by Jennifer Arlen and Lewis A. Kornhauser

In our forthcoming article, we develop a framework based on empirical evidence that identifies the optimal structure of corporate and individual liability when laws can deter through two channels: their ability to set social and ethical norms that express social condemnation (“expressive channels”), as well as through formal sanctions. We show that corporate liability is vital to the law’s ability to deter individuals from engaging in organizational misconduct through expressive channels. We also show that, in order to deter through either channel, governments must ensure that they reliably detect and sanction most individuals and companies who commit crime. Finally, we show why countries should not exempt companies from corporate liability based solely on their adoption of an ostensibly effective compliance program.

From Classical Deterrence Theory to Evidence-Based Deterrence Theory

Anyone seeking to determine how the law can deter misconduct must employ a framework that makes assumptions about four features of individual decision-making: (1) individuals’ central motivations; (2) how the law influences choices; (3) how people make decisions; and (4) how institutions, such as companies, affect people’s choices.

Most scholars currently rely on classical deterrence theory (CDT), a theory predicated on economic theory. CDT assumes that: (1) people act in their own narrow self-interest; (2) criminal law only influences behavior through the threat of publicly-imposed sanctions; (3) people rely on full rational deliberation—weighing all expected costs and benefits—to make choices; and (4) companies affect employees’ decisions only by interventions, such as financial incentives, that alter the egoistic expected cost and benefit to employees. Yet, in the decades since CDT was developed, we have benefitted from a flood of empirical analyses of human decision-making. These studies reveal that none of CDT’s foundational assumptions accurately describes human behavior.

Empirical evidence shows that people are not motivated solely by narrow self-interest, but also care about others’ well-being and about their good standing in society. Thus, they care about compliance with ethical and social norms and being perceived by others as the type of good person who would do so.  As a result, the law can influence people by establishing or enhancing a social or ethical norm against the prohibited conduct, in addition to deterring through threatened sanctions. Leading scholars relying on these first two insights concluded that the law should rely primarily on such expressive channels to deter. Yet this conclusion fails once we incorporate the two additional insights from empirical studies of behavior.

Whereas CDT assumes that people employ rational deliberation to make all choices, empirical studies show that they instead usually rely on nonconscious, instantaneous, and emotion-driven intuitive processes to make most ethical decisions, even when they think they are actively deliberating. People’s intuitive decisions are influenced by their social preferences. Yet, in contrast to the assumptions of leading expressive law theories, they usually are not primarily motivated by social and ethical concerns. Instead, self-interest tends to dominate intuitive decisions. Moreover, while self-interest can be overridden by ethical concerns under the right circumstances, people are motivated, unconsciously, to distort their assessment of the choices before them in ways that enable them to make the self-interested choice while maintaining their self-perception that they are ethical. The law can only reliably intervene to deter unethical conduct through expressive channels if people’s decision-making environment clearly highlights the unethical nature of an illegal but personally-beneficial choice, and does not provide ways for people to avoid guilt or shame if they seek to profit from misconduct.

Using insights from empirical psychology we develop an Evidence-based Deterrence Theory (EDT) and use it to identify how countries can most effectively structure corporate and individual liability for organizational misconduct if they want to deter through both traditional and expressive channels.

Role of Organizations and Justification for Organizational Liability

To deter effectively through expressive channels, countries must hold companies liable for all misconduct by their employees, imposing sufficient sanctions to ensure companies do not profit from misconduct. Countries must ensure that companies do not benefit from misconduct because corporations control their employees’ decision-making environment. They can structure internal operations to undermine—or alternatively enhance—the law’s ability to use its expressive voice to deter. They also substantially influence the deterrence effect of formal sanctions.

Companies largely control their employees’ understanding of laws against organizational misconduct.  Companies can train employees that compliance is important and a requirement for ethical behavior or, alternatively, can communicate that legal injunctions are an unnecessary impediment to profit.  Companies also determine employees’ incentives to commit crime. Corporate crimes directly benefit companies, and not employees. Employees only benefit to the extent that companies’ compensation, promotion and retention policies reward employees for actions that benefit the firm.

Companies also can, and regularly do, enable employees to pursue profit through misconduct without experiencing the guilt or shame that ideally would attend criminal conduct. First, companies regularly provide employees with a prosocial justification for violating the law. They prime employees to feel primarily loyal to their team or to the company itself. These prosocial aims will be more salient than those the law seeks to protect because (1) they align with self-interest and (2) the welfare of fellow employees is more salient than that of the distant, often statistical, victim the law seeks to protect. This alternative pro-social benefit of misconduct enables employees to feel “other-regarding,” rather than unethical, when they engage in misconduct to benefit the firm. Companies further enhance the salience of both self-interest and corporate loyalty by putting employees under so much time pressure, and requiring them to juggle so many competing tasks, that they do not have the time or energy needed to deliberate fully over the ethical implications of their choices; they feel driven to pursue the firm’s primary goal: profit. 

Companies also can, and regularly do, undermine the law’s expressive message through their treatment of employees that violate the law. Employees’ beliefs about whether legal injunctions express social norms is heavily influenced by whether those around them comply with the law. Companies undermine compliance when they fail to discipline high-performing employees who violate the law—especially through more visible violations such as sexual harassment. Employees learn that the legal injunction does not define the ethical culture of their firm.

Finally, companies can wittingly or unwittingly undermine the law’s ability to deter through expressive channels by assigning tasks to groups in which no one person is primarily responsible for compliance. Studies show that people tend not to experience guilt or shame when they share responsibility for harm-producing decisions with others.

Thus, in contrast to prior expressive law analyses, we find that countries seeking to deter through expressive law must hold companies liable. Moreover, they should not adopt a compliance defense because, as we show above, a company’s commitment to deterrence cannot be determined solely based on the efficacy of its compliance program. Many features of the firm—reaching down to the line-manager level—influence employees. Corporate law is needed to motivate companies to pursue the appropriate balance between productivity and compliance throughout every facet of the firm.

Individual Liability and Corporate Self-reporting and Cooperation

Corporate liability must not only be structured to incentivize companies to adjust their internal operations to enhance, rather than undermine, the law’s expressive message; it also needs to induce them to detect and self-report misconduct, and to fully cooperate with enforcement officials by identifying the individuals’ responsible for the misconduct and providing evidence against them.  Accordingly, enforcement policy must provide companies with substantial rewards for self-reporting and full cooperation that they cannot obtain otherwise.

Corporate self-reporting and cooperation is essential to deterrence because expressive law alone cannot suffice to deter as long as employees can benefit from misconduct without fear of punishment. Enforcement officials cannot create a salient threat of sanction on their own, however, because they rarely detect misconduct. Companies are far better positioned to detect and investigate misconduct. To deter effectively, corporate liability needs to be structured to incentivize companies to use their superior access to information to assist enforcement officials.

Jennifer Arlen is the Norma Z. Paige Professor of Law, and Lewis A. Kornhauser is the Frank Henry Sommer Professor of Law, at New York University School of Law. This blog is based on their forthcoming article, Battle for our Souls: A Psychological Justification for Corporate and Individual Liability for Organizational Misconduct, Ill. L. Rev. (forthcoming), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4152960.

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