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The level of optimal fines to prevent fraud when reputations exist and penalty clauses are unenforceable
Author(s) -
Lott John R.
Publication year - 1996
Publication title -
managerial and decision economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.288
H-Index - 51
eISSN - 1099-1468
pISSN - 0143-6570
DOI - 10.1002/(sici)1099-1468(199607)17:4<363::aid-mde768>3.0.co;2-3
Subject(s) - externality , damages , argument (complex analysis) , action (physics) , purchasing , economics , business , microeconomics , securities fraud , law and economics , law , operations management , political science , supreme court , biochemistry , chemistry , physics , quantum mechanics
This paper provides an efficiency explanation for the currently preceived ‘too low’ level of criminal fines for fraud. It shows that the optimal expected criminal fine for fraud does not equal the damages to the consumer purchasing the good, but equals any externalities not internalized by the market. In the absence of external costs, the optimal criminal penalty for fraud would be zero. An argument that fraud creates negative externalities by increasing the expenditures of third parties to prevent fraud is shown to be incorrect. Instead, any effect that the information of a fraudulent action has on the behavior of others should usually be interpreted as an external benefit.