Mandatory Equity Issuances as a First-Best Solution to Punishing Corporate Misconduct

Abstract

Corporate liability may lead to insolvency. Prosecutors who are concerned with job losses following insolvency may reduce liability in order to limit collateral consequences. In this article I analyze firms' choices of financing and malfeasance when decision makers take collateral consequences into account. I show that in equilibrium, firms will borrow excessively and engage in welfare-decreasing malfeasance, and prosecutors will impose insufficient liability to deter corporations. I show that the first-best can be achieved by mandating the firms pay liability through equity issuances.

Keywords: Corporate Liability, Collateral Consequences, Law and Economics, Corporate Finance

JEL Classification: K13, K20, K42, G32