Too Big to Jail? Company Status and Judicial Bias in an Emerging Market

Abstract

Manuscript Type: Empirical

Research Question/Issue: This paper examines prosecutorial and judicial decisions to incarcerate the suspect upon indictment or conviction of embezzlement or breach of fiduciary duty in Korean firms. Our aim is to evaluate whether the judicial system is biased in favor of large business groups or chaebols in criminal cases.

Research Findings/Insights: Using a sample of 84 indictments and 78 convictions for embezzlement or breach of duty against managers of publicly traded firms in Korea between 2004 and 2008, we find that the probability of incarceration is much smaller if the indicted are associated with large business groups or large firms. In non-large business group firms, initial disclosure of such accusation results in an average loss of a quarter of market value, and three quarters of convicted individuals are eventually removed from managerial positions. However, we observe neither such a loss nor turnover in large business group member firms.

Theoretical/Academic Implications: We identify a new determinant of judicial bias, namely the status of the company, in addition to individual-level social status or class that has been examined in the previous literature. Such bias may reflect potential future career concerns of the prosecutors and judges who later become lawyers. The results also suggest that an additional motivation behind empire building or size-maximizing behavior of top management is to effectively implement a legal strategy, a form of non-market strategy.

Practitioner/Policy Implications: Corporate managers may apply our findings to manage legal risks and to formulate nonmarket strategies. However, biases in individual sentences may create system risk and economy-wide inefficiencies. In order to reform the legal system, policymakers should take into account the externalities in individual sentencing decisions.