The effect of firm size, asset ownership, and market prices on regulatory violations

• Published date: 01 October 2019
• Author: Gilbert N. Nyaga,Alex Scott
• DOI: http://doi.org/10.1002/joom.1059
• Date: 01 October 2019

RESEARCH ARTICLE

The effect of firm size, asset ownership, and market prices

on regulatory violations

Alex Scott

1

| Gilbert N. Nyaga

2

1

Eli Broad College of Business, Michigan

State University, East Lansing, Michigan

2

D'Amore-McKim School of Business,

Northeastern University, Boston,

Massachusetts

Correspondence

Alex Scott, Eli Broad College of Business,

Michigan State University, 632 Bogue

Street, Office N323, East Lansing, Michigan

48824.

Email: ascott@msu.edu

Handling Editor: John Gray

Abstract

An individual's temptation to violate regulations for personal gain increases with

the economic payoff to do so. Firms, however, adopt strategies to reduce undesir-

able behavior from their employees. This article examines how individuals change

their propensity to violate regulations as the price for their services varies. We posit

that individuals will commit more intentional, but not unintentional, violations as

the payoff to do so increases, and that this effect will be moderated by the size of

the firm for whom he or she works and whether the firm or the individual owns the

assets used for production. To test our hypotheses, we link data from millions of

inspections of truck driver logbooks with spot market prices observed over the same

4-year period. We find that drivers who operate independently intentionally violate

restrictions on their work hours more frequently when prices increase—violating

34% more frequently when prices are at their highest versus lowest—but larger firms

and the firm's ownership of the assets reduce a driver's responsiveness to price

changes. At the extreme, drivers for large asset-owning firms are completely unre-

sponsive to prices. Asset-owning drivers are responsive to market prices, even for

the largest firms.

KEYWORDS

regulatory compliance, transportation safety

1|INTRODUCTION

Governments regulate firms to ensure safe working conditions

and promote the public welfare (Stigler, 1971). Some regula-

tions raise the cost of inputs, such as imposing a minimum

wage, while others restrict outputs, such as limiting how much

a firm can pollute. Faced with such restrictions, firms—and the

individual decision-makers within a firm—are tempted to vio-

late regulations to increase profits (McKendall and Wagner,

1997). Theory suggests that firms balance the costs and bene-

fits of intentionally violating a regulation when deciding

whether to do so (Becker, 1968). Thus, when the payoff to vio-

late increases, ceteris paribus, they should violate more

frequently—a proposition that has found empirical support in

centralized decision-making settings (Harris & Bromiley, 2007;

Wang, Winton, & Yu, 2010). Because noncompliance with a

regulation can negatively affect important outcomes such as

safety (e.g., Brown, Willis, & Prussia, 2000; de Koster, Stam, &

Balk, 2011; Wiengarten, Fan, Lo, & Pagell, 2017) and quality

(Das, Pagell, Behm, & Veltri, 2008), it is important for opera-

tions managers to understand when and where violations are

likely to occur (e.g., Gray, Anand, & Roth, 2015; Staats, Dai,

Hofmann, & Milkman, 2017).

In many cases, the decision to violate does not rest with

central managers but with front-line employees (Pinto,

Leana, & Pil, 2008); examples include mortgage officers

who misrepresent a loanee's financial status (Nguyen &

Pontell, 2010) and vehicle emissions inspectors who pass

Received: 12 April 2018 Revised: 18 July 2019 Accepted: 22 August 2019

DOI: 10.1002/joom.1059

J Oper Manag. 2019;65:685–709. wileyonlinelibrary.com/journal/joom © 2019 Association for Supply Chain Management, Inc. 685

vehicles that should have failed (Gino & Pierce, 2010). In

these situations, the effect of changing payoffs on an individ-

ual's propensity to violate is less clear because, while individ-

uals violate more when payoffs are higher (as shown in

laboratory settings; e.g., Gneezy, 2005, John, Loewenstein, &

Rick, 2014), firms utilize mechanisms such as monitoring

technology (Bendoly, Donohue, & Schultz, 2006; Pierce,

Snow, & McAfee, 2015), payment methods (Pierce &

Snyder, 2008), and terms in the employment contract

(Prendergast, 2015) to reduce undesirable employee behavior.

