paradox of whistle blowing

●I.J. Alexander Dyck, Adair Morse and Luigi Zingales, “Who Blows the Whistle on Corporate Fraud?（pdf）”（CRSP Working Paper No. 618, January 2007）

　Generalizing from these results on the identity and incentives of fraud detectors, we arrive at what might be called a paradox of whistle blowing: those with the weakest incentives to blow the whistle (e.g. employees) are most active, while those with the strongest incentives to act (e.g. shortsellers) are surprisingly less frequent actors. This paradox can be understood if we espouse Hayek’s (1945) view that information is diffuse. Actors with weak incentives have an advantage in whistle blowing because they have superior access to information about the fraud. So, despite having weak incentives, actors with access to information eventually bring frauds to light. In contrast, those with incentives apparently have difficulty accessing credible information to act upon.
　In fact, our data reveal the relative merits of two fundamental approaches to fraud detection. The first, which we label the “mandatory” approach, relies on entrusting some individuals with the task of collecting information that might lead to the detection of fraud. This category includes auditors, the SEC, and also possibly non-financial-market regulators. These actors are generally paid for the effort they exert, not for the outcome they achieve. The alternative approach, which we label the “market” approach, does not designate ex ante the people in charge of detecting fraud. By contrast, it provides a reward system for people who bring fraud to light. These incentives can be monetary, as in the case of shortsellers, or reputational, as in the case for the financial analyst who exposes a problem in her report. Overall, mandatory approaches to fraud detection account for only 35% of our sample, whereas market based institutions account for a much bigger portion, 65%, of our sample.