Justice for sale

Posted by Marc Hodak on May 22, 2008 under Invisible trade-offs | Comments are off for this article

Lou Pearlman was given an unusual sentence for defrauding investors of $300 million. He was nominally sentenced to 25 years in prison. However, the judge offered to reduce his sentence by one month for every $1 million Pearlman was able to return to his victims.

I’m not sure what the legal implications of such an offer might be, but the incentive issues are compelling. The first-order incentives are pretty clear: Pearlman has a strong incentive to return most, but not all of the money. Why not all? Because of economic laws, which are not subject to negotiation.

Pearlman is currently 53, so a 25 year sentence pretty much takes up most of his remaining life expectancy. I would bet that if he could buy his way out of that sentence in an all-or-nothing transaction, he would do so at any price. But most economic decisions are at the margin, and this one is one of them. As the sentence gets reduced, the marginal value of each month in prison is likely to go down. For instance, he may well decide that six months in prison is worth $6 million. I probably would. This remains true even if he’s resource constrained. For instance, if he only has enough to buy his way out of 15 years, he might still decide that the 121st month is worth an extra million, especially if he’s able to realize some returns on that million during the 10 years and a month he’d spend in the slammer.

The second-order incentives are a little more problematic. Regardless of whether Pearlman is resource-constrained or not, he’s simply paying for his crime at cost. If I defraud someone of a million, I shouldn’t be given the option of giving back that million and calling it even; there should be some extra penalty, either in cash or prison time (except that I personally don’t believe in swelling our prisons with non-violent offenders).

Also, is a million per month the right price? Or does the routine fraudster get a lower rate? Maybe it’s $100,000 per month for an executive? Or $10,000 per month for Guido? (Hey, I’m just sayin’.) More importantly, how much are prosecutor’s going to be selling freedom for? Government agents, like economic agents, will go with what the traffic will bear. So the question won’t be, “What is the appropriate price of freedom in this case?” It will be, “How much you got?”

I’m sure there are other considerations besides.