by Prof. Giancarlo Spagnolo, SSE-SITE, Tor Vergata, EIEF & CEPR Presented at WORLD BANK, Washington DC, Jan 19, 2016 Read more: https://www.hhs.se/site

1. New Tools Against Corruption
Taking Stock of What We have Learned
Giancarlo Spagnolo
SSE-SITE, Tor Vergata, EIEF & CEPR
WORLD BANK
Washington DC, Jan 19, 2016

2. 2
Overview of the Talk
• Introduction - Focus
• Crucial Characteristics of Corruption
• The “New” Legal Tools that Exploit Them
• How do They Work: Theory
• Pros and Cons
• Do They Work? How to Measure
• Experimental Evidence
• Empirical Evidence
• Where we need more research

3. 3
Which Corruption
Focus: “Bureaucratic Corruption”
• Legal Tools not effective against “Political
Corruption”
Focus: “Corrupt Transactions”
• è Multiple Agents è Organized Crime
èCooperation among multiple criminals needed

4. Different from individual crime
1. Governance problem: contracts cannot be used to
prevent internal hold-up/moral hazard
2. There is always at least one witness: the partner
Information already available that can be extracted
THESE FEATURES CAN BE EXPLOITED
Same features collusion, smuggling, trafficking (any
“trading of bads ), large frauds and robberies, mafia…
èMuch of what we say relevant to them, with
appropriate modifications for specificities
4

5. Individual vs Organized
• Individual crime: decision of a criminal;
• Organized crime: equilibrium of a criminal game;
è Not sufficient that expected gains are larger than
expected fines/sanctions
è More conditions needed to sustain a cooperative
criminal equilibrium, can be exploited to deter it
5

6. How?
Corruption must be an equilibrium
èDesign Laws so that it is not
Organized crime needs cooperation
èMaximize asymmetry, conflicts of
interests between criminal partners
There is always a witness / latent information
èLaw as “revelation mechanism”
6

7. Legal Tools that Do This
• Leniency/immunity policies: reduced
sanctions in exchange for information/
collaboration
• Asymmetric punishment: legalization of one
side, criminalization of the other
• Whistleblower rewards: protection & reward
schemes for innocent and accomplice
witnesses
7

8. Why “New”? Old cases…
• Ancient Roman’s “Divide et Impera”…
• XIII Century England’s Bounties…
• Common law’s prosecutorial discretion, plea
bargaining and settlements…
• US False Claim Act, the “Lincoln law” since the
Civil War...
• Accomplice-witness programs, e.g. against
Mafia and Terrorism in Italy in the 80s and 90s
8

9. Isolated Episodes
Most cases discretional and limited (apart from
dictatorships that instead “overused” them)
• New 1: success in Antitrust in US after ‘93 reform,
commitment to public rules è
• New 2: systematic economc research on optimal
design and costs and benefits of these tools è
• New 3: systematic diffusion around the world of
standardized design (for leniency) against collusion
9

10. Very briefly: Theory
10

11. 11
Cooperation Needed
• Becker’s B>αF only necessary for organized crime
• Agency problems, as in non-criminal organization or
transaction, need governance
• Cooperation is needed (between briber and bribee,
price-fixers, drug producer and retailer).
– There will be gains from defection , i.e. temptations to
betray running away with the cash , not delivering after
cashing a bribe, Stigler s secret price cuts…
– Court-enforced contracts not available

12. 12
Cooperation Must be Reached and Sustained
• Criminal organizations/transactions must be
self-enforcing, requires repetition/reputation
– An additional constraint, the incentive constraint
(IC) (also called self-enforcement or no deviation
constraint) for equilibrium as in Stigler (1964);
– And with multiple equilibria + risk of defection,
coordination/trust (CT) necessary (Spagnolo 2004)

