‘Useful Illegalities’ in Corporations from a Law and Economics Perspective (‘Nützliche Gesetzesverletzungen’ in Kapitalgesellschaften aus rechtsökonomischer Sicht)
Fordham University School of Law; European Corporate Governance Institute (ECGI)
Kristoffel R. Grechenig
Max-Planck-Institute for Research on Collective Goods
March 31, 2010
Wirtschaftspolitische Blätter, Vol. 57, No. 1, 2010
Fordham Law Legal Studies Research Paper No. 1586535
Entrepreneurship sometimes involves violations of legal norms, such as parking prohibitions, competition law, and others. According to the prevailing view in the legal literature, the agent or manager (and not the company) is required to bear the costs, even if the activity was beneficial ex ante for the company. This approach is problematic from a social welfare perspective. Since the company and its owners keep the benefits, they have an incentive to choose the optimal activity level only if they also bear the costs.
We analyze the consequences for different types of legal prohibitions and argue that for violations of laws that seek to internalize negative externalities, the fine should be borne by the firm. If the manager is required to pay the fine, the activity level will drop below the optimal amount. This argument has been well understood for breaches of contract, where courts and legal commentators generally accept that the company (and not the manager) has to pay damage awards to the counterparty.
There are two caveats. First, it is conceivable that having the manager bear the fine might help to mitigate an agency problem between shareholders and managers. Managers might in some cases have personal reasons to violate the law in their capacity as officers of the company, without any corresponding benefits to the firm. However, we suspect that there are very few, if any, cases of this type.
Second, a statute might be intended not just to internalize an externality, but to reduce the level of a specific activity to zero. This might be the case when there is no doubt that the activity is socially harmful under all circumstances, or when the court or administrative authority imposing the fine can identify those cases where the activity is socially desirable and refrain from penalizing the perpetrator. We suspect that criminal law often follows this approach.
Note: Downloadable document is in German.
Number of Pages in PDF File: 13
Keywords: corporations, agency problems, externalities, criminal law, fines, shareholders, directors, managers, officers, knowing violations of the law
JEL Classification: K22, K42Accepted Paper Series
Date posted: April 9, 2010 ; Last revised: September 14, 2010
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