The Impact of Anti-Bribery Enforcement Actions on Target Firms. Reputation Symposium 2011

Transcription

1 The Impact of Anti-Bribery Enforcement Actions on Target Firms Reputation Symposium 2011 The Centre for Corporate Reputation 16 September 2011 Jonathan M. Karpoff WAMU Chair in Innovation Foster School of Business University of Washington D. Scott Lee Professor of Finance Mays School of Business Texas A&M University Gerald S. Martin Associate Professor of Finance Kogod School of Business American University

2 U.K. Bribery Act of 2010 (implemented July 1, 2011) [T]he world's most draconian anti-corruption legislation The American Lawyer, July 1, 2011 FSA warns firms over anti-corruption rules The Financial Services Authority (FSA) has announced that although it does not enforce the Bribery Act, it can still take regulatory action against firms who fail to adequately address corruption risk. Financial Times, September 12, 2011 July 2011: The FSA fines Willis Ltd. 7m for inadequate antibribery and corruption controls failings Impacts of anti-bribery enforcement 2

3 Anti-bribery efforts worldwide From Trace International s Global Enforcement Report 2011 Impacts of anti-bribery enforcement 3

4 U.S. anti-bribery enforcement actions on the rise (1978 through June 2011) Total = 109 (excludes 44 actions not involving publicly traded firms) Impacts of anti-bribery enforcement 4

5 Our questions How costly is it to be targeted for bribery enforcement? What is the nature of the cost? Fines and penalties? Investigation expenses? Lost bribing business? A general loss in reputation? Impacts of anti-bribery enforcement 5

6 In one corner The U.S. Chamber of Commerce The current FCPA enforcement environment has been costly to business. Businesses enmeshed in a full-blown FCPA investigation conducted by the U.S. government have and will continue to spend enormous sums on legal fees, forensic accounting, and other investigative costs before they are even confronted with a fine or penalty, which can range into the tens or hundreds of millions. Even a single incident [of an FCPA bribery charge] can lead to irreparable economic hardship and reputational damage that may adversely affect the overall stability and competitiveness of any business. Pricewaterhouse Coopers Impacts of anti-bribery enforcement 6

7 In the other corner Enforcement advocates [T]he puny size of the penalties [for bribery] could provide an incentive for managers to stretch the rules. Fortune magazine, August 2009 Bribery enforcement is now a top public policy priority. U.S. Department of Justice and the FBI New, large penalties in high-profile cases Siemens ($800 million in penalties) Impacts of anti-bribery enforcement 7

8 Why is this important? For firms: An optimal investment problem: How much should a firm invest in antibribery compliance and control activities? A large FCPA compliance consulting sector stands eager to help For public policy: Should the costs be large? Should we rely on legal penalties or reputational losses to impose any costs? For regulators, an enforcement puzzle: Are there reputational costs? I.e., are the costs of bribery enforcement more like financial misconduct or environmental violations? If reputational loss are small, then deterrence depends on legal and regulatory actions. Impacts of anti-bribery enforcement 8

9 When it comes to reputation Is bribery more like: Financial misrepresentation and consumer fraud? Or environmental violations? Occasionally significant legal penalties Occasionally significant legal penalties Large reputational impacts on the firm s operations Small impact on ongoing operations Impacts of anti-bribery enforcement 9

10 An aside on reputation Reputation can refer to others perceptions, the absence of stigma, high quality, admirable qualities, etc. I mean none of those things. Reputational capital is the present value of the quasi-rents earned because of favorable terms offered by customers, suppliers, employees, and investors when they trust that you will not act opportunistically in ways that are costly for them. Impacts of anti-bribery enforcement 10

11 More on reputation Reputational capital is an asset, just like the company s physical plant and people. Reputational capital is created by investment, just like a building is created by investment. The value of a firm s reputational capital is affected by random events, good and bad luck, and things outside its control (just like a building s value). A damaged reputation can be repaired it s a present value problem. Sometimes it is worth the investment (Tylenol) and sometimes not (Arthur Andersen). Impacts of anti-bribery enforcement 11

12 Even more on reputation Examples: Does Walmart have a lot of reputational capital? How about McDonalds? Does a used car dealer of luxury cars necessarily have a lot of reputational capital? Impacts of anti-bribery enforcement 12

13 Our sample All 109 enforcement actions for bribery since the FCPA was passed, 1978 June 2011 All SEC and DOJ releases Factiva, Lexis-Nexis news searches Double-check with DOJ employees Impacts of anti-bribery enforcement 13

14 What constitutes an enforcement action? Impacts of anti-bribery enforcement 14

15 United States v. Faro Technologies Inc. (2008) Sells portable computerized measurement devices and software Beginning in 2005, Faro s subsidiary paid $533,163 to managers of China state-controlled firms to obtain sales contracts worth $4.9 million. In June 2008 Faro agreed with DOJ and SEC to: $1.1 million criminal penalty $1.4 million disgorgement Prejudgment interest of $439,637 Retain an independent compliance monitor Impacts of anti-bribery enforcement 15

16 Other DOJ and SEC bribery actions BAE Systems PLC (2010) Paid 135,000,000 to Saudi officials for defense contracts Kellogg Brown & Root LLC (2009) Paid $180 million to Nigerian officials for business worth $6 billion Westinghouse Air Brake Technologies Corp. (2008) Paid $170,542 to officials of the Indian Railway Board Chevron Corp. (2007) Paid $20 million in kickbacks during the Iraq food-for-oil program Impacts of anti-bribery enforcement 16

17 Who gets charged? Large manufacturing firms Impacts of anti-bribery enforcement 17

18 Why do firms pay bribes? Impacts of anti-bribery enforcement 18

19 How large are the bribes? What are the expected benefits to bribe payers? Fuzzy concept, frequently not the NPV Impacts of anti-bribery enforcement 19

20 Where are the bribes paid? China (n=24) Iraq (n=26) Nigeria (n=30) Impacts of anti-bribery enforcement 20

21 Market value losses Impacts of anti-bribery enforcement 21

22 What accounts for the losses? 1. Confounding news/associated charges 2. Fines and penalties 3. Investigation costs 4. Lost bribe-related business 5. Reputational losses Impacts of anti-bribery enforcement 22

23 1. Effect of simultaneous fraud charges The largest hits involve financial fraud Impacts of anti-bribery enforcement 23

24 2. Fines and penalties imposed in bribery enforcement actions Impacts of anti-bribery enforcement 24

25 3. Investigation and legal expenses Impacts of anti-bribery enforcement 25

26 5. Is there much of a reputation loss? Impacts of anti-bribery enforcement 26

27 What determines cross-sectional differences in market value losses? Impacts of anti-bribery enforcement 27

28 Summary 1. Bribery charges are associated with a relatively small but significant loss in market value 2. Why? 1. Confounding news/associated charges - Yes 2. Fines and penalties - Yes 3. Investigation costs - Yes 4. Lost bribe-related business - Yes 5. Reputational losses No Indirect costs do not matter, on avg. Direct costs matter, and more than explain the market value losses Impacts of anti-bribery enforcement 28

29 What does this mean? The costs of bribery enforcement actions on the target firm: Sometimes involve large fines and penalties Occasionally involve criminal penalties Include hefty investigation expenses But otherwise do not affect the firm s ongoing operations or costs of capital, i.e., there is no loss in reputational capital. That is, bribery enforcement costs are more like the costs of an environmental violation than the costs of being caught defrauding consumers or investors. Impacts of anti-bribery enforcement 29