Clinging Onto the Cliff: A Model of Financial Misconduct

Paper

AJ Chen
Author: AJ Chen

Nbr. Publication(s): 2
Position: Other
Affiliation: USC Marshall
Member of PolEconFin since: 31 May 2022

We propose a novel pressure-based model of financial misconduct. We interpret the robust empirical findings of a high “success rate of crime” as evidence of skewness in the payoff of white-collar crime. Our model proposes skewness-seeking as a key driver of financial misconduct, as opposed to the conventional analysis that postulates (an empirically elusive) positive expected payoffs associated to crime. In our model, criminal motives arise as optimal responses to a “tunnel vision” that engrosses firm managers, whereby the intense pressure to attain the focused goal triggers strong demand for negatively skewed bets in the form of crime. We show results that are consistent with the notion of a “slippery slope to crime” that is finding growing support in the literature as well as in practitioner accounts. Comparative static analyses on the model also reveal several empirical implications –for example, a “pecking order of crime” indicating that serious infringements will only follow the depletion of the more preferred (and possibly prevalent) option of milder incursions of law, e.g., minor violations of financial reporting standards– many of which find empirical support in the literature.

 

Co-Author(s): Suk Lee; Fernando Zapatero

# Tags: Financial reporting | Misconduct | White-Collar Crime

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