Another Way to Prevent Corporate Crime?

Do prosecutors need another arrow in their quiver? Professor John Coffee of Columbia Law School thinks so.

In Rethinking Corporate Prosecutions in the Harvard law school corporate law blog Coffee writes:

What threat could cause corporations to agree to turn in senior executives? Clearly, current penalties are not sufficient. In some event studies that we conducted for my book, the stock prices of corporations sentenced to record fines actually went up on the day of sentencing (even though these record fines could not have been easily predicted). This does not prove that corporations cannot be deterred, but only that cash fines on huge public corporations can be easily digested. Yet, heavy penalties can cause externalities that fall on the least culpable: low-level employees who might be laid off, creditors whose debt securities will decline in value, and local communities who depend upon the local industry to provide its tax revenues. We need therefore to focus the necessary penalty on the shareholders—who alone can take action to reform their firm and who are probably for the most part well diversified.

How can one do this? My proposal is the “equity fine”: a fine levied not in cash but in common shares. This fine would transfer some percentage of the corporation’s authorized, but unissued, stock to a victim compensation fund. Forcing the company to issue 10% to 20% of its stock is certainly severe enough to deter shareholders through dilution, but it has no real impact on low-level employees, creditors, or other stakeholders. Nor does it render the corporation less solvent or threaten bankruptcy (as cash fines do).

From a fairness perspective this does sound like a distinct improvement over present practices. But would the “equity fine” also serve as a more effective deterrent to corporate crime than the cash fine does?

My initial reaction to it was that the “equity fine” is built partly on a foundation of “homo economicus” thinking which – as described in in this prior post – reflects a hyper-rational economics-based view of human nature.   But I also see that an equity fine could improve the practice of compliance, particularly in large corporations. By focusing so directly on shareholders, which would include directors, such fines could bring an immediacy to compliance needs that in a variety of ways  (including building on applicable fiduciary duties) could make a compliance program more effective.

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