Out of Site, Out of Mind? The Role of the Government‐Appointed Corporate Monitor

• Published date: 01 December 2023
• Author: LINDSEY A. GALLO,KENDALL V. LYNCH,RIMMY E. TOMY
• Date: 01 December 2023
• DOI: http://doi.org/10.1111/1475-679X.12502

DOI: 10.1111/1475-679X.12502

Journal of Accounting Research

Vol. 61 No. 5 December 2023

Printed in U.S.A.

Out of Site, Out of Mind? The Role

of the Government-Appointed

Corporate Monitor

LINDSEY A. GALLO,∗KENDALL V. LYNCH,∗

AND RIMMY E. TOMY†

Received 4 February 2022; accepted 6 July 2023

ABSTRACT

We study the role of a relatively new type of external firm monitor, an

on-site government-appointed Corporate Monitor, and assess whether such

appointments reduce firms’ propensity to violate laws. Using a sample of de-

ferred and nonprosecution agreements, we first document the determinants

∗Stephen M. Ross School of Business, University of Michigan; †The University of Chicago

Booth School of Business

Accepted by Rodrigo Verdi. We are grateful for the helpful comments and suggestions of

an anonymous associate editor and reviewer. We thank seminar participants at the Univer-

sity of Michigan, the 2021 FARS Midyear meeting, the 2021 EFA annual meeting, the 2021

AAA annual meeting, the University of Notre Dame, and the University of Oklahoma for their

helpful comments and feedback. Wealso thank Ray B all, Phil Berger,Brandon Garrett (discus-

sant), David Hess, Pablo Florian, Vikramaditya Khanna, Anya Kleymenova, Greg Miller, Mihir

Mehta, Syrena Shirley (discussant), Kelvin Tan (discussant), Will Thomas, Gwen Yu, and a

Corporate Monitor who agreed to be interviewed but prefers to remain anonymous. We are

grateful to Byeongchan An, Alex Gordon, Matt Infante, Neil Jain, James Kiselik, Oleksandr

Umanets, and Jizhou Wang for excellent research assistance. We further thank Matt Carpen-

ter, whose experience with Corporate Monitors serves as the genesis of this paper. RimmyE.

Tomy gratefully acknowledges the support of the Kathryn and Grant Swick Faculty Research

Fund at the University of Chicago Booth School of Business. Kendall V. Lynch gratefully ac-

knowledges the support of the Paton Fellowship at the University of Michigan Ross School of

Business and the Deloitte Foundation Doctoral Fellowship. This paper was the 2022–23 recip-

ient of the Glen McLaughlin Prize for Research in Accounting Ethics from Steed School of

Accounting (University of Oklahoma). An online appendix to this paper can be downloaded

at https://www.chicagobooth.edu/jar-online-supplements.

1633

© 2023 The Authors. Journal of Accounting Research published by Wiley Periodicals LLC on behalf of The

Chookaszian Accounting Research Center at the University of Chicago Booth School of Business.

This is an open access article under the terms of the Creative Commons Attribution-NonCommercial

License, which permits use, distribution and reproduction in any medium, provided the original work is

properly cited and is not used for commercial purposes.

1634 l. a. gallo, k. v. lynch, and r. e. tomy

of Monitor appointment. We find firms that voluntarily disclose wrongdoing

and have more independent directors are less likely to have Corporate Mon-

itors, whereas those with more severe infractions, mandated board changes,

and increased cooperation requirements are more likely to have Monitors.

We find such appointments are associated with an 18%–25% reduction in vi-

olations while the Monitor is on site, however, the effect does not persist after

the Monitorship ends. Using a semisupervised machine learning method to

measure changes in firms’ ethics and compliance norms, we find that the re-

duction in violations is associated with changes in ethics and compliance that

also do not persist. Finally, we document that firms under Monitorship expe-

rience a persistent reduction in innovation, highlighting a previously unex-

plored cost of these interventions. Overall, our results suggest that, although

Corporate Monitors on site are associated with fewer violations, firms revert

to previous levels of violations following Monitors’ departure.

JEL codes: G30, G34, G38, K14, K22, K40, M14, M40, M41, M48

Keywords: corporate governance; corporate culture; corporate monitor;

corporate recidivism; enforcement; ethical norms; regulation

1. Introduction

Regulators use a variety of tools to deter and remedy corporate misconduct

in areas such as financial or tax fraud, insider trading, and environmental

or safety violations. Recent literature has studied, in various settings, the

effectiveness of these tools, including whistleblower programs (Call et al.

