Sad But True: Corporate Crime Does Pay
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Almost daily we read about another apparently stiff financial penalty meted out for corporate malfeasance. This year corporations are on track to pay as much as $8 billion to resolve charges of defrauding the government, a record sum, according to the Department of Justice. Last year big business paid the SEC $2.8 billion to settle disputes.
Sounds like an awful lot of money. And it is, for you and me. But is it a lot of money for corporate lawbreakers? The best way to determine that is to see whether the penalties have deterred them from further wrongdoing.
The empirical evidence argues they don’t. A 2011 New York Times analysis of enforcement actions during the last 15 years found at least 51 cases in which 19 Wall Street firms had broken antifraud laws they had agreed never to breach. Goldman Sachs, Morgan Stanley, JPMorgan Chase and Bank of America, among others, have settled fraud cases by stipulating they would never again violate an antifraud law, only to do so again and again and again. Bank of America’s securities unit has agreed four times since 2005 not to violate a major antifraud statute, and another four times not to violate a separate law. Merrill Lynch, which Bank of America acquired in 2008, has separately agreed not to violate the same two statutes seven times since 1999.
Outside the financial sector the story is similar. Erika Kelton at Forbes reports that Pfizer paid $152 million in 2008; $49 million a few months later; a record-setting $2.3 billion in 2009 and $14.5 million last year. Each time it legally promised to adhere to federal law in the future. Each time it broke that promise.
The SEC could bring contempt of court charges against serial offenders, but it doesn’t. Earlier this year the SEC revealed it has not brought any contempt charges against large financial firms in the last 10 years. Adding insult to insult the SEC doesn’t even publicly refer to previous cases when filing new charges.
We know that CEOs of big corporations never go to jail. We probably didn’t know they often benefit financially even when the corporations under their control violate the law. GlaxoSmithKline CEO Andrew Witty recently received a significant pay boost to roughly $16.5 million just four months after Glaxo announced it will pay $3 billion to settle federal allegations of illegal marketing of many of its prescription drugs. Johnson & Johnson Chairman and CEO William Weldon received a 55 percent increase in his annual performance bonus for 2011 and a pay raise despite a settlement J&J is negotiating with the Justice Department that could run as high as $1.8 billion.
What level of penalty might deter corporate crime? The Economist magazine recently addressed that question. It used the common sense framework proposed by University of Chicago economist Gary Becker in an influential 1968 essay. Becker proposed that criminals weigh the expected costs and benefits of breaking the law. The expected cost of lawless behavior is the product of two things: the chance of being caught and the severity of the punishment if caught.
Purdue Economics Professors John M. Connor and C. Gustav Helmers examined the market impact of over 280 private international cartels from 1990 to 2005 and the fines imposed on them by various governments. They estimated these criminal conspiracies in restraint of trade raised prices by $260-550 billion. The median overcharge was about 25 percent of affected commerce.
Thus a fine about 25 percent of revenue would repay the damage done. But that’s assuming wrongdoing is caught every time. The Economist suggests that catching one in three violations would constitute a good track record for regulators. That would mean a fine of 75 percent of revenue would be needed to deter future violations. But the study found that actual fines ranged only between 1.4 percent and 4.9 percent.