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Prof. Lin Nan
Brock Family Chair Professor
Senior Associate Dean | Department Head in Management
Mitchell Daniels School of Business | Purdue University

This paper examines how whistleblowing incentives shape a firm’s internal information system design. We study a model in which a manager commits to an information system ex ante to generate early warnings of defects. An employee, based on early warnings, can identify and fix the defects, or can blow the whistle. We first show that without potential whistleblowing, a manager who maximizes firm value optimally chooses a perfectly informative system, while in the presence of plausible whistleblowing, the manager may optimally deviate from the perfect information system. Two types of whistleblowing endogenously arise in the model: substantiated whistleblowing is value enhancing and boosts the employee’s effort, while meritless whistleblowing triggers inefficient liquidation and crowds out the employee’s effort. In particular, with a sufficiently large whistleblowing reward, we find that when the prior belief of defect is weak, the manager chooses an information system with a pessimistic bias to maximize firm value. In contrast, when the prior belief is strong, the optimal information system features an optimistic bias. We also show that strengthening whistleblowing incentives may lower the expected firm value, despite the manager’s aim to maximize it.