Quelle Surprise! Pollution Pays!

Those who’ve been around for a while may recall that diehard libertarian Alan Greenspan was forced to admit after the crisis that he had found a flaw in his ideology, and that self interest of financial institutions didn’t lead them to protect their shareholders.

Now despite that world-shaking incident, neoclassical economics remains the dominant economic ideology, which means that policy-makers are still subjected to corporate friendly blather about how companies can be relied upon to mind for themselves because the reputational cost of Doing Bad Things is large, and if that isn’t enough, litigation and the existing (ever weakening) regime of fines for bad behavior is more than adequate.

Again, as anyone who watched the crisis and its aftermath knows, all the big banks suffered was cost of doing business fines.

And this problem is widespread, as a new paper by Roy Shapira, Associate Professor at IDC Herzliya Radzyner Law School and Luigi Zingales, Professor at University of Chicago’s Business School suggests.

The authors make a case study of DuPont’s failure to remedy the emissions of a harmful chemical, C8. used in making Teflon, that eventually led to a $670 million settlement earlier this year. Du Pont is the sort of blue-chippy company that cares about corporate governance enough to make sure it gets good marks on those scorecards. On top of that, DuPont is a top player in environmental and toxic substances research. They conclude it was nevertheless perfectly rational for DuPont to keep polluting.

This conclusion won’t come as a surprise to anyone who has taken note of rampant corporate short-termism and the rise of the “IBG-YBG” mentality, that job churn is so high that any bad stuff being done now won’t rise to the level of being a real problem until after the people with their fingerprints on it have moved on.

But that view is, in corporate finance terms, tantamount to having a discount rate that is artificially high, which results in assigning incorrectly low costs to long term risks.

The interesting part of the Shapira/Zingales paper is that they argue that for Du Pont to keep polluting was a rational decision, using reasonable discounting assumptions. From their summary of their paper at Harvard Law School’s Corporate Governance and Financial Regulation blog:

The key decision point for DuPont came in 1984, when alarming information about the potential consequences of C8 emissions caused the company to call a top-executives meeting. By 1984 DuPont was aware that C8 is toxic, associated with birth defects, does not break down in the environment, and accumulates in human blood over time. Essentially, by 1984 C8 could already be considered a perennial red flag. DuPont’s executives acknowledged that the legal and medical departments would recommend stopping the usage of C8 altogether in light of the new alarming information. Yet, the business side overruled these recommendations and opted to continue C8 emissions (in fact they doubled them). Importantly, DuPont’s decision-makers also opted against investing in abatement options that were on the table, such as building an incineration device that would greatly reduce C8 emissions.

Was this a myopic managerial decision? An agency problem? The internal documents allow us to conduct a cost-benefit analysis, showing that even a shareholder-value-maximizing manager would have chosen to pollute. Our calculation shows that even if DuPont managers could have forecasted all future legal liabilities, they would have preferred to pollute as long as they thought that the probability of getting caught was less than 19%. Given the extreme set of unlikely events that led to the payment of heavy legal fines, and given the fact that other C8 users (like 3M) have escaped such heavy legal liability, we conclude that at that time polluting without abating was a reasonable bet by DuPont’s decision makers. Thus, it was value-maximizing for DuPont to pollute, in spite of the fact that—as we show—the costs C8 pollution imposed on society greatly exceeded DuPont’s own estimates of abatement costs.

The authors stress that potential legal costs weren’t a sufficient deterrent due to the time lag, particularly since companies like DuPont are in a position to create delays via clever PR that creates doubt about the dangers, court strategies, and influencing regulators. They also point out (emphasis original):

Regulation was not enough either. The Toxic Substances Control Act grandfathered in existing chemicals, making it difficult for regulators to obtain information about possible health risks. Even when regulators receive alarming information, large chemical companies can pull levers to soften regulatory enforcement, such as revolving door offers.

Given the large power imbalance when companies misbehave, Shapira’s and Zingales’ remedies are insufficient. They incorrectly frame the problem as in informational, as opposed to about incentives.

