In new research, Anat R. Admati, Nate Atkinson, and Paul Pfleiderer argue that when misconduct is profitable, enforcement mechanisms aimed at deterring corporate misconduct often fail to achieve their goals and they may even backfire. The reason is that corporations can adjust internal governance mechanisms, particularly managerial compensation, to reduce or nullify the deterrent effects of corporate or managerial sanctions. These responses may lead to more misconduct and exacerbate social harm.
This essay is closely related to articles published in ProMarket by participants in the 2025 Conference on Global Capitalism, Trust, and Accountability at Stanford University Graduate School of Business. Visit the conference website for additional content.
When corporations are chartered, they obtain a bundle of legal rights. Their only commitment is to obey the law. Yet, this commitment is put to the test when law enforcement is weak and the people who ultimately control the firm, shareholders and managers, can gain more from illegal conduct than they expect to lose from fines and other sanctions. In our paper, “Profitable Misconduct, Corporate Governance, and Law Enforcement,” we explore how prevailing law enforcement practices interact with corporate governance mechanisms such as stock-based managerial compensation. We show how contracts push managers towards profitable misconduct and how those contracts can be adjusted to further undermine the deterrent effects of law enforcement. We also examine the effectiveness of several common enforcement practices, such as offering reduced fines if corporations establish compliance programs or self-report wrongdoing and show that these can perversely increase the harm from corporate misconduct.
The economics and finance literature generally ignores the possibility that corporations will engage in misconduct and break laws when pursuing the conventional measures of business success: profits and rising share prices. Research in corporate governance is usually focused on ensuring that the interests of directors, executives, and shareholders are aligned. The critical assumption being made (almost always implicitly) is that well-designed laws protect other corporate stakeholders and society as a whole and that these laws are enforced effectively. If these assumptions do not hold, corporate decision makers whose interests are closely aligned with those of shareholders can cause significant harm.
The harm from corporate misconduct can be immense, including deaths, injuries, and massive financial losses. A few illustrative examples are:
• Volkswagen’s fraudulent manipulation of emission tests allowed it to sell vehicles that emitted 40 times the legal limit of nitrogen oxides for more than eight years, leading to increased levels of respiratory disease and premature deaths.
• Purdue Pharma fraudulently marketed its opioid painkillers, which started a massive opioid epidemic in which over 600,000 people died of overdoses.
• Pacific Gas and Electric (PG&E) was found guilty in a jury trial of criminal safety violations related to its gas pipelines and, a few years later, pleaded guilty to 84 counts of manslaughter related to wildfires caused by its decades-long reckless negligence in maintaining equipment for electricity transmission.
• Boeing misled the Federal Aviation Administration and its customers about key safety issues, leading to two plane crashes that killed 346 people.
In the cases above, the consequences for the corporations were strikingly inadequate to compensate victims properly or to create deterrence. For example, PG&E paid only $3.4 million in fines for the 84 manslaughter charges ($41,667 per lost life). By comparison, an individual may spend a year or more in prison for a single count of manslaughter. Purdue Pharma faced claims in the trillions from many government bodies, corporations and victims of the opioids epidemic by the time it filed for bankruptcy in 2019. After years of litigation, a recently proposed settlement will award all claimholders $7.4 billion, which means that many victims will receive little compensation for the harm they suffered. Purdue’s primary owners, the Sackler family, extracted billions in dividends and have kept significant assets out of reach from United States courts.
Of course, a key to deterring misconduct is that misconduct is detected and leads to sufficiently significant sanctions. However, misconduct can go undetected for years and may only get revealed when harm becomes visible enough that it cannot be ignored. Because the detection of misconduct is often uncertain and the fines imposed when misconduct is detected are often small, misconduct can be profitable and benefit shareholders even taking into account the potential consequences of breaking the law.
A host of factors can make law enforcement weak in the corporate context. These include concerns about possible collateral harm suffered by innocent parties when large corporate fines are imposed, the various ways bankruptcy can be used to limit liabilities for harms caused by a corporation, the costs and challenges involved in successfully sanctioning well-resourced corporations, and political pressures that can influence enforcement.