13. 13
Leniency and Asymmetric Sanctions: Pros
New deterrence channels:
1. Increase gains from deviation/reporting crime
to law enforcers, deter crime by violating the IC
ensuring corruption is not equilibrium (as in
Motta and Polo 2003, Spagnolo and Buccirossi 2006,
Lambsdorff and Nell 2007, Basu 2011, Spagnolo and
Dufwenberg 2015, Basu, Basu and Cordella 2015)
2. Reduce ‘trust’/hamper coordination, deter
crime by making CT harder (Spagnolo 2004)

14. 14
Leniency and Asymmetric Sanctions: Cons
1. Require capable and non-corrupt law-
enforcement to prevent retaliation (all)
2. Complex/subtle, may easily be poorly designed
and ineffective (all)
3. May be manipulated and backfire (all, e.g.
Buccirossi and Spagnolo 2006)
4. May send the “wrong message” (asymmetric
sanctions, e.g. Dreze 2011)

15. 15
Whistleblower rewards Pros
• Retaliation against whistleblowers (protection difficult),
èsubstantial monetary rewards for whistleblowers
essential to help against it
• Funded by fines and assets seized in convictions, as in
US False Claim Act, SEC, IRS, and CFTS programs
• Paid to accomplice or innocent witnesses, increase
deterrence through fear of beying reported (CT and α);
• Contrary to narrative rewards limit manipulations
(Spagnolo 2004, Buccirossi and Spagnolo 2006)

16. 16
Whistleblower rewards Cons
May induce “information fabrication” to cash rewards
• (but this is a crime, sanctions can be increased and
courts are there to avoid this)
Make whistleblowers less credible as witnesses
• (but better a weak witness than none; moreover, other
witnesses can be found after the whistleblower has
signaled the crime)
Moral outrage (“rewarding snitches” as in dictatorships)
Not needed/effective, may crowd out honesty/morality

17. Do they work?
17

18. Acconcia et al. (2014)
Focus:
• Italian Mafia-related crimes with victims
• 1991: Italian leniency/immunity program
(D.L. 13/05/1991 n. 152) + protection
program (D.L. 15/01/1991 n. 8)
Well run programs work with analogous crimes
18

19. Acconcia, Immordino, Piccolo e Rey (2014)
2

20. Acconcia, Immordino, Piccolo e Rey (2014)
20

21. Acconcia, Immordino, Piccolo e Rey (2010)
21

22. Acconcia, Immordino, Piccolo e Rey (2014)
22

23. 23
For corruption more difficult
“Victimless” in the sense of perception of crime:
• Directly observed only when detected/convicted
• But we interested changes in total crime population
Ex: Increase in conviction rate after a policy change
– Good news, if caused by improved enforcement
– Bad news, if caused by reduced deterrence
Perception measures help, but very noisy and culture-
dependent

24. Focus
Recent studies using:
- Indirect empirical methods that infer
changes in total population from changes in
convicted population
- Laboratory experiments where total crime
population can be directly observed
24

25. Indirect empirical
methods
25

26. On leniency
26
Miller (AER 2009):
Stochastic model of industries transiting in and out collusive
states, applied to US Cartel Detection Data 1985 – 2005
• Hypothesis #1: If the 1993 leniency revision resulted in an
increase in the probability of discovery then there is an
immediate rise in the number of discovered cartels.
• Hypothesis #2: If the 1993 revision resulted in a decrease
in the rate of cartel formation then the number of
discovered cartels should adjust to a lower steady level.