They call for bounties for whistleblowers plus a large tax on gag settlements in environmental cases. But it is hardly a secret, save maybe in academia, that whistleblowers ruin their careers and often their marriages, and pay a big psychological price, when the financial payoff is far from certain. Economists of the caliber of Shapira and Zingales should know that people are risk averse, and for good reason: there’s no reason to think you have more than one life. Why throw it away on a fight, even a righteous fight, which parties with much deeper pockets and staying power than you have who will do everything they can to pound you into the ground?

Similarly, the idea of a tax on gag settlements is just silly. The incremental cost of the tax will be too small to change behavior. Shapira’s and Zingales’ objective is to more disclosure, which would help regulators and parties considering litigation, when the companies will just pay the tax.

The obvious solution is to make executives accountable, by at a minimum forcing the payment of any large fines to come out of deferred comp and to require executives above a certain level to have a significant portion of their compensation be deferred. Only by hitting the executives where it hurts, in their wallets, and to enough of a degree to affect their standard of living, do you start to have a chance of changing behavior.

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  1. Foppe

    FYI, this is also an issue in the Netherlands, and an article has been published today about how the RIVM (CDC analogue, part of the ministry of health) and the involved local govts have decided that only people who basically live in the industrial zone where DP/Chemours is located, plus the directly surrounding unbuilt area — i.e., next to nobody — can apply for the (free) blood test to check their C8 levels. https://www.ad.nl/dordrecht/dordtenaren-grijpen-mis-bij-bloedonderzoek~a76b9153/

  2. hemeantwell

    make executives accountable, by at a minimum forcing the payment of any large fines to come out of deferred comp and to require executives above a certain level to have a significant portion of their compensation be deferred. Only by hitting the executives where it hurts, in their wallets

    Yves, does your emphasis on a financial penalty reflect a concession to the likelihood that time in jail is even more unlikely? Knowingly causing birth defects strikes me as deserving time in the clink, after a few gauntlet runs.

    1. JEHR

      This was my question too. When very rich people have to pay fines for their misbehaviour, fraud and corruption, it means absolutely nothing. They would just plan for such an exigency as, indeed, they already do. Goldman Sachs budgets a yearly “cost of doing business” amount in the billions. Paying money puts no big burden on them. Putting polluters in jail by starting at the top of the company would be a very good way of stopping such bad behaviour. I would also suggest that polluters must live in the area where they plan to pollute to make sure it remains safe!

      As for “cost-benefit” analysis, I would like such an analysis done on, say, bankers, and make it clear that any fraud or any corruption or any misbehaviour would be considered too high a cost and the benefit should be bankers go to jail for those offenses.

      1. Vatch

        Yes, prison is justified in some of these cases. However, some of the executives aren’t very rich people (yet); they are merely rich people. But when the corporation is fined, it doesn’t cost them even a penny. So large fines directed against corporate executives personally could have an effect in some cases. It will also be necessary to restrict the ability of corporations to compensate executives for such fines. Perhaps there should be a requirement that the executive be fired from his or her job to prevent later surreptitious compensation.

        Some of these issues are discussed in the book The Chickensh*t Club: Why the Justice Department Fails to Prosecute Executives, by Jesse Eisinger. I’ve only read the first half; it’s rather depressing. James Comey popularized the expression “Chickensh*t Club” when he was the U.S. Attorney for the Southern District of New York. It refers to prosecutors who have superb conviction rates because they only prosecute easy cases. Spoiler alert: about 100 pages into the book, Comey joins the Chickensh*t Club.

    2. Yves Smith Post author

      There is no willingness to devote prosecutorial resources to targeting corporate criminal activity unless it is easy peasy. Even what look like clear cut criminal violations of the Foreign Corrupt Practices Act (where the statutory grounds make prosecutions easy with the right facts) just lead to fines.

      Banks are wards of the state, so IMHO the political bar for calling for criminal prosecutions is lower. If and when we get it in banking, then we can start demanding it in other arenas as logically required (“Some of this bad conduct kills people, how can you not hold individuals accountable?”)

