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Monday, November 26, 2012

Strategic CSR - Cost Benefit Analysis

The article in the url below examines the costs of illegal behavior for firms—assessing whether current fines and other punishments stand a chance of preventing transgressions. The results are not encouraging:

It has been a bumper summer for corporate fines and settlements. In the past three months alone firms in Britain and America have agreed to pay out over $10 billion because of wrongdoing. But the economics of crime suggests that fines imposed by regulators may need to rise still further if they are to offset the rewards from lawbreaking.

The article makes clear that illegal corporate behavior is big business and, as such, well worth the risk of being discovered:

In a 2007 paper, John Connor and Gustav Helmers of Purdue University examined 283 international cartels that operated between 1990 and 2005. The aggregate revenue increase these cartels achieved by acting as they did was over $300 billion.

In terms of punishments, at the theoretical extremes, the article argues that regulators could either impose no fines (allowing market forces to punish wrongdoers) or it could seize all company assets (making the costs of a wrongful conviction prohibitive). Given that both of these options carry unacceptable risks, however, a more cost-effective method of calculating the fines imposed on firms is needed:

A middle way might be for regulators to levy penalties that offset the benefits of crime. Data on cartels supply useful guidance on how to go about calculating these fines. The first step is to measure the expected gain from crime which fines need to offset. In the study by Messrs Connor and Helmers, the median amount that cartel members overcharged was just over 20% of revenue in affected markets. Next, you need an assumption about the chances of being found out: a detection rate of one cartel in three would mean trustbusters were doing well. In this example, that would mean a fine of 60% of revenue is needed to offset an expected benefit of 20% of revenue.

This is a substantive punishment, but current fines pale in comparison. The fines in the above mentioned study, for example, “were between 1.4% and 4.9%.” Elsewhere, the story is equally discouraging:

Assessed against this methodology, even apparently hefty fines look pretty weak. … Britain looks particularly lenient. Its antitrust laws impose fines of up to 10% of revenues; American regulators levy penalties of up to 40%, and the European Commission goes up to 30%.

Consumer-based class action litigation (such as the settlement announced over the summer that imposed a $7.3 billion charge on MasterCard and Visa) is examined as one possible solution:

Yet litigation and criminal charges tend to take years to emerge; many wrongdoers are able to avoid court. To deter bad behaviour fines need to rise. The watchdogs are biting, but some need sharper teeth.

Perhaps crime does pay, after all!

Take care

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Fine and punishment
The Economist
July 21, 2012