Public Disclosure, Private Relevation or Silence: Whistleblowing Incentives and Managerial Policy Austen-Smith and Feddersen (2008) Cowgill and Ghani Nov 13, 2009 PHDBA 279A

Actors, Actions and Payoffs Actors: Employee, Manager, Firm and Society Actions: Employees can stay silent, report privately or whistleblow. Managers can ignore violation or fix. Payoffs: At the end of each game, we calculate the payoffs to society and the firm. The employee and manager’s payoffs are a function of society and the firm’s payoffs, weighted by their type. “High” type managers/employees place a greater weight on society’s payoffs.

Notation and Sequence of Events 1.Nature draws random assignments. v represents a violation whose value is [0,1] representing its severity. s represents manager type, which is from {0,1}. t represents employee’s type, which is from (0,1). β represents the prior probability of the manager’s type. 2.Manager announces a whistleblowing policy C(h,s). h represents history of events viewable by the manager. Manager’s threats are credible. 3.An employee chooses his response from the following options: ϕ represents doing nothing. p represents privately informing the manager. w represents whistleblowing. … the game now splits depending on the employee’s choice.

Notation and Sequence of Events … if the employee chooses silence … 4.Nature decides to reveal the violation publicly with probability of. 5.Payoffs are distributed. Society gets –δv if nature reveals and –v if it doesn’t. δ represents the reputational harm to the firm (which has negative externalities on society) The firm gets –(α+δ)v if nature reveals the violation. Otherwise it gets zero. … if the employee chooses private disclosure … 4.The manager decides to fix the violation (f) or not (~f). 5.Nature decides to reveal the violation publicly with probability of >. 6.Payoffs are distributed. Society gets 0 if the manager fixes. If she doesn’t fix and the violation is revealed, society gets –δv. Otherwise, society gets 0. The firm gets –av if the manager fixes. If he doesn’t fix and nature reveals it gets –(α + δ)v. Otherwise it gets zero.

Notation and Sequence of Events … if the employee chooses private disclosure … 4.v becomes common knowledge. 5.The manager fixes the problem by paying αv and punishing the employee with C. 6.Payoffs are distributed. Society’s payoffs are –δv. The firm’s payoffs are –(α + δ)v.

Payoff Matrix Manager FixNo fix Silence Report privately Whistleblow Employee

Lemma 1(a): When managers fix Type 1 manager (s=1) Type 0 manager (s=0) … the type 1 manager fixes everything reported to her.

Lemma 1(b): Preferences to report Type 1 manager (s=1) (who fixes all violations) … Type 1 manager wants everything reported to him.

Lemma 1(b): Preferences to report Type 0 manager (s=0): Case 1: v< Case 2: v>

Thresholds in t Depending on the level of violation and priors on the manager’s type, there are thresholds representing where the employee is indifferent between two actions. If the violation is low, is decreasing in. is increasing in both v and. If the violation is moderate, is decreasing in v and independent of If the violation is severe: all types of employees report the violation privately.

Summary: Equilibrium Results NO PENALTIESLow violationModerate violationHigh violation High-Type Manager Fixes all known v. Low-Type Manager Never fixes v.Fixes all known v, but prefers silence. Fixes all known v. Employee T φp decreasing in β (and v iff β > (q p -q φ )/q p ), T pw increasing in v, β. No whistleblowing, T φp independent of β, decreasing in v. All employee types always report all violations privately. WITH PENALTIESLow violationModerate violationHigh violation High-Type Manager Fixes all known v. Levies maximum penalty only for employee silence. Employee No whistleblowing, reports privately iff t ≥ t* φp.All report privately. WITH PENALTIESLow violationModerate violationHigh violation Low-Type Manager Never fixes v.Fixes v if reported.Fixes all known v. Penalizes private reporting and whistleblowing.No penalty. Employee Stays silent iff t ≤ t φp, if not, whistleblows. Reports iff t > t φp, otherwise stays silent. All report privately.

Prop 3: Eqm w/ High-Type Manager Comments: Lemma 2 analyzes behavior of t* φp but intuition comes from this inequality: Collecting for t yields: For ideal penalty threshold, set RHS equal to zero and solve for c by maximizing v (given that ). This ensures t* φp = 0.

Prop 4: Eqm w/ Low-Type Manager

Low-Type Manager’s Challenge: Minimizing p without increasing w Comparing employee payoffs… – Whistleblowing: – Reporting privately: – Staying silent: …yields three threshold types (given c): –

Low-Type Manager, Low Violation

Prop 5: Existence of Signaling Eqm Comments: Intuition rests on type zero manager’s incentives. High-type manager has no incentive to adopt C * 0, which would lead to reduced private reporting. Low-type manager who adopts C * 1 profits only when ethical types don’t whistleblow but report privately. So the less likely the employee is the high ethical type, the less likely it is that the type zero manager profits by deviating to mimic the type one manager.

Additional Comments How essential are assumptions to the results? – Costless imposition of penalties, and ability of managers to commit to any announced policy. – – Nature selects manager type (s) and employee type (t) independently (e.g. no matching). Could this analysis be simplified WLOG?