Benefits of financial crimes outweigh potential legal costs, and fines won't stop bad behavior

May 27, 2021
Fines may not deter the crimes. (Shutterstock)

Fines may not deter the crimes. (Shutterstock)

The economic benefits of illicit financial activity vastly outweigh the costs of litigation, according to new research, and trying to combat crime through external motivations such as fines is less effective than ethics-centered methods that focus on a combination of intrinsic and altruistic motivations.

According to a study published May 6 in the Journal of Business Ethics that considers data from the U.S. Securities and Exchange Commission and a recent legal case pertaining to investment-related misconduct, financial crime is profitable for corporations on a net present-value basis, overshadowing the potential risk of expensive legal battles should criminal conduct be exposed. 

Net present-value, in simple terms, refers to a method of calculating the total value or return-on-investment of a project. Finance actors engaging in criminal activities are presumed to pursue extrinsically motivated behavior, which prioritizes personal material gain and maximizes activities' net present-value or expected utility.

According to the study, from a "rational" perspective under prevailing assumptions of risk and profit, deterrence methods and punishments based on perceived utility or extrinsic motivations will often be ineffective, since the net present-value of many illicit financial activities is quite high in the current U.S. environment; some schemes, according to the researchers, allow companies to illicitly net tens of millions of dollars more than they otherwise would have. Furthermore, higher pay and other monetary incentives can always be used as a form of bribery or to sway allegiances.

Unless individuals can be identified as responsible for offenses, it is difficult to implement punishment through the criminal justice system, and even then, the corporations themselves often evade accountability through a network of cleverly designed shell companies. Million-dollar fines and penalties that are successfully enforced against corporations engaging in improper practices are more often than not experienced as a small-change slap on the wrist, although they sound severe to the average consumer. 

The median penalty handed down by the SEC in 2020 was about $200,000, according to researchers; the median disgorgement, or repayment or ill-gotten gains, ordered was about $500,000.

Karol M. Klimczak, an associate professor of finance at Lodz University of Technology, said he and his co-author, Alejo J.G. Sison of the University of Navarra, were inspired to investigate this topic following conversations between the two over coffee. The colleagues had followed media coverage of financial misconduct exposed during the 2007-2009 financial crisis and were appalled by how easily financial institutions could settle in court, easily evading responsibility after reaping hundreds of millions of dollars in illegal profit. 

"Academic literature, in contrast, appeared to study only the consequences of misconduct, but not motivations for it. We felt that this lack of scholarship is one reason why deterrence measures are ineffective," Klimczak told The Academic Times. "In our project, we wanted to dive into the motivations that drive finance professionals into misconduct or away from it. We hope the results can guide the development of new deterrence methods."

The researchers argue that deterrence measures based exclusively on utility and extrinsic motivation have very limited efficacy, since workers can simply be "bribed" into legally compliant behavior by means of higher wages. When the monetary stakes can always be raised, this cannot function as a definitive or long-lasting solution.

One alternative, according to the researchers, is to consider the financial market through a lens that includes intrinsic and altruistic motivations, in addition to extrinsic factors. For example, rather than focusing on the interplay between punishments and incentives, or the utility, honest dealings in finance could be promoted through human resource management policies that recruit and train intrinsically or altruistically motivated staff, and by encouraging leadership styles and organizational cultures that emphasize the importance of virtue and the pursuit of a common good over individual utility.

Business leaders can strengthen intrinsic and altruistic motivations by offering opportunities for personal development, advancement and collaboration in prosocial activities instead of monetary incentives like bonuses, according to Klimczak. Rewards geared toward extrinsic motivations such as bonuses can be detrimental to the retention of intrinsically motivated employees who demonstrate higher integrity. Hiring managers, too, should focus on positive virtues demonstrated by job candidates, rather than honing in on hard skills or corporate experience alone.

"The interactions between employees and managers can be based in trust and common spirit, rather than monitoring for punishment or reward. Evaluation and ratings can be based on how employees achieve their outcomes, rather than outcomes alone," Klimczak explained. "This would foster an alignment of goals, better performance, well-being and long-term success."

The study, "How to deter financial misconduct if crime pays?" published May 6 in the Journal of Business Ethics, was authored by Karol Marek Klimczak, Lodz University of Technology; Alejo José G. Sison, University of Navarra; Maria Prats, Northwestern University; and Maximilian B. Torres, The Catholic University of America.

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