Overview and Contributions:

In “Profitable Misconduct, Corporate Governance, and Law Enforcement,” Anat R. Admati, Nathan Atkinson, and Paul Pfleiderer show how misconduct, managerial compensation, and enforcement policy are closely — and at times perniciously — related. Corporate misconduct can cause extensive harm, including death, physical and mental injury, and environmental destruction. Profit-maximizing corporations can also harm democracy and the rule of law by impacting both the language and the enforcement of the law. This paper focuses on a situation in which, as is often the case, law enforcement efforts to address corporate misconduct are ineffective. There are many reasons for this situation, including difficulties in monitoring opaque corporations and detecting misconduct, as well as the many ways corporations can limit their liabilities.

The authors show that when managerial compensation aims to motivate maximizing profits for shareholders, managers will generally engage in profitable misconduct and, importantly, that corporations can reduce or nullify the deterrence effects of fines and penalties that target either the corporation or managers directly might have, thus further weakening already insufficient enforcement. They also show that common enforcement policies, such as those that offer discounted fines when corporations self-report misconduct or implement compliance programs, can backfire and exacerbate harm by making misconduct more profitable. Understanding corporations' strategic responses to law enforcement is essential for designing more effective policies to deter misconduct.
 

Corporate Governance, Misconduct, and Law:

The authors begin by discussing why the policing of corporate misconduct is so difficult. One problem arises because corporations are collections of individuals, which renders responsibility diffuse and complicates the identification of perpetrators. Detecting misconduct often depends on highly visible, chance events such as plane crashes, whistle-blowing, or media investigations. When the profits gained from misconduct exceed the expected fines and other financial consequences, executives may view misconduct as a “cost of doing business.” Other problems are due to the difficulties encountered in estimating the extent of the harm and the limitations on the penalties that can be imposed. Even when misconduct is detected, fines often fall short of the corporation’s private gains from that misconduct. In notable cases, corporations can limit the consequences by declaring bankruptcy. It is also very rare for directors and executives to face meaningful criminal liability.

Governments have often been unsuccessful in prosecuting misconduct because of the high legal bar required to show personal intent to commit crimes and the reticence of prosecutors to pursue challenging cases due to career concerns and limited resources, especially relative to the resources corporations can access. As we saw in the financial crisis, authorities often worry about targeting “important” corporations and imposing significant fines and sanctions.
 

Argument and Implications:

The authors’ mathematical model captures some of the complexities involved in the interactions among corporations, managers, and governments. One of the values of a model is that it can show how well-intentioned and seemingly reasonable policies can be counterproductive once one accounts for various ways profit-maximizing actors will respond. The authors consider, for example, some policies that have been designed to increase the probability that misconduct will be detected in a timely way. These policies encourage corporations to implement “compliance” programs or to self-report misconduct by promising that any fines they must pay will be heavily discounted. Using their model to analyze the effectiveness of this approach, the authors find that these policies can make matters much worse. This is because the discounted fines can increase the profitability of misconduct while it is undetected or not self-reported. This can lead to firms engaging more aggressively in misconduct, knowing that this can be self-reported later, and the corporation will be subject to reduced fines. If corporations strategically take all this into account, the total harm may actually increase. The authors are not contending that these policies will always increase harm, but they are pointing out that these policies are quite likely to be inferior to others that don’t allow strategic responses that can make things worse.

One reason that the fines imposed directly on corporations are often inadequate to deter misconduct is that authorities are reluctant to levy sufficiently large fines because they fear this will lead to “collateral damage” suffered by innocent stakeholders like employees and customers. These concerns are allayed if, instead of corporate-level fines, large fines are imposed on managers. The authors’ model shows that it can be very expensive for shareholders to offset the potential deterrence effects of managerial fines if the only way shareholders can do this is by increasing the manager’s stock-based compensation to make misconduct more rewarding relative to the level of fines. Because it is so expensive for the corporation and shareholders to respond in this way, relying more on managerial fines might be a good policy. Unfortunately, shareholders have much less expensive ways to offset fines on managers — they can indemnify the manager or provide insurance that pays for fines. Essentially, they can simply offset the fines with cash, which is much cheaper. As the authors point out, this suggests that, to strengthen enforcement and deterrence, limitations on corporations' ability to indemnify and insure managers are likely a good way forward.
 

One of the main lessons of the authors’ analysis is that internal governance practices set by the corporation and its shareholders can profoundly influence the effectiveness of external governance designed to limit the harm created when corporations and their managers engage in profitable misconduct. Further study of these interactions and their implications for effective enforcement policies is clearly warranted.

