Abstracts Business

The shield of legitimacy : strategic decoupling of sanction compliance programs in global firms

by Zhizhen https://orcid.org/0000-0003-2323-6676 Lu

The compliance of multinational corporations (MNCs) is critical to effective economic sanctions in a globalized era. While the literature on economic statecraft increasingly emphasizes the importance of firm-level theories, there is insufficient attention to business management strategies and consequent firm-level behaviors. Bringing strategic management and compliance theories, I enrich the understanding of business compliance with economic sanctions. Regulators are increasingly reliant on business self-regulation through corporate compliance programs, including the enforcement of economic sanctions. However, there is an empirical puzzle where many MNCs violating sanctions have compliance programs in place. I argue that conventional theories of compliance insufficiently address the strategic dynamic between firms and the states. Bringing the institutional and strategic perspectives, I advance a novel theory of costly signaling where firms use the sanction compliance programs to communicate their dedication to self-regulation, reducing investigation efforts from the regulator. As the regulator is constrained by investigative resources and information on the actual business operations, it takes the presence of compliance programs as a signal for deciding the most efficient enforcement level. I build a formal model to test the logic of this theory and find support for these two hypothesized mechanisms. The budget constraint that confronts the regulator is critical to a separating equilibrium where the low-profit firm can distinguish itself from the high-profit one. The regulator’s uncertainty over on-the-ground business practices enables firms to separate formal compliance structures and informal practices. While focusing on economic sanctions, this report has broader implications for the governance and regulation of global firms.