Clinging Onto the Cliff: A Model of Financial Misconduct

We propose a novel model of financial misconduct. In line with empirical evidence thereon, our model interprets white-collar crime as gambles with skewed payoffs, as opposed to conventional analysis that postulates positive expected payoffs associated to crime. In our model, criminal motives arise as optimal responses to a “tunnel vision” that engross firm managers, whereby the intense pressure to attain the focused goal triggers strong demand for negatively skewed bets in the form of crime. We find results that are consistent with the notion of a “slippery slope to crime” that is finding growing support in the literature as well as in practitioner accounts. Comparative static analyses on the model also reveal several empirical implications –for example, a “pecking order of crime” indicating that serious infringements will only follow the depletion of the more preferred (and possibly prevalent) option of milder incursions of law, e.g., minor violations of financial reporting standards – many of which find empirical support in the literature.