Economics of Corruption

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Does crime pay? When you think about the economics of bribery and corruption, most people look at the cost of the huge fines, reputation loss, and business interruption that companies face with when caught paying bribes. But companies that pay bribes never expect to get caught. To the contrary, companies that pay bribes expect to benefit from their corrupt activities. This leads to an obvious question: does crime pay? Or to put it in financial terms, what is the ROI of corruption?

We look at studies that answer important questions: Who bribes? How much do they pay? And what value do they get?

Also, do you get more if you pay more? And do firms that bribe perform better?
I am sharing my slides from my presentation at the CFO Asia Congress on October 8, 2013, under Creative Commons Attribution license. You are free to distribute, remix, tweak, and build upon my work, even commercially, as long as you credit me for the original creation by linking to this Slideshare URL. Each slide contains source attributions and URL; you should obtain the original images from the original sources before reusing. You must comply with any applicable license restrictions imposed by the original source.

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Economics of Corruption

  1. 1. Economics of Corruption CFO Asia Congress Orchard Parade Hotel 8 October 2013 By Eric Roring Pesik Image Credit: Get Your Roll On by Chris Potter (www.stockmonkeys.com) http://www.flickr.com/photos/86530412@N02/8449167986/
  2. 2. The FCPA Blog http://www.fcpablog.com/blog/tag/top-ten Image: Arms Folder by D Planet http://www.flickr.com/photos/dplanet/94441584/ Top 10 FCPA Fines of All Time $95 Million $137 Million $185 Million $219 Million $338 Million $365 Million $395 Million $400 Million $579 Million $800 Million Deutsche Telekom (Germany) Alcatel-Lucent (France) Daimler AG (Germany) JGC Corporation (Japan) Technip S.A. (France) Snamprogetti/ENI (Holland/Italy) Total S.A. (France) BAE (UK) KBR/Halliburton (USA) Siemens (Germany)
  3. 3. Greed by Liz West http://www.flickr.com/photos/53133240@N00/2207307656/
  4. 4. http://office.microsoft.com/en-us/images/results.aspx?qu=MP900422830&ex=1#ai:MP900422830|
  5. 5. Image: Cut your Bills by Images of Money http://www.flickr.com/photos/59937401@N07/5857660216/
  6. 6. Image: Chinese Flag by Philip Jägenstedt http://www.flickr.com/photos/48982392@N00/2489526032/
  7. 7. The value of a dollar by rahims http://www.flickr.com/photos/rahims/2110236034/
  8. 8. Where are we now?
  9. 9. International Currency by epSos.de http://www.flickr.com/photos/epsos/8453271596/
  10. 10. 11% 11% of companies say “firms like theirs” bribe Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012) Image: Don by D Planet http://www.flickr.com/photos/dplanet/94442620/
  11. 11. Corruption costs the equivalent of a 20% tax Six Questions on the Cost of Corruption With World Bank Institute Global Governance Director Daniel Kaufmann http://go.worldbank.org/KQH743GKF1 Image: We Want You by D Planet http://www.flickr.com/photos/dplanet/94442625/ 20%
  12. 12. 40% 40% of companies claim to have lost business to competitors who won contracts unethically Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012) Image: Adjust Tie by Dplanet http://www.flickr.com/photos/dplanet/94441582/
  13. 13. Who is making money?
  14. 14. Is bribery worth it?
  15. 15. Is it worth the risk of bribing and getting caught? Image: http://office.microsoft.com/en-sg/results.aspx?qu=MP900185047
  16. 16. Is it worth bribing and getting away with it? Image: Adjust Tie by D Planet http://www.flickr.com/photos/dplanet/94441582/
  17. 17. Image: Greed by Liz West http://www.flickr.com/photos/53133240@N00/2207307656/
  18. 18. What is the ROI of bribery?
  19. 19. Who bribes? How much do they pay? What value do they get?
