When ‘Good’ Corporate Governance Leads to Bad Behavior

The tragic wildfire that swept through Butte County, California, in 2018, serves as a stark illustration of this issue. Pacific Gas & Electric (PG&E), whose poorly maintained transmission lines were found to have triggered the fire, pleaded guilty to multiple counts of involuntary manslaughter. Despite the gravity of the offense, the financial penalty imposed was a mere $3.4 million, significantly less than the value of the lives lost. This case exemplifies how corporations, shielded from the harsher penalties faced by individuals, can treat fines as just another business expense.

The research conducted by Stanford professors Anat Admati, Paul Pfleiderer, and Nathan Atkinson highlights the inadequacies in enforcement that allow corporations to prioritize shareholder value over societal good. The study argues that weak penalties fail to deter misconduct, as the cost of fines is often outweighed by the financial gains from unethical practices. Moreover, companies employ strategies like insurance and bankruptcy to mitigate the financial impact of penalties, further diminishing the effectiveness of current enforcement mechanisms.

Why not simply increase fines to deter corporate misconduct? While larger penalties might seem like a straightforward solution, the reality is more complex. The researchers found that companies can counteract higher fines through managerial incentives like stock-based compensation, which align management actions with shareholder interests rather than ethical standards. Furthermore, political and economic considerations often prevent governments from imposing steep fines, especially on corporations viewed as national assets.

Exploring alternative approaches, the researchers considered incentivizing early reporting of misconduct by reducing fines for self-disclosure. However, this strategy may backfire by making it more profitable for companies to initially engage in misconduct. The promise of reduced penalties for self-reporting can inadvertently increase the frequency and severity of unethical behavior, as corporations weigh the benefits of misdeeds against the lower cost of potential fines.

To address these challenges, the authors suggest enhancing whistleblower protections and holding individual executives accountable through meaningful consequences, including potential prison sentences. They emphasize the need for a comprehensive reevaluation of corporate governance structures to better align corporate actions with societal responsibilities. By reinforcing ethical standards and effective enforcement, society can ensure that corporate interests do not override the common good.