Economics of Corruption

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/

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)

Greed by Liz West

http://office.microsoft.com/en-us/images/results.aspx?qu=MP900422830&ex=1#ai:MP900422830|

Image: Cut your Bills by Images of Money

Image: Chinese Flag by Philip Jägenstedt

The value of a dollar by rahims
http://www.flickr.com/photos/rahims/2110236034/

International Currency by epSos.de
http://www.flickr.com/photos/epsos/8453271596/

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

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
20%

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

Is it worth the risk
of bribing and
getting caught?
Image: http://office.microsoft.com/en-sg/results.aspx?qu=MP900185047

Is it worth bribing and
getting away with it?
Image: Adjust Tie by D Planet

Image: Greed by Liz West

Who bribes?
How much do they pay?
What value do they get?

Most bribery
statistics come
from firms that
got caught
http://office.microsoft.com/en-us/images/results.aspx?qu=handcuffs&ex=2#ai:MP900402864|

Who bribed and
got away with it
http://office.microsoft.com/en-us/images/results.aspx?qu=MP900443285&ex=1

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.

Image: St Munchins Contract Signing 60 by St Munchin's College
http://www.flickr.com/photos/stmunchins/6864640994/

Method 1:
Historical Analysis
http://office.microsoft.com/en-us/images/results.aspx?qu=MP900385334

Use the records of
firms that bribe
and got caught

Don’t look at the
date of revelation
of the bribery
Image: http://office.microsoft.com/en-us/images/results.aspx?qu=MP900414039

Look back to the
time the contract
was awarded

Look at company
performance when
bribing and getting
away with it

Method 2:
Efficient Markets
Analysis
http://office.microsoft.com/en-us/images/results.aspx?qu=MP900385334

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?

Image: http://en.wikipedia.org/wiki/File:Radar_gun.jpg
Suddenly flash
radar into a crowd
of cars

Image: http://en.wikipedia.org/wiki/File:Radar_Detector._canada._Escort_Passport_8500_x50_blue_3635.jpg

Take away the
ability to bribe
and see which
stocks hit the
brakes

1,388 fraud cases
100 countries
6 continents
2 year period
ACFE Report to the Nations on Occupational Fraud and Abuse (2012)

Companies don’t
pay bribes; people
pay bribes
http://office.microsoft.com/en-sg/images/results.aspx?qu=mP900442346

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

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

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

Gender of Perpetrators
Male
65%
Female
35%

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

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

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

*Except in Canada
Image: Portrait of a businesswoman by Victor1558

The average person
currently in prison
for FCPA violations is
58 years old

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)

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

$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

$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

Bribe as percentage
of project awarded:
1.94%
Image: http://www.flickr.com/photos/34728058@N08/4818131438/

4.42%1.22%
Bribe %
Low Rank
Official
Bribe %
High Rank
Official

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
“

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

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).

KPI = Cumulative Abnormal
Returns

-0.06%
-0.87%
-0.05%
CAR [-20;-1] CAR[0;1] CAR[2;20]
$2.43 Trillion Loss in Market Cap

Foreign Corruption
Exposure
Firms that operate
in more corrupt
environments
experience a larger
drop in firm value
Image: http://www.transparency.org/cpi2012/results

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

Other Anti-Bribery
Regulations
Firms that are
already subject to
US anti-bribery
regulations (FCPA)
experience a
smaller drop in
firm value

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

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

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

Median size firms with high
corruption exposure
experienced US $2.19M more
negative loss than firms with
low corruption exposure

But what about individual firms
and individual bribes...

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)

166 actual bribery incidents
107 publically listed firms
20 stock markets
52 countries
36 year time period

For the 166 bribes studied,
the average return was 10.5 x

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.

But that’s not the end of the
story...

Do firms that bribe
perform better?

http://office.microsoft.com/en-us/images/results.aspx?qu=reports&ex=1#ai:MP900422411|mt:2|

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

-1.20%
-1.50%
-0.90%
-0.70% -0.70%
-0.60%
-0.30%
ROA
Companies that bribe have poorer return on assets
(ROA = EBIT divided by total assets)

-12.10% -11.80%
-9.70%
-14.20%
-10.60%
-6.60%
-2.40%
Asset Turnover
Companies that bribe have poorer asset turnover
(sales revenue divided by total assets)

-0.90% -0.90%
-0.50%
-0.40%
-0.80%
0.00%
-0.30%
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)

0.00%
-0.50%
-0.10%
-0.20%
-0.40%
-1.20%
-0.60%
Net Profit Margin
Companies that bribe have poorer net profit margin
(net income divided by sales revenue)

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%
CAR

Bribe-paying firms
underperform the market
for 3 years before and 3 years
after winning the contract
(except for sales growth)

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

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

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

Why do bribe paying firms
underperform?
Culture of Corruption
Noncompliance Spillover
Compromised Internal Controls
Short Term Focus
Agency Problem
Prisoner’s Dilemma

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.

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).
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