*Research-in-Brief prepared by Adam Fefer.

What have been some of the most challenging aspects of conducting research in this field, and how did you overcome these challenges? 

Early on, one of the major challenges was finding a place with the right kind of support: interested colleagues, staff who could assist with fieldwork, and, especially, a community of graduate students interested in similar questions. That kind of environment takes time to build. Oxford had a very strong community with a lot of support, funding, and students working in this area. When I later returned to Stanford, we hired younger development economists and were able to build a similarly vibrant student community working on different aspects of behavior and development.

How do you see your research influencing policy or contributing to real-world change? 

Mostly through understanding behavior and what lies behind different types of decisions. That’s what matters. In addition, the direct policy impact has largely come through my students. Many have gone into academia, but many others have joined organizations like the World Bank, the IMF, or private companies. One student, for example, helped set up a commodity exchange in Ethiopia, which certainly had policy impact. So my influence on policy has been felt primarily through the work that my students go on to do.
 

How have things changed in your field since you first began your research, and how has this influenced the way you approach your work? 

Research methodologies have evolved significantly over time. In the early days, researchers did not even use surveys. Later, surveys became more rigorous, and the field moved toward panel data to follow households over longer periods. With the introduction of GPS, it became possible to work with spatial data in new and more precise ways. The emergence of randomized controlled trials marked another major shift and shaped development economics for many years, although that influence is now starting to decline. Conceptually, the growing importance of behavioral economics has also been a major change and has become increasingly central to how we study issues in economic development.

What gaps do you feel need to be addressed in your research field, and what do you anticipate you will study more in the future? 

There are always gaps. It never is a finished business. The challenges also change over time. Recently, in a very short period, many things built over our lifetimes have been undone. The question is whether to try to rebuild them or conclude that they did not work and try something else. I do not think many of the solutions being proposed now will last; they are not effective. The erosion of the rule of law is especially disturbing. Even democracies struggle with it, but in this country, it has essentially gone out the window. The neglect of international law is also profoundly shocking.

Could you elaborate on the broader shifts you’ve observed in recent years, especially the weakening of institutions and systems that once supported development and international cooperation? 

Closing down USAID is a massive change. Development institutions could certainly be improved, but shutting them down entirely is something very different. These shifts have also affected research funding. Funding has dwindled, and academic positions in development have declined. The job market in development economics overall seems to be shrinking. There is also less interest in people who study democracy, because their work would necessarily be critical of what is happening. It has been a significant backward step.

In times of uncertainty, what gives you hope for the future of your field? 

My students! Their enthusiasm has not disappeared, and the enthusiasm among researchers remains strong as well. Our international contacts remain solid, and parts of the world, especially in Europe, such as Germany and Switzerland, have not given up on these ideals. For example, Esther Duflo recently moved from MIT to Zurich, and we may see more moves like that.

Lastly, what book would you recommend for students interested in a research career in your field? 

Development economics now covers everything; it’s essentially all economics for 80 percent of the world, so there isn’t one book that summarizes it. If someone wants to start a research career focused on market institutions, I would recommend the book I wrote on that topic: Market Institutions in Sub-Saharan Africa: Theory and Evidence (MIT Press, 2003). But if I had to pick a book I personally enjoyed, it would be the historian Fernand Braudel's three-volume Civilization and Capitalism, which looks at market institutions across the world from 1400 to 1800. It was eye-opening and a lot more interesting than traditional, battle-focused history.
 

As he approaches retirement at the end of 2025, Dr. Fafchamps offers insights drawn from decades of research on behavior and institutions. His legacy endures through his students and the body of research that continues to shape scholarship worldwide.

On November 14, 2025, CDDRL and the King Center on Global Development hosted "Unfinished Business: A Tribute to Marcel Fafchamps" — a full-day academic symposium celebrating the career and contributions of economist Marcel Fafchamps on the occasion of his retirement. Featuring a keynote by Marcel himself, this tribute brought together colleagues, collaborators, and students to engage with the themes and ideas that have shaped his influential work in development economics, labor markets, and social networks.

Marcel's keynote on "Behavioral Markets" can be viewed below:

Motivation & Summary

Social, political, and religious polarization has steadily grown in many longstanding democracies. Some elected representatives and voters have come to view their opponents as illegitimate participants in politics who pose an existential threat to the nation-state; this justifies ignoring or violating democratic norms and procedures to prevent them from gaining power. As polarization increases, voters may prefer to support authoritarian parties that are viewed as better expressing their group identities, as opposed to democratic parties seen as hostile to those identities.