[2018], Soltes [2020], Dey et al. [2021], Berger and Lee [2022]), the dis-

closure of regulatory actions (Duro et al. [2019], Kleymenova and Tomy

[2022]), mandated firm disclosures (Christensen et al. [2017]), and en-

forcement or prosecution (Correia [2014], Silvers [2016], Nguyen [2021]).

We study a relatively new tool at the disposal of regulators in preventing

corporate misconduct: a government-appointed, on-site corporate compli-

ance monitor, also referred to as the “Corporate Monitor.”1Monitors are

appointed at large corporations that have already been exposed for wrong-

doing, with the aim of reforming the firm and preventing further miscon-

duct. However, given their relative novelty, less is known about their role

or effectiveness. In this paper, we examine whether the appointment of a

Corporate Monitor reduces the incidence of repeat misconduct.

By studying the impact of these Monitors, we address a timely and unre-

solved debate in the area of corporate prosecution. The George W. Bush

administration established guidelines regarding how federal prosecutors

should select and implement Corporate Monitors, but stated they “should

only be used where appropriate given the facts and circumstances of a par-

ticular matter” (Morford [2008]). The use of Corporate Monitors was more

widespread under the Obama administration, with a third of all prosecu-

1Throughout the paper, we capitalize Corporate Monitor to distinguish from other types

of monitors.

the role of the government-appointed corporate monitor

1635

tion agreements requiring them. However, although the Trump adminis-

tration pulled back on the practice, citing the burden on corporations, the

Department of Justice (DOJ) has recently reestablished its commitment to

using Corporate Monitors, calling them “an effective means of reducing the

risk of repeat misconduct” (Monaco [2021]). Given this seemingly ad hoc

approach by successive administrations, whether Corporate Monitors have

helped reduce corporate recidivism is an important and timely question

and may aid the DOJ in considering Monitor imposition going forward.

We study Corporate Monitors within the setting of deferred or nonpros-

ecution agreements (hereafter, N/DPAs), which are contracts between the

offending firm and enforcement agencies in which the firm agrees to reme-

dies and sanctions in exchange for not being prosecuted.2The federal gov-

ernment maintains the right to prosecute later if the firm fails to uphold

the agreement. Prosecuting large corporations that break laws can lead to

negative externalities that affect stakeholders, such as employees, pension

funds, or minority investors, who may not be directly responsible for the

corporate misconduct. Therefore, prosecutors may decide to prioritize ref-

ormation over retribution and enter into N/DPAs. Often the agreements

mandate firms to hire a government-appointed Corporate Monitor, who

is tasked with investigating the compliance failure that resulted in the vi-

olation, assessing its scope to provide adequate compensation to affected

parties, and providing recommendations to prevent future violations (Root

[2014], Arlen and Kahan [2017]).3

It is unclear whether government-appointed Corporate Monitors would

help prevent misconduct. The N/DPA generally outlines the compliance

measures that the firm must undertake; as long as the firm is motivated

to avoid future violations and any N/DPA violations, the Monitor may not

be incrementally effective. Corporate Monitors are also frequently former

prosecutors who may not have the firm-specific knowledge required to im-

prove governance. On the other hand, because Corporate Monitors are

outsiders, they may also be less prone to capture by the management. Ad-

ditionally, they may be particularly well versed in compliance issues. Given

the tradeoff between insider knowledge and objectivity, whether these out-

side Monitors help prevent violations at a firm that engaged in wrongdoing

is uncertain.

Furthermore, the appointment of Corporate Monitors imposes addi-

tional costs on the firm. Not only are Corporate Monitors and their teams

2As part of the N/DPA, the firm typically must admit responsibility and agree to a state-

ment of facts that can be used against it in the case of noncompliance, making conviction (if

pursued) highly likely (Arlen and Kahan [2017]).

3Corporate Monitors are also used, albeit to a lesser extent, as part of plea agreements.

We limit our analyses to N/DPAs, given the relative frequency with which these agreements

use Corporate Monitors (Alexander and Cohen [2015]). Prosecutors generally use plea agree-

ments and N/DPAs to extract different concessions, with the latter used more often to achieve

governance changes (Alexander and Cohen [2015]). Furthermore, limiting our sample to

N/DPAs allows us to restrict unobserved variation in the Monitor and non-Monitor firms,

which improves the precision of our difference-in-differences estimates.