In today’s corporate landscape, doing the wrong thing can sometimes be the more profitable choice. A shocking example of this occurred during the catastrophic 2018 wildfire in Butte County, California, which devastated the town of Paradise and claimed 85 lives. Investigators revealed that the inferno was ignited by Pacific Gas & Electric’s (PG&E) outdated and poorly maintained power lines.

While individuals responsible for such devastation face severe legal consequences—over 80 counts of involuntary manslaughter could lead to 90 years in prison—corporations operate under a different set of rules. PG&E paid a mere $3.4 million in penalties for the tragedy, equating to about $42,000 per lost life, with no executives facing criminal charges.

This sobering reality highlights the findings of a recent paper from Stanford University's finance professors Anat Admati and Paul Pfleiderer, along with law professor Nathan Atkinson from the University of Wisconsin, Madison. Their research dives deep into how corporate misconduct can flourish under existing governance frameworks, revealing that the very structures intended to promote ethical behavior may instead incentivize wrongdoing.

The Flaws in Corporate Governance

Maximizing shareholder value has long been the gold standard in corporate governance. However, this principle often clashes with the collective good, leading to harmful outcomes. Admati asserts, “Economists assume any market-approved activity benefits society, overlooking that corporations might profit from causing harm.”

The researchers created an economic model revealing that when penalties are low, companies perceive them as just another operational cost. They argue that fears of damaging national pride or economic stability often result in lower fines, failing to deter misconduct effectively.

Why Bigger Fines Aren’t Enough

While raising fines is a proposed solution, the authors show that larger penalties can still fall flat. Companies frequently bolster executive incentives to counteract the impact of fines, ensuring shareholder profits remain a priority. Furthermore, insurance can shield executives from the financial backlash of misconduct, and bankruptcy can help corporations limit their legal liabilities—often leaving victims with little to recover.

The Risks of Incentivizing Self-Reporting

One intriguing discussion within the paper centers around whether offering lower fines for early self-reporting could curb corporate crimes. Initially, this seems a viable deterrent, but the analysis reveals a startling trend: such programs might actually make misconduct more enticing, as companies focus on profits over ethical behavior.

Imagine if tax fraud could be reported without serious penalties. Wouldn’t it lead to an increase in dishonest declarations? That’s precisely the concern the authors point out: when the cost of misbehavior is lowered, it often encourages more of it.

Towards Effective Corporate Accountability

The authors emphasize the need for innovative strategies to foster a culture of accountability in corporations. This includes improving protections for whistleblowers and examining limits on corporate debts that shield misbehavior.

Ultimately, the paper calls for a more profound reflection on the financial incentives that guide corporate actions. Admati warns, “When profit remains the sole goal, we can’t expect companies to act responsibly.” Effective governance is vital not just for corporations, but for the welfare of society as a whole.