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Article

How Scandal Helps Punish Powerful Corporate Criminals

Strategy

Could scandals actually be good for society? Often brushed aside as simply media hype or gossip, new research shows that scandals can be potent opportunities for regulatory authorities to challenge individuals or corporations that are otherwise untouchable because of their high status.

Panamapapers_sollock29

Cover Photo Credits: Panama papers ©sollock29

#MeToo, Jeffrey Epstein, the Panama Papers. High-profile movie moguls, actors and financiers have been felled by allegations of sexual misconduct. Politicians, even leaders of countries, have been forced out of office because of revelations of financial improprieties. In one striking instance, in 2017, incumbent Pakistan Prime Minister Nawaz Sharif was disqualified from holding public office for life. How the mighty have fallen in recent years, engulfed by the sulfurous odor of scandal.

While the individuals involved in personal scandals often attract the most heat, the wrongdoing behind corporate scandals may be more harmful, damaging many lives, whole business sectors, even entire economies. The subprime mortgage crisis is the most recent, sweeping example. Yet without the whirlwind of scandal, many powerful organizations and individuals remain effectively untouchable. With this in mind, my coauthor and I sought to clarify the conditions under which high-status entities can face punishment for their misdeeds. 

The perks of being a big fish

High-status individuals and organizations are typically powerful, have an effective network, and command the trust and respect of society. These factors make it very difficult for regulatory authorities to even investigate allegations — let alone take a punitive action — against high-status individuals and organizations. Therefore, high-status individuals and organizations often get away with their violations of rules and norms, while low-status individuals and organizations are punished disproportionally for their violations.

High-status individuals and organizations often get away with their violations of rules and norms, so under what circumstances can high-status wrongdoers actually be brought in line? 

Scandal nullifies the advantages of status

So under what circumstances can high-status wrongdoers actually be brought in line? For our study, which focused on corporate malfeasance, we looked at firms that were at risk of an SEC (Securities and Exchange Commission) enforcement action because their alleged violation of securities laws warranted a class-action lawsuit. We examined the period from 2006 through 2011, which saw two major corporate scandals: the options backdating scandal and the subprime mortgage scandal. The SEC took enforcement action against 14 percent of the firms accused of corporate fraud during this period.

Harvey Weinstein
Cover Photo Credit: Harvey Weinstein at the 67th Annual Peabody Awards Luncheon, Astoria Hotel in New York ©ANDERS-KRUSBERG

We theorized that it is exactly in conditions of scandal that high-status organizations were more likely to be targeted by SEC punitive action, because it is in such moments that their clout is reduced. Specifically, scandal increases the chances of punishment for high-status wrongdoers by enabling three conditions:

1.    Scandal encourages evidence from several different sources about the violations (lack of evidence is often a problem in cases against high-status organizations); 
2.    scandal makes it easy to make public accusations, and public anger means that the bar needed to establish guilt is reduced (the bar to establish guilt is typically very high for high-status organizations); and
3.    the friends and the network of the accused are of little help because they fear that they might be contaminated by the scandal (friends and network typically come to the rescue of high-status organizations when in trouble)

A chance to clean up the water

Our main finding is thus that status becomes a liability during a widespread scandal, with its attendant media outcry and public calls for action, increasing the likelihood of enforcement action: High status corporations are punished more when their misconduct is part of a widespread scandal but are less likely to face punishment for fraud when there is no scandal but simply a standalone violation.

Scandals present an opportunity for regulatory authorities to challenge the clout of high-status organizations.

We contend therefore that far from being simple tabloid fodder or the latest trending topic on Twitter, scandals present an opportunity for regulatory authorities to challenge the clout of high-status organizations. Scandals are powerful and opportune occasions with consequences that are ultimately good for society, a moment when regulatory authorities can catch the big fish that are polluting the water.

Methodology

Focus - Methodologie
Our sample consists of firms that were at risk of an SEC enforcement action because their alleged violation of securities laws warranted a class action lawsuit. We focus on class-action lawsuits filed from 2006 through 2011 — a period that saw two major scandals, the options backdating scandal and the subprime mortgage scandal. Our final sample consists of 806 lawsuits. The SEC took 112 enforcement actions against the firms accused of corporate fraud from 2006 to 2011, which amount to 14 percent of the sample. We measure the effect that firm status and the existence of a multi-actor scandal have on whether or not the SEC initiates enforcement action.

Applications

Focus - Application pour les marques
First of all, scandals may be opportunities for regulatory authorities and victims of misconduct to bring powerful individuals or organizations to justice, thus bringing balance to society. Corporations that are guilty of fraud destroy lives, employment and the earnings of investors. Scandals turn the spotlight on misdeeds, and offer the public an opportunity to scrutinize these organizations. For corporations or individuals who are caught up in a scandal, it is important to be aware of the anger that scandal ignites. The assumption by the public is often “guilty until proven innocent.” Therefore, especially if corporate actors or individuals are innocent, they should clearly establish their innocence and state their position early on. Otherwise, they might suffer the negative consequences that guilty parties suffer.
Based on an interview with Yasir Dewar and his article “Catching the Big Fish: The Role of Scandals in Making Status a Liability” (Academy of Management Journal, October 2019), co-written with Michael Jensen of the University of Michigan.

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