We examine how an individual's decision to violate var-

ies with changes in the payoff to do so and whether these

decisions are systematically different for employees who

work for small and large firms and based on who owns the

assets used for production. We posit that an individual's pro-

pensity to violate is closely related to their decision-making

autonomy (Jensen & Meckling, 1992), which enables them

to act on opportunities to violate as stipulated in the motive-

opportunity-choice (MOC) framework (McKendall and

Wagner, 1997). An individual's decision to violate (choice)

is influenced by both the potential payoffs from violating

(motive) and the spectrum of decision-making options

(opportunity). This suggests that individuals who operate

their own firms as single-employee, stand-alone entities

(sometimes referred to as the “zero agency-cost base case”

[Ang, Cole, & Lin, 2000, p. 81]) will violate more fre-

quently as the payoff to do so increases because the individ-

ual has both the opportunity—there are relatively few

restrictions on their decisions—and a stronger motive—they

make more money if they commit the act—to violate.

Two organizational factors that could moderate the decisions

of individuals to violate are the size of the firm for whom they

work (Josefy, Kuban, Ireland, & Hitt, 2015) and whether they

own the assets used for production (Grossman & Hart, 1986;

Williamson, 1985). The decisions of individuals who work for

firms of more than one employee affect not only themselves,

but their coworkers; thus, to limit the potential negative exter-

nalities of one employee's bad decisions (e.g., theft, shirking,

unsafe driving), these firms reduce an employee's opportunity

to violate by limiting their potential decisions (Baker & Cullen,

1993). This suggests that employees for larger firms should not

only have a reduced propensity to commit regulatory violations

on average as a first-order effect but also be less responsive to

changing payoffs for violating as a second-order effect.

Firms use asset ownership as a strategy to reduce unwanted

behavior by employees (Prendergast, 2017). Firms who own

the assets (i.e., make) retain more control over how they are

configured and used (Baker & Hubbard, 2003) compared to

firms who contract with others for production purposes

(i.e., buy; Grossman & Hart, 1986; Tsay, Gray, Noh, &

Mahoney, 2018). This suggests that employees who work for

firms that own the assets should have a reduced propensity to

violate regulations on average and be less responsive to chang-

ing payoffs for violating.

We test these ideas in the context of the U.S. trucking

industry, where the Department of Transportation (DOT)

restricts a truck driver's working hours via “hours of service”

(HOS) regulations to reduce the number of overly-fatigued

drivers on public roads and highways (Cantor, Corsi, &

Grimm, 2006; Miller, 2017). The balance of supply and

demand in the truckload market varies exogenously to an

individual driver's output, thus the marginal value of a driver's

production varies over time and space (Scott, 2018a). We link

data from millions of inspections of truck driver logbooks,

which record their recent work schedules, conducted from

2012 to 2015 spatially and temporally with prices observed in

private auctions for spot truckload services.

We find that intentional violations, such as exceeding

legal driving limits, occur more frequently when the prices

for a driver's services are relatively high, but not uni-

ntentional violations, such as paperwork errors. Drivers who

own and operate their own single-employee firms are highly

responsive to market prices—they increase their frequency

of intentional violations by 13.1% per unit increase in spot

prices—but, at the other extreme, drivers who operate a

large firm's trucks are not. In general, drivers who own their

trucks are considerably more likely to violate, both on aver-

age and in their responsiveness to market prices, compared

to drivers who use the firm's trucks, and this effect holds for

even the largest firms.

We make several contributions in this research. Much

research examines the factors that contribute to dishonest behav-

ior

1

—for example, the probability of detection (Fischbacher &

Föllmi-Heusi, 2013), pay relative to others (John et al., 2014),

altruism (Erat & Gneezy, 2012), and fatigue (Mead, Baumeister,

Gino, Schweitzer, & Ariely, 2009)—and a central result of this

research stream is that people are more dishonest when the payoff

to do so is larger (Balasubramanian, Bennett, & Pierce, 2017;

Duggan & Levitt, 2002; Gneezy, 2005; Jacob & Levitt, 2003).

Much less research, however, examines how payoffs affect dis-

honest behavior by individuals in organizations (Leana &

Meuris, 2015) as opposed to the more common laboratory set-

ting, and what factors may moderate the propensity for dishonest

behavior.

We also contribute to the study of compliance with regu-

lations and processes (e.g., Anand, Gray, & Siemsen, 2012;

Ko, Mendeloff, & Gray, 2010; Staats et al., 2017). Our study

highlights how two common and important organizational

factors—firm size and asset ownership—interact with pay-

offs to affect an individual's compliance. Our unique and

rich dataset combines price variation with violations found

in roadside inspections, which allows us to credibly evaluate

changes in compliance behavior with changes in the price

for services.

686 SCOTT AND NYAGA