I almost never agree with Robert Monks about corporate governance (or politics or, well, pretty much anything), but he's doing the Lord's work with his latest commentary:
... no one wants to bring a criminal case against a corporation. The memory of the Arthur Anderson case is still strong in people’s minds when thinking about this. The unintended consequences of criminal charges in that case led to one of the country’s largest and most prestigious accounting firms to go out of business. Except in the most extreme cases, it doesn’t do anyone any good to drive a company out of business, and so there has been an aversion to charging corporations with crimes. ...
Little attention is paid to the people making the decisions at the head of the corporations. They alone are responsible for the (sometimes repeated) offenses, and yet the financial burden is borne by the shareholders. Bonuses and salaries are paid to top management regardless of company performance. Even when a CEO is fired, more often than not he or she has craftily arranged a golden parachute and walks away with a fortune.
When the government imposes a fine, the intention is to reduce the book value of the stock which is to the detriment of the shareholders -- and nobody else. They end up in the disagreeable position of having their cash reserves depleted and having been misled by executives. We see a vast discrepancy between salaries for corporate managers and their personal risk. We’re told that they warrant outrageous compensation because of the risks they take. What risks? No responsibility for corporate misdeeds or failure is carried by executives. Their contracts remove all personal and financial risk. No, all financial burdens fall to the shareholders.
So, here’s a question: Why shouldn’t fines be paid out of executive bonuses & board of director’s fee? Once that amount is met then any amount over and above could be paid out of shareholders’ equity. Obviously there would be consequences -- I’m sure compensation consultants, lawyers and mangers would find a way to wrap that bonus money into regular salaries. For the time being, though, it would be an interesting and useful way of addressing a problem. I mean, if an executive knows he or she will be held personally, financially liable then wouldn’t they less likely to break the law? If a director knows there are ramifications wouldn’t they be more likely to take their oversight duties seriously?
He was so close to nailing it. If we strike the reference to paying the excess out of shareholder equity, as I have done above, however, we can get him back on course.
There is an argument for imposing civil liability on corporations and other institutions (i.e., legal persons) where their agents commit torts or breach contracts. A major function of civil liability, after all, is compensation of victims of malfeasance and misfeasance. The legal person will often have far deeper pockets than any of the natural persons amongst its stakeholders. Having one defendant rather than many, moreover, reduces tertiary costs for both parties and society. (Note, BTW, that because compensation is a key goal of civil liability, burning the place down would seem counterproductive.)
Having said that, however, I'm not completely convinced. In the first place, most major corporate misconduct implicates senior corporate officials, such that a regime of personal--rather than corporate--liability would provide them with incentives to cause the corporate entity to insure against the risk of such losses, which satisfies the goal of compensation.
More important, however, the role of compensation as a justification for corporate liability is more compliucated than one might think. In an important article, Vicarious Liability for Fraud on Securities Markets: Theory and Evidence, 1992 U. Ill. L. Rev. 691, Jennifer Arlen and William Carney, tackled this question with regard to corporate liability for securities frauds committed by agents of the firm. As they demonstrate, when a corporation pays a large fine the resulting balance sheet effect is to reduce assets on the left side. On the right hand side, liabilities remain constant. To offset the decline in net assets, accordingly, shareholder equity must fall. As a result, the effect of civil monetary liability is to replace "one group of innocent victims with another: those who were shareholders when the fraud was revealed. Moreover, enterprise liability does not even effect a one-to-one transfer between innocent victims: a large percentage of the plaintiffs' recovery goes to their lawyers. Finally, enterprise liability may injure innocent people in addition to shareholders. For example, employees are injured if enterprise liability sends a firm into bankruptcy or causes it to lay off employees." Id. at 719.
The case for corporate criminal liability is even weaker. The principal functions of criminal liability are retribution and deterrence. As I have argued elsewhere in the context of corporate reparations:
A corporation is not a moral actor. Edward, First Baron Thurlow, put it best: "Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and nobody to be kicked?" The corporation is simply a nexus of contracts between factors of production. As such, there is no moral basis for applying retributive justice to a corporation - there is nothing there to be punished.
So who do we punish when we force the corporation to pay reparations? Since the payment comes out of the corporation's treasury, it reduces the value of the residual claim on the corporation's assets and earnings. In other words, the shareholders pay. Not the directors and officers who actually committed the alleged wrongdoing (who in most of these cases are long dead anyway), but modern shareholders who did nothing wrong. Retributive justice is legitimate only where the actor to be punished has committed acts to which moral blameworthiness can be assigned. Even if you assume the corporation is still benefiting from alleged wrongdoing that happened decades or even centuries ago, which seems implausible, the modern shareholders are mere holders in due course. It is therefore difficult to see a moral basis punishing them. They have done nothing for which they are blameworthy.
As always in corporate accountability, both efficiency and morality require that punishment be directed solely at those who actually commit wrongdoing. In this context, it would be the directors, officers, or controlling shareholders who actually enslaved people. Since they're long dead, there is nobody left who properly can be punished.
That conclusion was influenced in part by the Arlen and Carney paper, which argues for imposing liability on the corporation's agents:
... we find that there is little reason to believe that enterprise liability is the superior rule from the standpoint of deterrence, and there are many reasons to suspect the contrary. The deterrent effect of the available monetary sanctions under agent liability probably exceeds the deterrent effect of enterprise liability because a civil judgment against an agent hurts his reputation more than does a sanction imposed by the firm in private. Moreover, the threat that sanctions will be imposed appears to be greater under agent liability. Agent liability places the responsibility of sanctioning wrongful agents with the victims, who have no reason not to proceed against them and have every reason to proceed. Enterprise liability, by contrast, places the responsibility of proceeding against the wrongful agents with the firm, and thus with the very agents (and their close associates) most likely to have committed fraud. Moreover, agent liability in effect enlists insurance companies as corporate monitors and disciplinarians, thereby eliminating the agency costs associated with firm managers monitoring and disciplining each other. Furthermore, the judgment proof problem under agent liability can be completely eliminated if, in addition to civil liability, the government imposes sufficient nonmonetary criminal penalties on agents, such as imprisonment.
Although they are discussing civil liability, their comments on deterrence seem equally applicable to the criminal law.
A while back, the WSJ had an op-ed by Eamonn Butler that spoke to these issues and came down basically in the place that I do:
Where fines are levied, it is generally on corporations rather than individuals, which means that shareholders and customers (and indeed taxpayers) end up paying instead of those actually responsible. Network Rail, Britain's rail infrastructure provider, was fined £3 million last year for safety failings over the Potters Bar disaster in which seven people were killed, and another £4 million in April for the Grayrigg crash that killed one person and seriously injured 28 others. It will be passengers who stump up that £7 million, not rail executives.
In May this year, Abbott Laboratories agreed to a $1.6 billion corporate fine over its marketing of antiseizure drug Depakote. In July, GlaxoSmithKline settled for $3 billion for the marketing of antidepressants and failing to report safety data on a diabetes drug. Johnson & Johnson could pay $2.2 billion over its promotion of antipsychotic drug Risperdal. Chunky fines, totalling 32%, 37% and 23% of these firms' current income—but no individuals have been charged.
Instead of de facto taxing the corporation's shareholders, he argues for individual liability:
Regulation is not best delivered by constantly peering over the shoulders of traders at huge bureaucratic cost. It is served by setting clear, broad rules, and by punishing those who break them.