  20. 20. Most bribery statistics come from firms that got caught http://office.microsoft.com/en-us/images/results.aspx?qu=handcuffs&ex=2#ai:MP900402864|
  21. 21. Who bribed and got away with it http://office.microsoft.com/en-us/images/results.aspx?qu=MP900443285&ex=1
  22. 22. Theatrical poster for Fight Club, Copyright © 1999 by 20th Century Fox. All Rights Reserved. http://en.wikipedia.org/wiki/File:Fight_Club_poster.jpg This image is of a poster, and the copyright for it is owned by either the publisher or the creator of the work depicted.
  23. 23. Image: St Munchins Contract Signing 60 by St Munchin's College http://www.flickr.com/photos/stmunchins/6864640994/
  24. 24. Who bribes? How much do they pay? What value do they get?
  25. 25. Method 1: Historical Analysis http://office.microsoft.com/en-us/images/results.aspx?qu=MP900385334
  26. 26. Use the records of firms that bribe and got caught Image: http://office.microsoft.com/en-sg/results.aspx?qu=MP900185047
  27. 27. Don’t look at the date of revelation of the bribery Image: http://office.microsoft.com/en-us/images/results.aspx?qu=MP900414039
  28. 28. Look back to the time the contract was awarded Image: http://office.microsoft.com/en-us/images/results.aspx?qu=MP900442939
  29. 29. Look at company performance when bribing and getting away with it Image: http://office.microsoft.com/en-sg/results.aspx?qu=MP900430507
  30. 30. Method 2: Efficient Markets Analysis http://office.microsoft.com/en-us/images/results.aspx?qu=MP900385334
  31. 31. Image: http://en.wikipedia.org/wiki/File:Radar_Detector._canada._Escort_Passport_8500_x50_blue_3635.jpg How do the police detect cars with radar detectors?
  32. 32. Image: http://office.microsoft.com/en-us/images/results.aspx?qu=MP900442392
  33. 33. Image: http://en.wikipedia.org/wiki/File:Radar_gun.jpg Suddenly flash radar into a crowd of cars
  34. 34. Image: http://en.wikipedia.org/wiki/File:Radar_Detector._canada._Escort_Passport_8500_x50_blue_3635.jpg
  35. 35. Image: http://office.microsoft.com/en-us/images/results.aspx?qu=MP900442392
  36. 36. http://office.microsoft.com/en-us/images/results.aspx?qu=MP900387936&ex=1 Take away the ability to bribe and see which stocks hit the brakes
  37. 37. Who bribes? How much do they pay? What value do they get?
  38. 38. Who bribes?
  39. 39. Method 1: Historical Analysis http://office.microsoft.com/en-us/images/results.aspx?qu=MP900385334
  40. 40. 1,388 fraud cases 100 countries 6 continents 2 year period ACFE Report to the Nations on Occupational Fraud and Abuse (2012)
  41. 41. Companies don’t pay bribes; people pay bribes http://office.microsoft.com/en-sg/images/results.aspx?qu=mP900442346
  42. 42. Pressure
  43. 43. 4.1% 4.7% 4.8% 5.3% 6.5% 6.5% 7.9% 8.1% 8.4% 12.6% 14.8% 14.8% 18.2% 19.2% 31.5% 35.6% Instability in Life Circumstances Excessive Pressure from Family or Peers Complained About Lack of Authority Past Legal Problems Refusal to Take Vacations Excessive Pressure from Organization Complained About Inadequate Pay Past Employment Related Problems Addiction Problems Irritable, Suspicious, Defensive Attitude Divorce or Family Problems Wheeler-Dealer Attitude Control Issues, Unwilling to Share Duties Unusually Close with Vendor or Customer Financial Difficulties Living Beyond Means ACFE Report to the Nations on Occupational Fraud and Abuse (2012) Image: http://office.microsoft.com/en-us/images/reults.aspx?qu=MP900431223
  44. 44. Living Beyond Means Financial Difficulties Control Issues, Unwillingness to Share Duties Unusually Close with Vendor/Customer Wheeler-Dealer Attitude Asset Misappropriation Corruption Financial Statement Fraud ACFE Report to the Nations on Occupational Fraud and Abuse (2012) Top 5 Behavioural Red-Flags
  45. 45. Never a 1:1 relationship
