Misconduct in Organizations

Abstract

Insider misconduct, such as financial misconduct and privacy breaches, has received an increasing amount of public scrutiny in recent years. Empirical studies have argued that employee seniority plays a role in insider misconduct. Our study provides intuitions for these empirical findings and insights into how regulations can be designed to improve social welfare. We model the interactions between lawmakers, organizations, and their employees under the risk of insider misconduct. Employees are the source of insider threats. Firms interact with employees and enforce a certain level of monitoring. Lawmakers influence other parties’ incentives by imposing legal penalties. We study the interaction among the three parties in a two-stage game model. In the first stage, we analyze an optimization problem where the lawmakers decide the penalties to employees for engaging in misconduct and firms for overlooking this behavior. In the second stage, we analyze a simultaneous game where the firms decide the monitoring effort and employees decide whether to engage in misconduct and study the comparative statics. We derive closed-form solutions to the equilibriums in the second stage. We show how monitoring and misconduct change with respect to financial incentives and employee seniority. Under regularity conditions, we formulate an optimization problem for the lawmakers as a linear optimization problem. Our model helps explain empirical evidence that middle management and top management typically cause large-scale misconduct. From a welfare point of view, a seniority-based penalty for misconduct is better than a uniform penalty. In addition, stiff penalties are not necessarily more helpful than a milder regulation.