Game theory, compliance, and corporate criminal liability: Insights from a three-player inspection game

Abstract

The economic analysis of crime has contributed significantly to our understanding of corporate criminal activity. To derive implications for legal policy, most theoretical papers, however, take public enforcement as exogenous, i.e. non-compliance with laws is punished with a given probability by a mechanical enforcer. We apply a game-theoretic perspective to corporate criminal behavior, self-disclosure, and policing. In this paper, we model corporate compliance as a three-person inspection game in order to analyze the impact of different liability regimes on rule breaking behavior by the firm’s agents, monitoring effort by corporate management and enforcement effort by authorities. Our analysis shows that one out of two equilibria in mixed strategies can be desirable for policy makers: while the first equilibrium requires a delicate regime of composite liability to induce self-disclosure, the second outcome is less prone to specification errors and does not rely on self-disclosure by firms. Which equilibrium is socially more desirable regarding social costs depends largely on the relative difference in monitoring costs between the corporation and authorities. We also find that a composite liability regime is more vulnerable to the reallocation of punishments by the agents through contracts or civil litigation. Moreover, we also consider the effects of whistleblower protection programs and a negligence-based liability regime to induce efforts to prevent crime ex-ante.