  3. jaackiebass

    As long as the penalty for bad behavior cost less than the profit made from bad behavior nothing will change.

  4. nad

    It never ceases to amaze me that when we are surrounded by unambiguous examples of conspiracies, they are never framed as such.

    “When I sell liquor, it’s called bootlegging; when my patrons serve it on Lake Shore Drive, it’s called hospitality.” ~ Al Capone

  5. Vatch

    The obvious solution is to make executives accountable . . . .

    Agreed! Now, how are we going to make this happen? Attorney General Jeff Sessions and EPA Administrator Scott Pruitt certainly won’t do it, just as Obama administration Attorney General Eric “Place” Holder refused to make executives accountable. So Republicans in the current administration and establishment Democrats cannot be relied on. A big part of the solution will be to replace many establishment Democrats with politicians who understand the need to directly punish the people (not the corporations, even though they are people, too, my friend [thank you Mr. Romney]) who commit corporate crimes. People need to pay attention to primary election campaigns, and to vote for insurgent progressives. We can’t wait for the November election — the time for action occurs months earlier.

  6. Susan the other

    It is terrifying to think about the carrying capacity of the planet for all our pollutants. Thinking of every chemical plant, power plant, industrial farmer, big and small manufacturer, oil rig, car, house, furnace, refrigerator, toilet; every pill swallowed. Every everything. Where to start?

  7. Bruce H. Jennings

    In 1986 the voters of California passed a ballot measure enacting a law known as Proposition 65 (The Safe Drinking Water and Toxics Enforcement Act). Among other provisions, the law reversed the long-standing burdens that are most always placed on the public to prove harm/damages and set in motion a prohibition on the release of known toxicants to drinking water sources (a list that has grown to many hundreds of chemicals). Perhaps the most notable twist on the law allowed for both citizen enforcement and the collection of potentially very large sums against polluters (what industry came to call ʻbounty hunterʻ provisions).
    In negotiations years later with DuPontʻs over a group of compounds related to C8 (e.g. PFOA), their lobbyists lived in fear that activists would pursue a ballot measure modeled after Proposition 65.
    The success of the law can be measured both in the virtual elimination of many substances from commerce as well as the perennial efforts by corporate lobbyists in D.C. to kill the California law. To be certain, Proposition 65 contains certain provisions of dubious merit, but overall suggests a pathway to pursue in other state legislatures and ballot measures (where feasible).

  8. Wukchumni

    Driving through LA, we couldn’t believe how much trash was strewn on the side of the freeways. It was never like that, once upon a time.

    1. jrs

      City of Angels or Louisiana? If the former when was that 40-50 years ago? We haven’t had that spirit here since 1969? Because it’s been that way for ages .. But the homeless problem spreading beyond all control is newer … ever so much human debris. On second thought it is possible that the degree of litter you encountered WAS an evacuated homeless encampment. The normal amount of litter disposable cups and the like is not, but yea when all sorts of permanent household items are all piled up ..

    2. MyLessThanPrimeBeef

      That’s why the sales tax there went up to 9.5% as of October 1.

      The City needs that extra money to buy drones.

  9. knowbuddhau

    ISTM all to depend on the definition of “rational.” There’s a conflation between the highly stylized sense as used by highly specialized academics, and the ordinary sense.

    Since when is it rational for organisms to make their environments uninhabitable?

    That DuPont continued knowingly to pollute looks to me like a measure of how delusional were the decision-makers. How is it rational to be rich in a ruined world?

    That’s not rational. That’s just using simplistic mathematics to camouflage greed. That one sum is greater than the other does not make it better. How does simplistically preferring greater values make one rational?

    Take the tribes of the Pacific NW for example. Before contact, they had the technology to take every last fish from every river every year. But they didn’t. They knew better than to conflate “more now” with “good thinking.” They managed such irrational profit non-maximization for literally thousands of years.

    Then along come us settlers. And in less that a century the runs were nearly all wiped out. Both the tribes and the salmon (as if there was a difference) still haven’t recovered. But fortunes were made. So who were the rational ones?

