Companies sometimes find it more profitable to break rules and pay penalties than to follow regulations, according to a recent study by Stanford Graduate School of Business professors Anat Admati and Paul Pfleiderer, along with Nathan Atkinson, PhD ’19, now an assistant professor of law at the University of Wisconsin, Madison. Their paper examines how corporate governance practices intended to align with shareholder interests can inadvertently create incentives for harmful behavior.
One example discussed in the paper is the 2018 wildfire in Butte County, California. The fire was caused by aging and poorly maintained transmission lines operated by Pacific Gas & Electric (PG&E), resulting in the deaths of 85 people and significant property destruction. While PG&E pleaded guilty and agreed to pay $3.4 million—the maximum penalty—no executives or employees were criminally charged.
“It’s all about incentives,” Admati says. The authors argue that weak law enforcement can make maximizing shareholder value detrimental to society. “Reasonable-sounding changes in policies can actually lead to bad results,” Atkinson says.
The research uses economic modeling alongside real-world cases to demonstrate that fines set too low are often treated as just another cost of doing business by corporations. “There are many reasons why the fines are set too low,” Atkinson says, noting factors such as national pride in major companies or concerns about job losses if penalties become too severe. Corporate lobbying also plays a role in weakening regulations.
Raising fines might seem like a solution, but according to the researchers’ model, larger fines alone do not necessarily deter misconduct. Companies may adjust managerial incentives through stock-based compensation or similar mechanisms that neutralize increased financial penalties. “They can ramp up the incentives for managers in ways that offset higher fines so that shareholder value is maximized,” Pfleiderer says.
Insurance policies further shield executives from personal financial consequences; after the 2018 fire, PG&E’s settlement for $117 million with its executives and board members was entirely covered by insurers. The company also declared bankruptcy during its legal troubles, limiting liabilities and reducing compensation available for victims.
The authors question whether early detection programs—such as offering lower fines when companies self-report violations—are effective deterrents. “On one level, this strategy sounds reasonable,” Admati says. However, their findings indicate these programs may make it more profitable for managers to misbehave and report only when advantageous for shareholders.
“We show that in some situations voluntary programs based on discounted fines do not improve things at all,” Pfleiderer says. “And in a subset of those, they actually make things worse.” He cites tax fraud as an example where reduced penalties for self-reporting could increase overall violations despite higher detection rates.
While not prescribing definitive solutions, the researchers recommend exploring measures such as enhanced whistleblower protections and restrictions on corporate use of debt or bankruptcy to escape liability for wrongdoing. They also emphasize holding individual managers accountable with meaningful consequences when laws are broken.
Admati concludes: “Corporations have an enormous impact on our lives… Society needs to govern corporations through well-designed and effectively enforced rules.”
This article was originally published by Stanford Graduate School of Business.
