Cover-Ups

Lengthy cover-ups are a repeated feature of the organizational landscape. This paper studies executives’ optimal cover-up strategies given the penalties and the evolving beliefs of strategic outside parties who investigate malfeasance. The analysis shows that organizational self-policing and external investigation are strategic substitutes in any given period. Over time, successful cover-ups increase the incentive to cover up, and changes in the current environment, such as an increased awareness of the harmful effects of the employee’s actions, can result in a reduction in cover-ups in the short term but an increase in the long term. We analyze how fines for executives and rewards for investigators affect the welfare of different stakeholders. We extend the model to study two alternative prosecutorial regimes: a prosecutor who can commit to an investigation policy and a long-lived prosecutor who internalizes the impact of their early decisions on a subsequent prosecutor’s incentives.

Duke Scholars

Author Rachel Kranton Economics