Get access

Whistle-Blowing and Incentives in Firms

Authors


  • We thank the Editor and two anonymous referees for their comments, and Bruno Biais, Uwe-Wilhelm Bloos, Patrick Bolton, James Brickley, Mike Burkart, Kong-Pin Chen, Mathias Dewatripont, Denis Gromb, Barry Ickes, Christian Laux, Andy Leone, Fausto Panunzi, Paul Povel, Canice Prendergast, Michael Raith, Patrick Rey, Andrei Shleifer, Maria Simatova, Jean Tirole, Dimitri Vayanos, Joanna Wu, and Luigi Zingales for helpful discussions. We also thank the audiences at various conferences and seminars. All errors are ours.

Abstract

Whistle-blowing is an important mechanism of corporate governance. We show that whistle-blowing has negative effects on productive efficiency by undermining the incentives within a corporate hierarchy. In our model, a top manager intends to overreport earnings; a division manager may have evidence about the intended overreporting. We show that the division manager is more likely to have such evidence when the performance of his own division is low. Top management may offer a bribe to prevent the manager from blowing the whistle. This provides the division manager with an additional payoff when his division’s output is low. Therefore, potential whistle-blowing undermines the division manager’s incentives to exert effort, which results in a less efficient outcome.

Ancillary