Encouraging Firms to Police Themselves: Strategic Presentations to Promote Corporate Self-Auditing
32 Pages Posted: 20 Mar 2001
This article revisits the conventional wisdom that privilege protection is necessary to avoid chilling corporate self-evaluation and remediation. Courts and commentators have repeatedly urged that if a firm knows a regulator can access its internal audit records, it will correspondingly not engage in diligent compliance monitoring. In this way, the firm can avoid generating information that a regulator or other third parties can use against it. To investigate this contention, I have presented a formal game theory model that incorporates the different strategies employed by a firm and a regulator. This model emphasizes that the firm's self-audit records are not independent. Rather, both the firm and the regulator change their respective strategies depending on each's perception of the other's strategy/response. Hence, it is necessary to conduct an equilibrium analysis to consider both the firm's and the regulator's response simultaneously.
More specifically, this analysis demonstrates that the protection accorded by the SEP removes the disincentive for self-policing but does not create any positive incentive for self-policing. In contrast, a legal regime that grants regulatory access to internal audit materials creates a positive incentive for firms to engage in self-policing. In contrast, a legal regime without regulatory access (i.e., an inspection regime). Increased corporate self-policing achieved through a higher self-auditing rate enables us to capture the societal benefits of early detection and remediation of environmental violations. Under this analysis, a multi-pronged embrace measures that create positive incentives for firms to engage in self-policing, such as permitting regulatory access to audit materials and providing mitigated penalties for firms engaging in self-policing. As part of such a regime, limiting the admissibility of audit materials in third-party proceedings reduces the disincentive for firms to engage in self-policing.
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