  46. 46. 0.6% 0.6% 0.7% 1.1% 1.2% 1.4% 1.9% 2.0% 3.7% 4.2% 5.7% 5.9% 6.9% 11.9% 12.8% 17.4% 22.0% Legal Internal Audit Research and Development Marketing/Public Relations Human Resources Board of Directors Manufacturing and Production Information Technology Finance Warehousing/Inventory Purchasing Other Customer Service Executive/Upper Management Sales Operations Accounting ACFE Report to the Nations on Occupational Fraud and Abuse (2012) Image: http://office.microsoft.com/en-us/images/results.aspx?qu=MP900422882
  47. 47. Gender of Perpetrators Male 65% Female 35% ACFE Report to the Nations on Occupational Fraud and Abuse (2012)
  48. 48. Female 52% 45% 29% 25% 18% 18% 16% 48% 55% 71% 75% 82% 82% Male 84% Canada United States Oceanina Central & S.America Africa Asia Europe Gender of Perpetrators ACFE Report to the Nations on Occupational Fraud and Abuse (2012)
  49. 49. Tenure of Perpetrators ACFE Report to the Nations on Occupational Fraud and Abuse (2012) - Scaled Risk Factor (Frequency * Amount) 1.0 7.4 9.4 10.0 Less than 1 year 1 to 5 years 6 to 10 years More than 10 years
  50. 50. Education of Perpetrators ACFE Report to the Nations on Occupational Fraud and Abuse (2012) - Scaled Risk Factor (Frequency * Amount) 1.0 3.3 4.1 10.0 7.2 Other High School or Less Some College College Degree Postgrad Degree
  51. 51. Who bribes?
  52. 52. *Except in Canada Image: Portrait of a businesswoman by Victor1558 http://www.flickr.com/photos/76029035@N02/6829334723/
  53. 53. The average person currently in prison for FCPA violations is 58 years old
  54. 54. How much do they pay?
  55. 55. Method 1: Historical Analysis http://office.microsoft.com/en-us/images/results.aspx?qu=MP900385334
  56. 56. 166 historical bribery incidents 107 publically listed firms 20 stock markets 52 countries 36 year time period Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012)
  57. 57. Median bribe amount Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012) Image: http://office.microsoft.com us/images/results.aspx?qu=MP90044
  58. 58. $1.06 M $11.43 M Low Rank Officials High Rank Officials Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012)Image: http://office.microsoft.com/en-us/images/results.aspx?qu=MP900422532
  59. 59. $16.77 M $13.77 M $7.63 M $5.32 M $5.00 M $0.50 M $0.19 M Head of State Member of Parliament Government Minister Military Officer Judge Head of Agency Governor/Mayor Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012) Image: http://office.microsoft.com/en-us/images/results.aspx?qu=MP900448685
  60. 60. Bribe as percentage of project awarded: 1.94% Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012) Image: http://www.flickr.com/photos/34728058@N08/4818131438/
  61. 61. 4.42%1.22% Bribe % Low Rank Official Bribe % High Rank Official Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012) Image: http://office.microsoft.com/en-us/images/results.aspx?qu=MP900401019
  62. 62. What benefits do they get?
  63. 63. Image: http://www.fanpop.com/clubs/marlon-brando/images/9109847/title/godfather-fanart Don’t write if you can talk, don’t talk of you can nod your head, don’t nod your head if you don’t have to. The Family Corleone Prequel to Mario Puzo's The Godfather “
  64. 64. Method 2: Efficient Markets Analysis http://office.microsoft.com/en-us/images/results.aspx?qu=MP900385334
  65. 65. UK Bribery Act 2010 Exogenous shock: Newspapers did not discuss vote Previous legislation was early 19th & 20th century All previous attempts had failed Included unexpectedly severe fines Zeume, Stefan, Bribes and Firm Value - Evidence from Anti-Bribery Regulation (August 18, 2013).Image: http://office.microsoft.com/en-us/images/results.aspx?qu=MP900422830
  66. 66. 645 UK firms $3.768B Average Market Cap $429M Median Market Cap Event Date: 25-March 2009 Zeume, Stefan, Bribes and Firm Value - Evidence from Anti-Bribery Regulation (August 18, 2013).
