Economics of Corruption

Economicsof CorruptionCFO Asia CongressOrchard Parade Hotel8 October 2013 By Eric Roring PesikImage 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-tenImage: Arms Folder by D Planet

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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 Westhttp://www.flickr.com/photos/53133240@N00/2207307656/

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

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

Where are we now?

International Currency by epSos.dehttp://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 http://www.flickr.com/photos/dplanet/94442620/

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/KQH743GKF1Image: We Want You by D Planethttp://www.flickr.com/photos/dplanet/94442625/

20%

40%

40% of companies claim to have lost business to competitors who won contracts unethically


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Who is making money?

Is bribery worth it?

Is it worth the riskof bribing and

getting caught?

Image: http://office.microsoft.com/en-sg/results.aspx?qu=MP900185047

Is it worth bribing andgetting away with it?

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Image: Greed by Liz Westhttp://www.flickr.com/photos/53133240@N00/2207307656/

What is the ROI of bribery?

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

Most bribery statistics comefrom 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

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Image: St Munchins Contract Signing 60 by St Munchin's Collegehttp://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 companyperformance when bribing and getting away with it


Method 2:Efficient Markets Analysis


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

Who bribes?

1,388 fraud cases100 countries6 continents2 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

Pressure

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

LivingBeyond Means

FinancialDifficulties

Control Issues, Unwillingness to

Share Duties

Unusually Close withVendor/Customer

Wheeler-DealerAttitude

AssetMisappropriation

Corruption

Financial Statement Fraud

ACFE Report to the Nations on Occupational Fraud and Abuse (2012) Top 5 Behavioural Red-Flags

Never a 1:1 relationship

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%

LegalInternal Audit

Research and DevelopmentMarketing/Public Relations

Human ResourcesBoard of Directors

Manufacturing and ProductionInformation Technology

FinanceWarehousing/Inventory

PurchasingOther

Customer ServiceExecutive/Upper Management

SalesOperationsAccounting

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

Male65%

Female35%

ACFE Report to the Nations on Occupational Fraud and Abuse (2012)

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 PerpetratorsACFE Report to the Nations on Occupational Fraud and Abuse (2012)

Tenure of PerpetratorsACFE 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 PerpetratorsACFE 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

Who bribes?

http://office microsoft com/en-us/images/results aspx?qu=MP900408932

*Except in Canada

Image: Portrait of a businesswoman by Victor1558http://www.flickr.com/photos/76029035@N02/6829334723/

The average personcurrently in prison for FCPA violations is58 years old

How much do they pay?

166 historical bribery incidents 107 publically listed firms20 stock markets52 countries36 year time period


Median bribe amount


Image: http://office.microsoft.comus/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

OfficialCheung, 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)


What benefits do they get?

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 CorleonePrequel to Mario Puzo'sThe Godfather

“

Method 2:Efficient Markets Analysis


UK Bribery Act 2010Exogenous 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 CapEvent 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 CapZeume, Stefan, Bribes and Firm Value - Evidence from Anti-Bribery Regulation (August 18, 2013).

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%

BaselineLow Foreign

Corruption ExposureHigh 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 FirmsForeign 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 incidents107 publically listed firms20 stock markets52 countries36 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 greatersales 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 marketfor 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, andexecutive 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 fromabout 1% to 5% of the project awarded

What benefits do they get?

The average bribe returns10.5 x the bribe amount

But the more you pay, the less you get

And you generally underperform the market

Discussion Questions

Why do bribe paying firms underperform?

Culture of CorruptionNoncompliance SpilloverCompromised Internal ControlsShort Term FocusAgency ProblemPrisoner’s Dilemma

Does Crime Pay?

Acknowledgements

AcknowledgementsHow Much do Firms Pay as Bribes and What Benefits do They Get? Evidence from Corruption Cases WorldwideCheung, Stephen Yan-Leung, Rau, Raghavendra and Stouraitis, Aris, (March 30, 2012). http://ssrn.com/abstract=1772246

Bribes and Firm ValueEvidence from Anti-Bribery Regulation Zeume, Stefan, (August 18, 2013). http://ssrn.com/abstract=2179437

Report to the Nations on Occupational Fraud and AbuseAssociation of Certified Fraud Examiners (2012)http://www.acfe.com/rttn.aspx

Microsoft Office OnlineImages from Microsoft Office Online are used with permission from Microsoft. http://office.microsoft.com/en-us/images/

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Other SourcesCorporate logos are property of their respective companies. All other sources and images are acknowledged where they appear.

About the AuthorEric 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.

BackgroundMr. 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 PresentationsMany of Mr. Pesik’s presentations are available on SlideShare at: http://www.slideshare.net/ericpesik

DisclaimerThis work represents the opinions of the author alone, and is not the opinion his employer.

Creative Commons Attribution LicenseYou 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/

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Economics of Corruption

Business

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