27. Miller (2009)
27
Actual and estimated number of DOJ cartel cases
Not super robust, but statistically significant

28. Perrotta Berlin and Spagnolo (20??)
• Adapt Miller approach to corruption, collect data on
detected corruption cases in China, to evaluate:
– Basu’s (2011) proposal to legalize bribe-paying
for extortionary (harassment) bribes
– Dufwenberg and Spagnolo’s (2015) suggestion to
use leniency (immunity conditional on reporting)
Both policies experimented in China in last decades!
28

29. Perrotta Berlin and Spagnolo cont’d
• Important: Amendment IX to Criminal Law proposed
oct. 2014 has heavier penalties for bribery, but
leniency and asymmetric punishment more limited
and discretional.
• Introduced in 1997, it has been claimed that these
policies “did not work” (Li, 2012)
but no empirical evidence available
29

30. Perrotta Berlin and Spagnolo cont’d
30
Test for structural break
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b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742b = −18.742
t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5t = !3.5
10
20
30
40
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Year
Population−adjustednumberofcases
Actualandestimated−OLS
Consistent with significant deterrence effect of legal change
(leniency and asymmetric punishment strengthened) in 1997 (red
vertical line)
Test of structural break consistent with significant
deterrence effect of legal changes in 1997

31. Caveats: much left to do
• We don’t know which cases are extortionary (harassment)
bribes and which to gain illegitimate benefit
• We don’t know in which cases leniency was applied and in
which asymmetric sanctions were
• For asymmetric punishments, potential denomination
effect if briber-givers’ and bribe-takers’ cases recorded
separately (However, in Guo (2008) 4-9% of cases)
Ongoing case files analysis on a sample before and after
Would love access to procurates’ data, can anyone help?
31

32. On Whistleblowers and Rewards
Stylized facts:
1. No big problems with US False Claim Act
2. Small rewards ineffective (UK, Korea)
3. Whistleblowing extremely costly
– Death is a frequent price paid in many societies
– Long unemployment, harrassment and social
ostracism in the best of the cases
32

33. Dyck, Morse and Zingales (2010)
Who brings corporate fraud to light? What motivates them?
• Study all reported fraud cases in large U.S. companies
between 1996 and 2004.
Legal and financial whatchdogs ineffective:
• SEC accounts for only 7% of cases, auditors only 10%
• Debt holders are absent, equity holders play trivial role
Other agents play a key role: employees (17%), non-
financial-market regulators (13%), the media (13%).
33

34. Dyck et al. (2010) cont’d
Monetary rewards play a crucial role:
• In healthcare – where suits in which whistleblowers are
typically rewarded – 41% of frauds reported by
employees; only 14% in other industries
• Difference significant at the 1% level, effect robust to
controls for industry characteristics
Monetary incentives to blow the whistle work!
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35. Lab Experiments
35

36. 36
Leniency
Bigoni et al., “Trust, Leniency and Deterrence,”
J. of Law Ec. and Org., (2015)
Strong deterrence effect with α=0 and F finite.

37. Bigoni et al. (2015)
Deterrence with α=0 and F finite è First Best
achievable with organized crime and leniency
• Confirms Spagnolo (2004), contrast to Becker’s
(1968) point for individual crime…
• Robust, replicated by Chowduhury and
Wandscheneider (2015) and Kindsgrab (2015)
è Leniency + robust sanctions (F) works against
corruption/organized crime
37

38. Asymmetric punishment
Two main lab experiments:
1. Engel, Georg and Yu (2013)
2. Abbink, Dasgupta, Gangadharan and Jain
(2014)
– Use different corruption games, with and
without the possibility of hold-up
– Obtain opposite results
38

39. Engel, Georg and Yu (2013)
One-shot corruption game with governance problem:
• Payer bribes first, then receiver can deliver
• Receiver can hold-up payer not delivering
Spagnolo (2000), Buccirossi and Spagnolo (2006) and
Lambdorff and Nell (2007):
reduced sanctions may become a governance tool
reporting credible punishment against hold up
39

40. Engel et al. (2013) cont’d
Results:
More bribery with asymmetric punishment
• cheaper to punish hold-up and govern transactions
• both in session run in China and Germany
As in Buccirossi-Spagnolo (2006): reduced sanctions
used to enforce/govern occasional corruption!
40

