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How to Fight Corruption—and Why We Should
Petty corruption was long thought to grease the wheels of business. But economists are learning how much it can hold back some companies and local economies.
- May 20, 2019
- CBR - Corruption
Targeting companies’ bribery practices
After dozens of countries pledged to support a US anti-corruption law, authorities had more success enforcing it.
Rauter examined 343 companies, based mostly in Canada, the United Kingdom, and Norway, that were required to report payments related to resource extraction. (Norway is covered by the regulation as a member of the European Single Market.) Once companies were made to disclose their official payments in more detail, they increased the reported sums they paid foreign governments, presumably because they decreased the amount they’d been paying in bribes, he finds. Their payments increased most significantly in corrupt countries.
However, the regulation also had unintended consequences: disclosing companies reduced their investments because the higher official payments increased their operating costs and lowered their margins. In corrupt countries, regulated companies decreased their investments by a larger amount.
Meanwhile, companies not covered by the disclosure regulation took advantage of the fact that their rivals were subject to higher scrutiny. Before the Canadian and EU laws took effect, resource-extraction companies across the industry displayed consistent investment patterns. After the payment disclosure law, however, Canadian and EU-based energy and mining companies reduced their capital spending in certain host countries—but companies in the US and elsewhere raised theirs.
The findings suggest that anti-corruption measures are more effective when big countries are on board, Rauter says. When global regulation is coordinated, and particularly when the US has signed on to a corruption crackdown, measures seem more effective than when regulation affects only some players in a market.
The private sector also wins
That said, domestic crackdowns can still influence economic growth. Consider Brazil, whose federal government launched an ambitious anti-corruption campaign in 2003 that involved 39 rounds of intensive audits of municipalities, in which it looked for irregularities in procurement contracts, as well as close scrutiny of companies. When the audit results became public, some politicians and bureaucrats lost their jobs. Brazil selected audit targets randomly, which made it possible to measure the causal relationship between corruption and economic growth.
Chicago Booth’s Emanuele Colonnelli says that in theory, given Brazil’s labyrinthine bureaucracy and inefficient regulations, its data should support the “grease-the-wheels” theory of corruption. “It takes several steps to apply for a contract,” he says. “Nobody’s arguing that corruption is good for economic activity in a perfect world, but this is a second-best scenario.”
Yet, Brazilian municipalities that had been subject to audits saw higher levels of economic growth and entrepreneurship over the following five years, as well as better access to financing, according to research by Colonnelli and Del Rosario University’s Mounu Prem. These changes were most pronounced in areas with higher levels of corruption, and in industries—such as retail or construction—most exposed to government corruption. In retail, stationery companies may compete to supply local schools. Construction companies may compete for local government building contracts.
Anti-corruption audits were good for most companies, including those directly affected by bribery and corruption in the first place, Colonnelli and Prem argue. Postcrackdown, some of these companies continued to win contracts on their own merits, without having to pay the extra bribery costs. The researchers conclude that the crackdown resulted in a positive net impact on corporate performance, as measured by employment, revenues, and investment level.
“A lot of research focuses on corruption’s effects on the public sector,” says Colonnelli. “But it affects the private sector, too, and here we’ve looked at that and found it’s bad for the private sector.”
The findings that corruption crackdowns help private companies differ from Rauter’s research suggesting that crackdowns hurt resource-extraction companies. One key difference may be the size of the companies involved. Rauter studied large multinational companies, which often are able to dictate the price and benefit of their bribes and make relatively small illicit payments to secure a contract on excellent terms. Colonnelli and Prem, by contrast, studied companies that had an average of just 32 employees. In the small and midsize Brazilian cities where these companies operate, local government officials tend to have tight control over the private sector and can demand relatively large payments for limited concessions, shrinking companies’ margins.
Companies respond to shaming
If research is collectively revealing the reasons to crack down on corruption, Rauter’s study of large resource-extraction companies is also making the case that activists can make anti-corruption measures more effective.
Activists can use anomalies in payment records as fuel for shaming companies—just as the NGO Global Witness did when it launched a campaign against Shell for allegedly bribing Nigerian government officials to gain access to an offshore oil field. Companies that were the targets of activist campaigns or the focus of media attention in the past, or sold products directly to consumers, responded most to the payment reporting rules. These companies, vulnerable to shaming, increased their payments and decreased their investments more than otherwise similar companies.
The work of activists can thus feed off of itself. Case in point: when the US government vacillated between 2010 and 2015 over adopting the payment disclosure rules, investors took note. Share prices of oil and gas companies indicated that investors expected the rules to be most onerous for companies with higher reputational risk, according to Katharina Hombach of the Frankfurt School of Finance & Management and Ludwig Maximilian University of Munich’s Thorsten Sellhorn. Similarly, on the day the UK passed what later became the Bribery Act 2010, stock prices fell for companies doing business in high-corruption countries, finds research from University of Illinois’s Stefan Zeume.
Sellhorn says that while it’s tough to find nuance and causal relationships in stock prices, the researchers supplemented their data with interviews, “and what’s clear is that disclosure rules allow a much greater role for public pressure groups,” which investors view as increasing the reputational risk for companies that are especially vulnerable to activism campaigns.
While corruption crackdowns appear to produce broad benefits for businesses and economies, company executives complain when they are unevenly enforced. One side effect of crackdowns that target bigger international companies might well be an unfair playing ground for companies based in Europe, Canada, or, in some cases, the US, compared with companies from China or other unregulated markets. Similarly, while consumers generally lend support to public-shaming campaigns and anti-corruption regulations, they might feel differently if they were to experience rising global prices for gas, electricity, jewelry, or cell phones. Whether they could stomach that change would be determined not in the research lab, but at the polls.
- Hans B. Christensen, Mark G. Maffett, and Thomas Rauter, “Policeman for the World: US Enforcement of Foreign Corruption Regulation and Corporate Investment Policies,” Working paper, March 2019.
- Emanuele Colonnelli and Mounu Prem, “Corruption and Firms: Evidence from Randomized Audits in Brazil,” Working paper, November 2017.
- Raymond Fisman and Jakob Svensson, “Are Corruption and Taxation Really Harmful to Growth? Firm Level Evidence,” Journal of Development Economics, May 2007.
- Katharina Hombach and Thorsten Sellhorn, “Firm Value Effects of Targeted Disclosure Regulation: The Role of Reputational Costs,” Working paper, June 2018.
- Samuel P. Huntington, Political Order in Changing Societies, New Haven: Yale University Press, 1968.
- Daniel Kaufmann, “Corruption: The Facts,” Foreign Policy, Summer 1997.
- Nathaniel H. Leff, “Economic Development through Bureaucratic Corruption,” American Behavioral Scientist, November 1964.
- Paolo Mauro, “Corruption and Growth,” Quarterly Journal of Economics, August 1995.
- Benjamin Olken, “Corruption and the Costs of Redistribution: Micro Evidence from Indonesia,” Journal of Public Economics, May 2006.
- Thomas Rauter, “Disclosure Regulation, Corruption, and Investment: Evidence from Natural Resource Extraction,” Working paper, February 2019.
- Stefan Zeume, “Bribes and Firm Value,” Review of Financial Studies, May 2017.
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