A Carrot Without a Stick - The Effect of Monetary Rewards on Corporate Whistleblowing

Abstract

Whistleblowers may face significant costs from reporting on misconduct. While regulations offering monetary rewards to ensure a certain level of reporting have become increasingly popular around the world, the European Union remains hesitant, requiring only minimum protection for whistleblowers by December 2021. It is up to the individual member states to decide about implementing additional reward schemes. We contribute to the on-going policy developments by analyzing the impact of monetary rewards on managers' and employees' behavior. Our model explicitly considers two unique aspects of whistleblowing: (i) potential whistleblowers act on suspicion rather than actively searching for misconduct, and (ii) their doubt might be wrong and result in false accusations. We derive trade-off conditions that regulators have to consider when weighting rewards, protection from retaliation, and fines for manipulation to achieve an efficient regime. While monetary rewards can compensate for retaliation and foster whistleblowing, higher rewards also come at the cost of increasing false reports. The strength of a whistleblowing regulation further depends on the litigation environment due to potential substitution effects, with stricter litigation weakening its efficiency.

Keywords: Corporate Governance, Fraud, Misreporting, Retaliation, Reward, Whistleblowing

JEL Classification: C72, M40, M48