The ROI of Violating Environmental Laws

Is Pollution Value-Maximizing? The DuPont Case is a case study by Roy Shapira and Luigi Zingales that finds even a billion dollar fine for violating environmental laws can be cost-effective in creating shareholder value. This is what we have referred to as “the externalizing machine,” the corporate structure that makes it not just possible but inevitable that corporations will maximise the upside for executives and shareholders while imposing all of the costs on the government and the community.

DuPont, one of the most respectable U.S. companies, caused environmental damage that ended up costing the company around a billion dollars. By using internal company documents disclosed in trials we rule out the possibilities that this bad outcome was due to ignorance, an unexpected realization, or a problem of bad governance. The documents rather suggest that the harmful pollution was a rational decision: under reasonable probabilities of detection, polluting was ex-ante optimal from the company’s perspective, albeit a very harmful decision from a societal perspective. We then examine why different mechanisms of control – legal liability, regulation, and reputation – all failed to deter socially harmful behavior. One common reason for the failures of deterrence mechanisms is that the company controls most of the information and its release.

The authors conclude:

There are two clear findings in this case. The first one is that inefficient pollution pays off, even when a company anticipates all the legal consequences of its behavior. While the specifics are very case contingent, the reasons why pollution occurs are not. Regulation does not work because the penalties are too low and the regulators too captured. Legal liability does not work because victims find it hard to collect the information and sue. Even when – through a series of lucky circumstances – victims win the
legal battle, the penalty comes too late to deter pollution. Market discipline in the form of reputational sanctions cannot operate given the asymmetric information, and the inability of academics and journalists to certify and widely diffuse opaque information. Even when bad news breaks, the company can still maneuver to reduce attribution of responsibility and mitigate any reputational damages.

The second finding is that the main way corporations succeed in reducing their expected liability is by suppressing and distorting information.

The only way to begin to address this balance is to ensure that incentive compensation is reliant on meeting or exceeding environmental standards and debarring board members of companies that pay multi-million dollar fines from serving on public company boards.