Effects of External Whistleblower Rewards on Internal Reporting

Many have argued that rewards for external whistleblowing on corporate crimes to regulatory agencies could discourage internal reporting in companies, but this issue has not yet been fully analyzed. Based on the observations of past trends in whistleblower cases, this paper develops a model based on the hypotheses that internal reporting helps a company’s internal governance system prevent crime through the exercise of internal control and that external whistleblowing helps a regulatory agency deter crime through the threat of sanctions. The model shows the amount of external whistleblower rewards has a non-monotonic relationship with the probability of internal reporting occurring: As the amount of rewards increases, the probability of internal reporting first increases and, after reaching a maximum, decreases to zero. The socially optimal amount of external whistleblower rewards is determined by considering a trade-off between internal reporting as a means of prevention and external whistleblowing as that of deterrence.