To explore the issues, we develop a model that captures key elements of corporate governance and enforcement practices. In our model, managers choose levels of profitable actions that either benefit or harm society, and corporations modify compensation structures and other strategies in response to law enforcement policies. We show that when misconduct that leads to social harm is profitable, shareholders can design stock-based compensation structures that provide incentives for managers to engage in the level of misconduct that most benefits shareholders. More interesting is how contracts respond to changes in the enforcement regime. Whereas for any given incentive contract, managers will generally engage in less misconduct if fines are increased, we show that adjustments meant to ensure that managers act in the interest of shareholders can undo much—or even all—of the harm-reducing effects of increased fines. Much of what is considered “best practice” in corporate governance is based on economic theories that show how the interests of a firm’s managers can be aligned with the owners of the firm, the shareholders. These practices can address conflicts of interest between managers and shareholders within the corporation, but as we show they can perversely undermine law enforcement and harm society.
Enforcement actions related to corporate misconduct can target individuals within corporations. After all, corporations can only act through humans. Unfortunately, diffused responsibility within corporations often makes it difficult to identify individuals who should be held accountable for corporate misconduct. Even if the corporation commits crimes, it may be impossible, or too costly, for those working for enforcement agencies to pursue charges against individuals and prove crimes or other misconduct in court. In most cases, including the examples mentioned above, corporate leaders do not suffer meaningfully following corporate misconduct, even if failed to prevent it and potentially benefited from the profits it generated. Books by Jesse Eisinger and Jed Rakoff explain some of the dynamics that lead to this situation
Indeed, our analysis shows that even if authorities attempt to impose penalties on individual managers to deter corporate misconduct, many of the same forces that weaken the deterrent effects of enforcement actions taken against the corporation also undermine the effectiveness of actions taken directly against individuals. Specifically, we show that corporations can offset the potential effects of increasing managerial liability by raising the manager’s equity stake. Although doing so is costly for shareholders, costs are lower than the benefits the shareholders receive from preserving the manager’s incentives to engage in profitable misconduct. In addition, deterrence is significantly weakened by the routine practice of shareholders shielding managers from liability through insurance and indemnification.
The challenges and costs associated with detecting and investigating corporate misconduct have led many authorities to seek the cooperation of corporations. To provide incentives, authorities offer to reduce fines significantly in exchange for this cooperation. We study two prominent forms of cooperation. The first consists of voluntary compliance programs meant to facilitate faster detection and mitigation of misconduct. In exchange for implementing “adequate and effective” compliance programs, prosecutors offer potentially large discounts in fines. The second cooperative approach is to offer large discounts on fines when corporations self-report misconduct. In May 2025, the Department of Justice substantially revised its policies so that companies that self-disclose and meet other criteria will receive a declination of prosecution. Speaking of the changes, the head of the Criminal Division stated, “never before have the benefits of self-reporting and cooperating been so clear.”
We study whether offering discounted fines in exchange for voluntary compliance programs and self-reporting can reduce social harm in those cases where misconduct is profitable for shareholders. Our results show that approaches based on voluntary cooperation in exchange for discounts in fines can actually exacerbate the problem and increase the overall harm caused by corporate misconduct. Although these programs may help reduce the expected duration of misconduct episodes, when misconduct is profitable the corporation will only choose to cooperate with authorities if it finds cooperating and benefitting from reduced fines more attractive than not cooperating, which requires that the discounts in fines be sufficiently high. If the discounts are high enough to induce cooperation, the corporation will generally have incentives to pursue harmful activities at a greater intensity up to the point where misconduct is detected or self-reported. We show that the total harm can be greater if discounts are given for cooperation than if no discounts are given and there is no cooperation. In other words, giving incentives for cooperation may make matters worse.
Our analysis produces important insights that can guide both future research and policy. The analysis highlights, for example, the importance of policies that increase detection (e.g., through whistleblowers) in ways that don’t rely on offering discounted fines in exchange for voluntary cooperation by corporations. It also suggests that finding ways to increase the personal liability of key decision makers in the corporation, particularly in ways that shareholders cannot easily undermine, would be valuable.
More broadly, our framework shows how methods aimed at addressing agency issues within corporations can weaken and subvert external governance mechanisms designed to address the numerous potential conflicts between corporations and society. Whereas corporate governance research and practice have focused almost exclusively on the relations among shareholders, directors and managers, our paper shows that it is important to incorporate the potential conflicts between the corporation and other stakeholders or society as a whole. Presuming that laws and law enforcement mechanisms are “optimal” is inappropriate, and the case of underenforcement that we analyze is clearly relevant in the real world. A holistic perspective that might be called societal corporate governance seeks to ensure that corporations have the proper incentives to produce benefits for society without causing undue harm.
Author Disclosure: The author reports no conflicts of interest. You can read our disclosure policy here.
Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.
Subscribe here for ProMarket’s weekly newsletter, Special Interest, to stay up to date on ProMarket’s coverage of the political economy and other content from the Stigler Center.