41. Abbink et al. (2014)
One-shot corruption without governance problem:
• Bureaucrat may ask for a bribe
• Citizen can refuse, pay, or pay and report
No problem of enforcing agreement, as Basu (2011),
Dufwenberg-Spagnolo (2015), Basu et al. (2015)
• Possibility that bureaucrat retaliates if reported
41

42. Abbink et al. (2014) cont’d
Results:
Less corruption with asymmetric punishment
• Somewhat fewer bribes proposed
• Somewhat more bribes reported
Small effect
It disappears when possibility of retaliation introduced
42

43. Whistleblowers rewards
Apesteguja, Dufwenberg and Selten (2007)
• Experimental one-shot whistleblower game
• Weird effects of rewards, slightly hinders
reporting in one-shot collusion game
Bigoni et al. (2012)
• Repeated game with learning, rewards (only)
very effective in eliminating collusion
43

44. Abbink and Wu (2013)
Repeated bribery game between client and officials with
governance problem (official may take bribe but not deliver)
• Three variations of report/reward mechanism: both can
report, only the client, only the official
• Moderate size of reports
Results
Symmetric and last mover (official) report types mildly
effective in deterring bribing with repeated corruption
44

45. Abbink and Wu (2013)
• All extremely effective without repetition
• Corrupt favors granted at lower rate only in periods
where agents were uncertain whether the game
would continue
• No manipulation to solve governance problems
CONCLUSIONS
(Moderate) rewards work very well, less powerful if
corruption repeated, no point in restricting to one side
(all as in Spagnolo 2004)
45

46. Butler, Serra and Spagnolo
(in progress)
46
Lab experiment with strong frame on whistleblowers
motivations
• multiple 3-person firms: one boss, two employees
• members of public (6 per session)
Boss can corrupt, benefiting also employees, but imposing
negative externalities on the public
Employees may blow the whistle at a cost, harming boss but
benefitting the public
With and without monetary rewards for whistleblowers

47. Social judgment
47
Members of the public always informed about the manager’s
law-breaking. We vary whether the public…
• …learns about the harm done to them or not (visible vs.
invisible externalities)
• …learns about whistleblowing (public vs. private
whistleblowing)
• In “public whistleblowing” treatments, each member of the
public may judge the whistleblower by sending one of these
costless messages

48. (Very) Preliminary results
• Result 1 (‘Rewards effect’): Monetary rewards work,
though partly crowded out by visibility of negative
externalities of corruption (sense of duty?).
• Result 2 (‘Traitor effect’): Making whistleblowing
public reduces whistleblowing when externalities
from corruption are invisible.
• Result 3 (‘Hero effect’): Making whistleblowing
public increases whistleblowing when externalities
from corruption are made visible.
48

49. Conclusions
• Theory works: most prediction of early models
supported by empirical and experimental evidence
• These tools may work extremely well, potentially
very strong corruption deterrence effects
• Subtle, easy to wrongly design them, details matter
• Can be manipulated and used to govern corruption
• Not so much if “high powered”: with large monetary
rewards for wistleblowers, safer and more effective
49

50. Words of caution
• Require some independent law enforcers (FBI-like
agencies) or other healthy third party
• Must be well designed and managed and adapted to
countries’ insitutional situation (not always advised with
low judiciary independence/high judiciary corruption)
• Can be used as monitoring tool by donor agencies, but
carefully: poorly designed/managed programs may be
counterproductive
– anonymity then crucial to avoid putting wistleblower’s life at stake
50

51. Other issues
1. Risk of istitutional capture: mild forms of leniency
without strong incentives reduce deterrence but
increases number of succesfull convictions, making law
enforcers appear “heros” while damaging society
2. Multi-crime problem: if corruption combined with other
crimes for which no leniency is available, the tools will
not work (antitrust/corruption)
3. Centralization needed: Mexico (2013), Brazil (2014)…
decentralized… may be used as retaliation…
4. …..
51

52. Thank you for
listening J
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