Trust lies at the root of these processes: polarized individuals tend to believe that those who differ from them will not act from a place of goodwill and will lack the incentive to promote their interests. Revitalizing democracy would thus seem to require revitalizing trust. Yet one’s sense of trust is often shaped by factors that are difficult to change, such as childhood socialization. How, then, can trust be increased?

In “Financial market exposure increases generalized trust,” Saumitra Jha, Moses Shayo, and Chagai M. Weiss provide evidence from an experiment conducted among Israelis in 2015. The authors find that individuals who participated in the stock market were more likely to agree with the statement that “most people can be trusted.”

Their argument builds on the intuition that stock markets are fundamentally about trust: investors take a risk by placing their assets in the hands of unfamiliar people who nonetheless have an incentive to promote their interests. As these assets grow, participants ought to become more trusting, not only of financial markets but also of people more generally. Surprisingly, the authors find that even those whose assets did not grow became more trusting. Another surprise is that the increases in trust were higher for Israelis on the political left and right. In other words, polarized voters — those who especially struggle to trust others — exhibited greater increases in trust than centrists.

Prior Research

Social scientists have analyzed trust as both a cause and a consequence. Much of this research concerns the economy, as transactions, contracts, and negotiations all require the belief that other parties will honor their commitments. Higher levels of trust may be a cause of higher economic growth. Conversely, consumers tend to distrust firms that are subject to scandals, leading the corresponding value of those stocks to decrease.

Apart from the economy, trust is also a central aspect of ‘social capital,’ which consists of the resources gained from one’s social networks. Trust can also promote good governance by enabling collective action and by providing legitimacy to political institutions. And as Americans and others learned during the COVID-19 pandemic, trust is central to public health compliance.

Survey research has identified a persistent trust deficit; less than a quarter of respondents to the World Values Survey agree with the statement that “most people can be trusted.” This deficit has many root causes. At the personal and psychological level, one’s sense of trust likely develops in childhood. Meanwhile, people who have experienced trauma or discrimination are less likely to trust others. Whether or not two people are from the same country or the same ethnic or religious group also affects their sense of trust. Those whose ancestors were victims of the African slave trade centuries ago exhibit lower levels of trust today. People in economically unequal societies are also less likely to trust each other. All of this suggests that improving trust is very difficult, especially in polarized societies.
 

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Fig. 1. Generalized trust around the world. (a) Geographic Distribution of Generalized Trust. This figure reports cross-national patterns of generalized trust from the World Values Survey (Wave 7). For each country, we report the share of respondents who state that most people can be trusted. Since Israel is not included in the most recent wave of the World Value Survey, the figure shows generalized trust data from the 2004 World Value Survey.

The Experiment

Studying whether stock market participation affects trust is difficult because participation is itself correlated with pre-existing levels of trust, as well as with other relevant factors like gender or personality traits (such as excitability). The authors’ experimental methodology seeks to overcome this by randomly allocating a large number of participants (over 1300) into treatment and control groups. Prior to this allocation, the authors conducted a survey to establish participants’ baseline levels of trust.

Those in the treatment group participated in an additional survey that explained the study rules as well as how their asset values would be determined on the stock market, quizzing them on these topics afterwards. Participants were given either $50 or $100 (USD), which was between 64% and 128% of the average Israeli daily wage in 2015.

Stock market participants received weekly updates on the prices of their assigned assets, along with a description and valuation of their portfolio, when the markets closed at the end of each week. Individuals in the treatment group were given weekly opportunities to decide whether to buy up to 10% of their portfolio, sell up to 10% of it, or make no change. (If no decision was made, they lost the 10% that could have been traded.) Participants ultimately traded at high levels: around 70% did so at every opportunity, and 80% did so in six out of the seven weeks.

As stated above, participation increased the probability of expressing trust by around six percentage points. These effects were largest for polarized voters and for those whose stocks performed well; however, even those who suffered market losses exhibited increases in trust.
 

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The authors carefully show how trust can be not only a cause but a consequence of stock market participation. Their approach is not paternalistic because it lets participants make independent financial decisions — as opposed to lecturing them — from which trusting attitudes then develop. In addition, the study can be replicated on a large scale because (a) it can be integrated within existing government cash aid programs and (b) participants would not need much special teaching or supervision. The authors’ approach should appeal to both those who seek solutions that promote equality and empowerment and to those who oppose top-down social programs but support market-driven solutions.

*Research-in-Brief prepared by Adam Fefer.