  67. 67. KPI = Cumulative Abnormal Returns
  68. 68. -0.06% -0.87% -0.05% CAR [-20;-1] CAR[0;1] CAR[2;20] $2.43 Trillion Loss in Market Cap Zeume, Stefan, Bribes and Firm Value - Evidence from Anti-Bribery Regulation (August 18, 2013).
  69. 69. Foreign Corruption Exposure Firms that operate in more corrupt environments experience a larger drop in firm value Image: http://www.transparency.org/cpi2012/results
  70. 70. 0.51% more negative CAR [0;1] $2.19M more negative loss for median-size firm -0.87% -0.61% -1.12% -0.51% Baseline Low Foreign Corruption Exposure High Foreign CorruptionExposure Zeume, Stefan, Bribes and Firm Value - Evidence from Anti-Bribery Regulation (August 18, 2013).
  71. 71. Other Anti-Bribery Regulations Firms that are already subject to US anti-bribery regulations (FCPA) experience a smaller drop in firm value Image: http://office.microsoft.com/en-us/images/results.aspx?qu=MP900400667
  72. 72. 0.37% more negative CAR [0;1] $1.58M more negative loss for median-size firm -0.87% -0.92% -0.55% -0.37% Baseline No Cross-Listing US Cross-Listing Zeume, Stefan, Bribes and Firm Value - Evidence from Anti-Bribery Regulation (August 18, 2013).
  73. 73. Spillover to Foreign Firms Non-UK firms with UK links and high foreign corruption exposure experience higher drop in firm value Image: http://www.transparency.org/cpi2012/results
  74. 74. Foreign firms with high foreign corruption exposure and UK links had 0.19% more negative returns -0.87% -0.19% -0.31% -0.12% -0.19% UK Firms Foreign Firms Foreign Firms with UK Link Foreign Firms without UK Link Zeume, Stefan, Bribes and Firm Value - Evidence from Anti-Bribery Regulation (August 18, 2013).
  75. 75. Median size firms with high corruption exposure experienced US $2.19M more negative loss than firms with low corruption exposure
  76. 76. But what about individual firms and individual bribes...
  77. 77. Method 1: Historical Analysis http://office.microsoft.com/en-us/images/results.aspx?qu=MP900385334
  78. 78. Example: Elf Aquitaine paid $46M in bribes to acquire German oil refinery assets in 1992 At the time the deal was originally announced, Elf earned $327M excess returns (7 X return) with a net benefit of $281M after cost of bribe or an ROI of 6.1 (The bribe was later discovered later and numerous executives received jail terms in 2002-2003) Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012)
  79. 79. 166 actual bribery incidents 107 publically listed firms 20 stock markets 52 countries 36 year time period Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012)
  80. 80. For the 166 bribes studied, the average return was 10.5 x Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012)
  81. 81. 10.5 X 5.5 X All Bribes High-Rank Politicians CAR [-1,+1] relative to initial contract announcements, divided by amount of the bribe. Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012)
  82. 82. But that’s not the end of the story...
