Volume 72, Number 4

October 1997

Controlling Corporate Misconduct: An Analysis of Corporate Liability Regimes

Jennifer Arlen, Reinier Kraakman

Corporations have historically been held to a standard of strict vicarious liability for the wrongdoing of their employees. However, several areas of federal and state law have shifted to new duty-based schemes that mitigate liability for companies that have implemented compliance programs or reported wrongdoing to the government. Some states even grant privilege to environmental audit reports.

Professors Arlen and Kraakman compare the norm of vicarious liability with various types of duty-based liability regimes, analyzing the benefits and costs of each approach. They conclude that social welfare is maximized by a mixed regime that includes elements of both strict and duty-based liability. The authors find that the mixed liability regime with the widest application is a composite regime, which imposes high penalties subject to mitigation for firms that engage in compliance activities. Under this regime, firms that satisfy all enforcement duties would nonetheless face substantial residual liability equal to the harm caused by wrongdoing divided by its probability of detection. They then examine the existing composite liability regimes embodied in the United States Sentencing Guidelines for corporate defendants and the evidentiary privileges that many states have adopted for companies’ environmental audit reports. They conclude that both current approaches are flawed, as they do not adequately create proper incentives for companies to monitor, investigate, and report employee wrongdoing.