    I agree that the behavior of those who are so deluded as to think it rational, to be rich in a ruined world, needs to be changed now. And the way of being in the world that sponsors it needs to be challenged forcefully, too. It is desperately and critically important that people realize that we and the environment are not two. Organisms are not other than their environments. What we do to world at large we do to ourselves.

    The very idea, that it’s ok to pollute as long as you’re showing a profit, is the problem. The idea that environmental costs don’t count, only those that can’t be excluded, by hook or by crook, from spreadsheets, need be accounted for, iow, the very definition of “rational” as used by economists, is the problem.

    Imagine the world as imagined by ignoring environmental costs. On what grounds could business take place? How could you possibly conduct business without an environment? Now that’s irrational.

  10. D

    What to say about California, its Legislation/Propositions!™, and the ACTUAL reality in California (Fracking Galore!; Utterly opaque water quality; Alviso Canyon Methane Gas Leak, etcetera, etcetera, etcetera …). Volumes could be written on it. I await the day that the film Chinatown is updated, and then some.

    E.G. There are still 23 (plus?, my cancer med fogs my brain at times, it might be 24, but it’s no less than 23) – A US record of concentrated SuperFund Sites – as of yet still toxic Superfund sites residing in Silicon Valley alone (99%.99+- in Santa Clara County alone).

    05/09/14 Palo Alto company tackles toxic plumes – New application by Terradex maps out contaminated sites, cleanup efforts

    The murky and complex topic of groundwater contamination has been a hot one in cities like Palo Alto, where a toxic plume under what is known as the “Hewlett Packard-Varian site” in the Stanford Research Park raises perpetual concerns about new developments. And in Mountain View, contamination has been found under an industrial site around North Whisman Road, a legacy left by computer companies that occupied the site in the 1970s. Groundwater in both cities contain trichloroethylene (TCE), a chemical that has been deemed a carcinogen by the Environmental Protection Agency.

    Though regulatory agencies have long detailed the potential harm of TCE, including neurological and reproductive, the information about specific Silicon Valley cities isn’t easy for a layman to find. Data about these underground contaminants are dispersed throughout dozens of different databases, Wenzlau said, making it difficult for city officials and residents to access and understand the information. This, in turn, makes it hard for cleanup efforts to generate momentum.

    Is anyone under the illusion that Larry Page and Sergey Brin (in the Google Toxic Plume instance) spend 40 hours a week in these places, versus finding a bargain in knowing how toxic they still were (Zuckercreep found his bargain in the majority Black and Hispanic neighborhoods Facebook is centered between and is every bit as toxic as Page and Brin):

    “Over the past 30 years, industry has transformed to new office parks hosting businesses like Google and Facebook, … vulnerable to carcinogenic vapors from shallow contaminated groundwater plumes from legacy businesses.”

    A Google Plume:

    02/22/13 02/22/13 Google Buildings Polluted With Toxic Vapors From Chemical Spills

    (yep, that’s Capitalism and that’s why it is utterly deadly, one needn’t call themselves a Socialist or Communist to understand that reality.)

    1. knowbuddhau

      Gd, that’s awful. And yet thank you. I rest my case.

      That’s not the metaphorical debasement of the earth and ourselves (aitwad) into a Wasteland, like I’m (probably annoyingly) always on about, but the actual fact. That the carcinogenic vapors intoxicating Silicon Valley are arising from the ghosts of great capitalist crimes past, is just sublimely perfect.

      So the grounds on which business takes place, in this world in which it is “rational” and “profitable” to pollute the ground from which we all arise, is in fact a carcinogenic Wasteland. Put those spiraling health care costs. just for starters, in your spreadsheets and tell me again how “rational” it is to pollute.

      [ROBIN WILLIAMS, CHANNELING ALBERT EINSTEIN IN A YIDDISH ACCENT:] “I gave you simply e=mc2 , you meshuggeneh, and you f^ck it up like dis?”

      Shakespeare (A Meltdowner’s Nightmare),
      from the album Reality…What A Concept

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