the Defendant to make restitution to victims and pay a fine greater than that recommended without substantially jeopardizing its continued viability.”

Yet at the time of the plea agreement, Hynix had a market capitalization of $2 billion and a book value of $3 billion, calling into question the claim that Hynix was unable to pay the full fine.

Officials instead seemed to have paid closer attention to Hynix’s net current assets—the firm’s cash and short-term assets minus its short-term liabilities—which were negative $765 million. However, this was a mistake. With Hynix’s substantial book value and market capitalization, it could surely have financed a much larger fine.

To see why, compare Hynix’s position, for example, to a reckless driver claiming that they cannot afford to pay a speeding ticket because they have no income, no money in their checking account, and a $10,000 credit card bill that comes due next month—despite owning a $5 million home outright. Regardless of their checking account, income, and credit card bill, it’s plain that the driver can comfortably afford their speeding ticket, even if it requires accruing additional interest on a credit card or taking a home equity loan until they are back at work.

When regulators under-penalize corporations out of exaggerated concerns, it allows companies to avoid properly compensating victims or internalizing the costs of misconduct. This ultimately subsidizes and enables future wrongdoing.

Officials should be far more skeptical of corporate claims that fines will lead to insolvency or job losses. Public companies in particular frequently have ample means to pay fines through raising debt or equity, without severely impacting operations. Officials must better apply basic corporate finance principles to rigorously evaluate if a company could truly pay the penalty.

Equally important, officials need to do a better job at explaining to judges and the public penalty reductions rather than relying on vague claims around “collateral consequences” or “ability to pay.” This transparency would allow for proper scrutiny of whether reductions were warranted, guiding future enforcement.

In some cases, however, the concerns about collateral consequences are valid. Take, for example, the homebuilder Beazer Homes, which was assessed a $50 million penalty in 2009 for fraudulent lending practices. The settlement was widely criticized for being too low, but the U.S. Attorney’s office justified the amount by stating that “the imposition of additional criminal penalties or the requirement of additional payment at this time would jeopardize the solvency of Beazer and put at risk the employment of approximately 15,000 employees and full-time contractors not involved in the criminal wrongdoing.”

At the time of the settlement, Beazer had a book value of $196 million and a market capitalization of only $71 million, making the concerns about insolvency much more real than in the Hynix case.

How then should an official set a fine when there are legitimate concerns about the fine contributing to insolvency and the associated collateral consequences?

In a working paper, I explore the equilibrium effects of concerns about collateral consequences in a deterrence framework. When there is a legitimate concern about collateral consequences, officials face a tradeoff between ex ante deterrence (high fines) and ex post efficiency (low fines). Anticipating this, firms can strategically increase their leverage in order to increase the cost of imposing a fine for officials, thereby inducing reductions.

That is, government concerns about collateral consequences can perversely increase corporate misconduct and sow the seeds for those very collateral consequences to arise.

In my working paper, I consider a proposal first made in the legal literature by John Coffee, which mandates that the firm issue new equity to pay fines. Equity issuances avoid collateral consequences by recapitalizing the firm and imposing the full incidence of liability on the firms’ shareholders. This in turn means that officials need not exhibit the same reticence when imposing fines through equity issuances, thereby improving deterrence, and better aligning the incentives of corporations with society more broadly.

Ultimately, optimal deterrence requires fines that lead to the firm internalizing the externality of its misconduct. Unprincipled fine reductions undermine this, effectively subsidizing misconduct at the public’s expense. By more rigorously probing guilty firms’ finances, officials can better ensure that fines are serving a social purpose.

Author Disclosure: The author has no relevant or material financial interests that relate to the research described in this paper.

Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.