  83. 83. Do firms that bribe perform better? http://office.microsoft.com/en-us/images/results.aspx?qu=MP900443251&ex=1
  84. 84. http://office.microsoft.com/en-us/images/results.aspx?qu=reports&ex=1#ai:MP900422411|mt:2|
  85. 85. 2.70% 5.10% 3.20% 0.90% 2.30% 1.40% Year -3 Year -2 Year -1 Year 0 Year +1 Year +2 Year +3 Sales Growth Companies that bribe have greater sales growth compared to control firms Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012)
  86. 86. -1.20% -1.50% -0.90% -0.70% -0.70% -0.60% -0.30% Year -3 Year -2 Year -1 Year 0 Year +1 Year +2 Year +3 ROA Companies that bribe have poorer return on assets (ROA = EBIT divided by total assets) Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012)
  87. 87. -12.10% -11.80% -9.70% -14.20% -10.60% -6.60% -2.40% Year -3 Year -2 Year -1 Year 0 Year +1 Year +2 Year +3 Asset Turnover Companies that bribe have poorer asset turnover (sales revenue divided by total assets) Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012)
  88. 88. -0.90% -0.90% -0.50% -0.40% -0.80% 0.00% -0.30% Year -3 Year -2 Year -1 Year 0 Year +1 Year +2 Year +3 Operating profit margin Companies that bribe have poorer operating profit margin compared to control firms (operating profit divided by sales revenue).Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012)
  89. 89. 0.00% -0.50% -0.10% -0.20% -0.40% -1.20% -0.60% Year -3 Year -2 Year -1 Year 0 Year +1 Year +2 Year +3 Net Profit Margin Companies that bribe have poorer net profit margin (net income divided by sales revenue) Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012)
  90. 90. Companies that bribe have poorer cumulative abnormal returns (difference between the sum of the monthly returns for bribing firms versus control firms) -2.90% 0.50% 1.50% 1.60% 0.30% -4.60% -6.80% Year -3 Year -2 Year -1 Year 0 Year +1 Year +2 Year +3 CAR Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide (March 30, 2012)
  91. 91. Bribe-paying firms underperform the market for 3 years before and 3 years after winning the contract (except for sales growth)
  92. 92. Recap
  93. 93. Who Bribes? Well educated, senior-level males in accounting, operations, sales, and executive management Working at companies focused on sales growth Living beyond their means
  94. 94. How much do they pay? The median bribe is $2.5 Million The typical bribe ranges from about 1% to 5% of the project awarded
  95. 95. What benefits do they get? The average bribe returns 10.5 x the bribe amount But the more you pay, the less you get And you generally underperform the market
  96. 96. Discussion Questions
  97. 97. Why?
  98. 98. Why do bribe paying firms underperform? Culture of Corruption Noncompliance Spillover Compromised Internal Controls Short Term Focus Agency Problem Prisoner’s Dilemma
  99. 99. Does Crime Pay?
  100. 100. Acknowledgements
  101. 101. Acknowledgements How Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases Worldwide Cheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, (March 30, 2012). http://ssrn.com/abstract=1772246 Bribes and Firm Value Evidence from Anti-Bribery Regulation Zeume, Stefan, (August 18, 2013). http://ssrn.com/abstract=2179437 Report to the Nations on Occupational Fraud and Abuse Association of Certified Fraud Examiners (2012) http://www.acfe.com/rttn.aspx Microsoft Office Online Images from Microsoft Office Online are used with permission from Microsoft. http://office.microsoft.com/en-us/images/ Flickr Creative Commons Images from Flickr Creative Commons are used under Creative Commons license. http://www.flickr.com/creativecommons/ Other Sources Corporate logos are property of their respective companies. All other sources and images are acknowledged where they appear.
  102. 102. About the Author Eric Pesik Eric Pesik is a frequent speaker on legal and compliance matters and has taught law school and business school in the USA and Singapore. Background Mr. Pesik is currently the Associate General Counsel and Compliance Officer for Seagate Singapore International Headquarters Pte Ltd. He has been a lawyer since 1997 and is a member of the State Bar of California, USA. He is also admitted to the US Court of International Trade in New York and the US Supreme Court in Washington, DC. Other Presentations Many of Mr. Pesik’s presentations are available on SlideShare at: http://www.slideshare.net/ericpesik Disclaimer This work represents the opinions of the author alone, and is not the opinion his employer. Creative Commons Attribution License You are free to share, copy, distribute, and transmit this work; to remix or adapt this work; and to make commercial use of this work, under the condition that you must attribute this work to me (but not in any way that suggests that I endorse you or your use of this work). http://creativecommons.org/licenses/by/3.0/ Each slide contains source attributions and URL; you should obtain the original images from the original sources before reusing. You must comply with any applicable license restrictions imposed by the original source.

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