Whistle-Blowing and Incentives in Firms

Friebel, G and Guriev, SG (2012) Whistle-Blowing and Incentives in Firms. Journal of Economics and Management Strategy, 21 (4). pp. 1007-1027. ISSN 1058-6407

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.