Determinants of the Invisible and Visible Hands of Punishment: An Examination of Corporate Bribery Prosecutions

Abstract

The purpose of this research is to examine how the market, or the invisible hand, and regulators, or the visible hand, penalize organizational misconduct through the imposition of reputational penalties and legal sanctions respectively. Reputational penalty measures market based losses a firm suffers when it engages in illegal behavior, causing its immediate stakeholders to change the terms of doing business. On the other hand, sanctions refer to the punishment provided by regulators for deviating from social norms and regulations. The aggregation of these two components reflects the total punishment for these transgressions. I develop a comprehensive model that estimates the total penalty and examines the determinants of each of its components.

I assess reputational penalties by conducting event study analyses on the population of public firms prosecuted for bribery under the Foreign Corrupt Practices Act from 1978 to 2010. The analyses show that these firms lost over $60 billion in market capital during this period. This translates to a reputational penalty of 83¢ for every dollar of share value loss; the remaining 17¢ represents the direct costs to the firm to manage the prosecution. Omission of reputational penalties in rational choice calculus underestimates bribery costs by 4.5 times. Drawing on organization stigma literature, I then explore the degree to which stigma is attached, diffused, or embedded in accounting systems. The combination of host country corruption stigma, involvement of compromised executives and corruption entrenchment in accounting systems explain variations in reputational penalty.

I also examine the hazard rate of recovery of firms’ reputational penalty following the occurrence of bribery events. Prior firm reputation affects the likelihood of recovery in a manner that it hinders recovery for firms with higher reputations than those with lower reputations. This suggests that deviant activity has greater repercussions for the former firms than the latter firms.

Under the sanctions model of punishment, I evaluate a process model of how firms regain legitimacy after allegations of misconduct. A new measure of sanctions is developed and tested. The results demonstrate that bribery misconduct is sanctioned according to its severity. Firms that internally investigate and terminate culpable employees are rewarded with lesser sanctions.

Overall, the experiences of firms prosecuted for corporate bribery suggest that firms should proactively institute corporate monitoring mechanisms to prevent criminal misconduct. My research has advanced current knowledge of punishment from corporate misconduct.