How should one regulate a firm when its investment may cause a negative externality? In this paper we present a model on regulating a firm run by a manager and owned by a shareholder. The regulator can impose a penalty on the manager, the shareholder, or both. Our characterization of optimal...

Using a Department of Justice policy intervention intended to increase individual responsibility of managers for corporate offenses (e.g., pollution) as a natural experiment, I find that firms with a high ex-ante probability of regulatory violations (“exposed firms”) suffer an abnormal...