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Yielding to corruption abroad boosts companies' local sales but not its profits, new research finds
After a year in which U.S. Department of Justice prosecutions for foreign corrupt business practices fell to their lowest level in nearly a decade, the department is vowing to step up the pace in 2016. And corporate managers who take this pledge seriously will have additional reason to intensify anticorruption efforts as a result of new research in a leading accounting publication.
The research in the current issue of the American Accounting Association journal The Accounting Review takes advantage of unique access to confidential anticorruption ratings of companies to assess whether bribery pays off for firms in parts of the world where it is rife. And it finds that, while going along with corruption does substantially boost local sales, its overall effect on a company's financial strength is nil even as it risks triggering media exposure damaging to the firm and its executives.
According to the study by George Serafeim and Paul M. Healy of Harvard Business School, "Weaker corruption controls and enforcement allow...firms to generate higher sales growth in high-corruption markets. Yet, bribes are costly...The low returns on equity on incremental sales in high-corruption markets for [bribery-practicing] firms imply that these costs are not fully recovered through higher prices on corrupt contracts or though scale economies from increased sales."
Thus, in a sample of 480 large multinationals from 32 countries, firms with strong anti-corruption programs had average sales growth over three years of 2.6% in high-bribery countries or regions, far below the 14.1% achieved by anticorruption laggards. Yet, this did not translate into a greater gain in companies' return on equity in the latter group compared to firms in the former. In the words of the study, "on average the sales growth and ROE effects are offsetting."
Comments Prof. Serafeim: "While the evidence for and against yielding to local bribery practices has been mixed, the conventional wisdom among corporate managers has continued to be that in large parts of the world there really isn’t much choice, a view strengthened by the fact that managerial compensation abroad is commonly based on growth in sales. Yes, our study does reveal that yielding to local corruption does boost area sales, but our findings should raise red flags even for managers whose actions are dictated by narrow self-interest, since we find these practices lead to increased likelihood of subsequent media exposure potentially damaging to companies and individuals alike."
Thus does the study find that firms with low ratings for anti-corruption probity are significantly more likely to be called out for corruption in the news media than companies that are highly rated. Companies one standard deviation above the mean in diligence (roughly those in the top 10 or 20% in this regard) were 15 to 20% less likely than firms of average diligence to be cited in news stories for corruption, bribery or financial crime. The difference could be quite considerable: over the course of three years covered by the study, half the companies in the sample were not cited at all in this way, while 25% were cited in more than five articles.
In carrying out the research, Profs. Serafeim and Healy had access to ratings of company anticorruption efforts compiled by Transparency International (TI), a non-profit organization that garners data from individual firms but restricts itself in its published materials to country ratings and other aggregate information. TI's company ratings, which the professors are pledged to keep confidential, are based on corporate self-reporting on 14 indicators of anti-corruption strategy, policy, and management systems. Given the possibility that this self-reporting can consist of boilerplate or what the professors call "cheap talk," Serafeim and Healy developed their own ratings based on TI's estimates and many factors that research has found to be associated with anti-corruption efforts, including (1) those related to regulatory monitoring and enforcement – for example, the level of enforcement in a company's home country or whether a non-U.S. firm is cross-listed in the U.S.; (2) those related to corruption risks – such as bribery prevalence in different industries or in companies' home countries; and (3) those related to company governance – such as the percent of independent directors.
With anticorruption ratings in hand, the professors proceeded to analyze the relationship of individual companies' ratings in a single year to two principal developments over the course of the next three years – sales growth in areas with high and low prevalence of bribery and appearance of media stories alleging corruption. They found no significant relationship between anticorruption ratings and sales growth in low-bribery countries or regions, but, as indicated above, did find a strong relationship in areas with high prevalence, with lower-rated companies experiencing greater local sales increases but not greater overall return on equity. As previously indicated, too, low-rated firms proved at particular risk of being called out for corruption by news and business media.
In a finding that should gratify Transparency International, the professors conclude that TI’s ratings, based on company self-reporting though they are, reflect true anticorruption commitment. In the words of the study, "In terms of the question whether self-reported anticorruption efforts reflect a genuine commitment to combat corruption or are merely cheap talk...our findings are more consistent with disclosures’ reflecting firms' actual anticorruption efforts rather than cheap talk."
Adds Prof. Serafeim, "This conclusion ought to be of interest to investors, because, even though TI's company ratings are confidential, they are largely derived from data that are available to the public — namely, information on management and compliance practices contained in company financial statements and sustainability reports. Our findings suggest investors would do well to attend to that information."
The new study, entitled “An Analysis of Firms' Self-Reported Anticorruption Efforts,” is in the March/April issue of The Accounting Review, published every two months by the American Accounting Association, a worldwide organization devoted to excellence in accounting education, research, and practice. Other journals published by the AAA and its specialty sections include Auditing: A Journal of Practice and Theory, Accounting Horizons, Issues in Accounting Education, Behavioral Research in Accounting, Journal of Management Accounting Research, Journal of Information Systems, and The Journal of the American Taxation Association.