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.

Credit: Lincoln Agnew

Rose Jacobs | May 20, 2019

In the oil, gas, and mining industries, the temptation to pay a bribe can be strong. 

Multinational companies that dominate these industries typically agree to pay host countries for the extraction of natural resources, which involves acquiring licenses and setting up agreements that specify the terms of the process and any payments to the host country, including royalties, license fees, and bonuses. 

But each company strikes its own deal with a host country, so why not just pay a bribe in exchange for a more favorable agreement? Some might see it as necessary grease in the wheels of business, the price of getting work done in countries where regulation is lax and bureaucracy the law.

However, research suggests that avoiding bribes might be a good thing—and not just because businesses could get caught and might have to pay fines, such as the $1.78 billion in penalties Brazilian oil-and-gas company Petrobras agreed to pay last year. 

Starting in 2013, the European Union and Canada established rules meant to crack down on corruption in the extractive industries, requiring detailed disclosures meant to give activists and other watchdogs the ability to spot signs that corruption may have taken place. Analyzing data in the wake of the anti-corruption measures, researchers find that companies forced to increase their disclosures also increased their official payments to foreign governments, potentially making more money available to the local communities. This and other research studies are revealing that cracking down on corruption can benefit some companies and even spur economic growth—while providing a clearer understanding of the best ways to design and enforce anticorruption measures.

The onerous costs of corruption 

Academics have debated for decades whether corruption hampers economic development. In the 1960s through the ’80s, one popular notion was that corruption played a positive role, at least in the developing world. Economists such as Columbia’s Nathaniel H. Leff and political scientists such as the late Samuel P. Huntington of Harvard argued that bribes serve as a means of skirting inefficient bureaucracy, and help to promote economic growth and its many benefits.

In the 1990s and ’00s, however, analyses from researchers including Paolo Mauro (now at the International Monetary Fund) and Daniel Kaufmann (now at the Natural Resource Governance Institute) began to indicate that corruption tends to undermine government accountability and reduce economic development. 

Over time, this has become the more commonly held position among academics. Boston University’s Raymond Fisman and Stockholm University’s Jakob Svensson argue that bribery is associated with more-anemic company-level growth. And MIT’s Benjamin Olken finds that corruption’s costs can be so onerous as to undermine government antipoverty programs. 

African countries have lost more than $1 trillion in official payments since the 1970s through bribery of government officials, abusive transfer pricing that sold off resources at an unfairly low price, tax evasion, and other illicit practices, according to a 2015 United Nations Economic Commission for Africa report. That $1 trillion roughly equals the amount of development aid that Africa has received over the same period. More than 75 percent of those lost payments can be attributed to the activities of oil, gas, and mining companies, and in some cases, the payment losses arising from the behavior of those multinational businesses reached up to 20 percent of an African country’s annual GDP. 

How companies respond to crackdowns

Anti-corruption measures could change these troubling patterns, research indicates. 

Chicago Booth’s Hans B. Christensen, Mark G. Maffett, and Thomas Rauter looked at the effects of stepped-up enforcement in the mid-2000s, when 45 cooperating countries agreed as part of the Organisation for Economic Co-operation and Development’s Anti-Bribery Convention to join forces in the global enforcement of anti-corruption regulation. The Anti-Bribery Convention requires regulators and enforcement agencies in signatory countries to cooperate with each other, which makes corporate documents more widely available to regulators and facilitates prosecutions. Given US regulators’ superior resources and political impetus to pursue cross-border enforcement cases, the US Foreign Corrupt Practices Act is the most frequently used basis for prosecution. For companies that are under US legal jurisdiction, the FCPA treats bribing foreign public officials as a crime and requires companies to have internal controls and recordkeeping systems in place to be able to detect such bribes.

Critics have argued that the FCPA puts US companies at a competitive disadvantage and have expressed concern that the policy affects companies and people who, as foreign entities and citizens, have little recourse against US law. However, the research findings indicate that the increased enforcement—the result of countries cooperating to enforce the US law—didn’t hurt US companies relative to their foreign competitors from other OECD countries. 

Targeting companies’ bribery practices

After dozens of countries pledged to support a US anti-corruption law, authorities had more success enforcing it.

As a result of stepped-up enforcement, affected companies sharply pulled back on capital spending in corrupt countries, as defined by the Corruption Perceptions Index of the nongovernmental organization Transparency International. On average, companies subject to foreign corruption regulation reduced their foreign direct investment in a corrupt country by 33 percent. And corrupt countries saw less foreign direct investment overall, as the decreases weren’t offset by increases from companies not subject to the regulation.

Moreover, the stricter enforcement of foreign corruption regulation led both US and non-US companies to exercise more caution when investing in corrupt countries, the researchers find. Companies took longer to evaluate deals and were more likely to hire as their mergers-and-acquisitions adviser a reputable accounting firm, defined as one of the Big Four—Deloitte, Ernst & Young, KPMG, and PwC—plus Arthur Andersen, which closed its auditing operations during the time period covered by the study. US companies were not disproportionately affected by the enforcement.

Does the decline in foreign direct investment hurt a country’s economic growth on balance? This is tougher to parse. On one hand, a decrease in foreign direct investment probably does reduce economic growth on its own. On the other hand, previous research suggests that corruption can make resource allocation less efficient, reinforce political regimes that exploit host countries’ citizens, and concentrate wealth and power in a few hands—factors that hurt economic development.  

Coordinated action works best

The crackdown Christensen, Maffett, and Rauter studied was a multicountry effort. Other research suggests that these types of coordinated actions are more effective than unilateral ones. 

Though the United States, the European Union, and Canada all set out to crack down on corruption in the oil, gas, and mining industries, only the EU and Canada began enforcing their legislation, while the US delayed implementation. In February 2017, Congress effectively struck down the US reporting rules, the first in a series of Obama-era laws overturned by President Donald Trump during his first year in office. US industry lobbyists celebrated the repeal, while anticorruption nongovernmental organizations condemned it.

Because the Canadian and EU disclosure laws took effect at different points in time, Booth’s Rauter was able to measure how the increased transparency affected companies’ behavior, without worrying about the effects of the wider economy or other contemporaneous but unrelated events.

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.