Updating the Corporate Playbook For Global Corruption

Multinationals need to adjust strategies to match the type of corruption they’ll face
By: 
Alan Morantz
Fraudulent people in trenchcoats passing money in a briefcase.

The essentials

• High levels of corruption in a country influences the foreign direct investment decisions of multinationals.

• In countries with pervasive “grand corruption”, multinationals prefer to partner with local firms. Where “petty corruption” is the larger issue, they prefer a partner from their own country.

• Multinationals are more inclined to partner with a local firm when they enter a country noted for public-sector corruption. They will set up a wholly-owned subsidiary when concerned about business-to-business corruption.

• Firms able to survive in highly corrupt countries tend to keep a higher level of equity in their foreign direct investment.

Most executives in a multinational’s far-flung operations eventually acquire a lexicon of coded terms: “little carps” (in Prague), “tea for the elders” (in Nairobi), “beans for the kids” (in Kinshasa), “oiling money” (in Budapest). These quaint phrases are euphemisms for bribery, influence peddling and other forms of corruption. They are also entryways to a vast hidden economy, representing, by one estimate, five per cent of the global gross domestic product.

Plenty of people rationalize away corruption. Some scholars even argue that corruption greases the wheels of income growth, that it can help firms overcome burdensome government regulations and work around intransigent bureaucrats. But make no mistake: The scourge of corruption manifests in low levels of education, public health and environmental protection and high levels of endemic poverty in any country where it runs rampant. 

Globetrotting corporations know all this. They know that NGOs and law enforcement—including the RCMP here in Canada—aim to bring them to account for dabbling in graft. But for multinationals hungry for new markets, it’s not always simple to ignore an emerging market with a dodgy reputation. In the 1990s, General Electric, for example, took the high road by adopting high ethical standards and abandoned some countries. Competitors were happy to take the low road and fill the vacuum GE left.

Reducing uncertainty

For firms willing to invest in countries with rampant corruption, the question becomes: How best to reduce the uncertainty of dealing with people and institutions that cannot be trusted, the same people and institutions that issue procurement contracts, set regulations and approve licences? 

According to new research, one way to deal with such uncertainty is found in how firms choose to set up in another country and use their equity: as a partner in a joint venture or as the sole owner of a subsidiary. 

Business researchers have struggled to understand how a country’s corruption influences foreign direct investment decisions of multinationals. To Michael Sartor, this is an intriguing puzzle in an area of personal interest. Before entering academia, Sartor, now Distinguished Faculty Fellow of International Business at Smith School of Business, was an executive in the foreign subsidiary operations of a multinational.

While working on his doctorate some eight years ago, Sartor decided to tackle this puzzle head-on. He got his hands on a rich set of data on the foreign subsidiary investment activity of multinationals for the past 25 years. He quickly found that earlier researchers adopted an overly broad view of corruption. Sartor found distinct types of government corruption that differ from private corruption. “I discovered that these disparate types of corruption were exerting distinctly different impacts on foreign investment behaviour,” Sartor says.

Petty versus grand corruption

Several studies later, a new story has emerged. For one thing, Sartor found that two types of corruption—“petty” and “grand”—present different challenges to multinationals. Petty corruption—colloquially known as “facilitation payments” or “speed money”—are the small payments to low-level administrators to speed up a process, get a permit and the like. Grand corruption is generally a big cash contribution to a political party or politician to secure, say, a lucrative contract or get regulatory approval.

This is a key distinction for a multinational making foreign market entry decisions. Will the firm be more exposed to petty corruption from on-the-ground players or grand corruption from state-level actors?

Sartor and his co-author found that in a foreign country where grand corruption is pervasive, multinationals prefer to partner with local firms. That’s because a local partner can shield a foreign subsidiary from the arbitrary actions of political leaders or senior functionaries.

But when petty corruption is the more pressing issue, multinationals prefer to partner with a firm from their own country. It boils down to trust. Research shows that pervasive petty corruption erodes social trust. This, in turn, pushes community members—multinationals in this case—towards relationships that offer in-group trust. A partner from back home provides such reassurance.

Business-to-business corruption

In another study, Sartor and his co-author took aim at private-sector corruption. Examples include commercial bribery, kickbacks, corporate fraud, collusion and insider trading. How would a multinational’s entry strategy look if seen not as a response to grand versus petty corruption but to public- versus private-sector corruption?

In this case, they found that multinationals prefer to have a local equity partner when they enter a country in which corruption is mostly a government problem. Here’s why: A local partner can reduce or eliminate the need for the multinational to interact with the government directly. It can also teach the foreign firm how to avoid more corrupt government agents.

But in countries where private corruption predominates, “you’re going to prefer to avoid a partner in the foreign market,” says Sartor. “Multinationals are increasingly worried about opportunistic behaviour in their relationships with suppliers and potential partners.” Such partners generally focus on their own interests at the expense of collaboration. A wholly-owned subsidiary gives a foreign firm maximum control to limit exposure to these stakeholders.

How to survive

Knowing how corporate entry strategy adapts to the types of corruption in foreign markets is certainly useful. Perhaps even more useful is what can be learned from foreign-investing firms that operate successfully in such challenging environments.

Firms new to foreign direct investing are generally given two pieces of advice: One, if you enter into a joint venture with one or more local firms, take only a small equity share to mitigate hazards and minimize potential exit costs. And two, if you establish a subsidiary, deploy expatriate managers who have strong ties to the home office and who know how to protect the firm’s interests abroad.

Sartor and his co-author sensed this advice would not necessarily be useful in emerging economies with high levels of corruption. Turning again to the data, they found that the bigger the stake the multinational retains in its foreign subsidiary investment, the greater the likelihood the subsidiary will survive. So much for keeping your equity stake low.

The reason is simple: Given restrictive global regulations that prohibit overseas corruption, and the harsh consequences of being caught, it’s important to have as much control over foreign operations as possible. 

“I tell executives that they’re better to retain a higher proportion of equity,” says Sartor, “which is consistent with the behaviour we’ve seen when firms are anticipating high levels of private corruption in foreign markets.”

The other piece of conventional wisdom—to airdrop a cadre of managers from the home office—did not hold up either. Sartor could find no evidence that deploying expatriate employees makes any difference to the survival rate of a multinational operating in a highly corrupt country.

High-stakes investments 

While his studies are ongoing, the evidence that Sartor has already amassed should help business strategists update their playbook for entering emerging markets. The timing is right: He’s heard from many of his executive education participants and consulting clients that, post-pandemic, firms will be eager to speed up their foreign investment plans because their existing business has contracted so sharply. 

Sartor hopes Canadian business people, in particular, take his advice. Canadian firms have been progressively expanding their global footprint. They were responsible for $1.25 trillion in foreign direct investment in 2018

As they venture farther afield, Canadian firms become more exposed to the risks of global corruption. Consider the publicity surrounding the host of multinational construction, defence, transportation and mining companies that have attracted the attention of regulatory authorities. Perhaps because of these high-profile cases, Sartor says he has fielded more questions from executives about corruption.

“I do advise both executive audiences and consulting clients that emerging markets with high levels of corruption can be really, really challenging investment environments,” says Sartor. “Typically these firms are looking at fairly substantial investments. They just cannot afford to not get this right from the start.”

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