Can self regulation work?: a story of corruption, impunity and cover-up

Abstract

This paper analyzes the reputation-based incentives of a Self-Regulatory Organization (SRO) to detect and expose consumer fraud committed by its members, and the members’ incentives to bribe the SRO in exchange for a cover-up to avoid an external punishment. In a corruption-free benchmark, SROs are effective in detecting, exposing and deterring fraud only if exposure yields a reputation gain to the SRO, which depends on consumers inferences about the SRO’s type. However, if this case prevails the member can succeed in bribing the SRO in exchange for a cover-up and impunity. Despite this, a bribed SRO yields more vigilance and lower fraud than no self-regulation at all.