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    Corrupting Silence: Companies Must Speak Up Against Bribes
    24 Nov 2014Research & Ideas

    Corrupting Silence: Companies Must Speak Up Against Bribes

    by Michael Blanding
    Does corruption really pay? Paul Healy finds that corruption may not be as lucrative—or as unavoidable—as it may seem.
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    In a 2012 Harvard Business School case on corruption at German conglomerate Siemens AG, Peter Solmssen —brought in to clean house —reflects on how people approach a business bribe.

    "The stupid ones say, very simply, what are you going to do for me?" says Solmssen, managing board member and general counsel. "Sometimes they'll be a little more subtle and say, 'My wife's going to be in Hong Kong next week, and she's going shopping.' Either you say, 'That's nice,' and you pass on, or you say, 'What store is she going to, and can I give you an account number?' "

    In 2006, Siemens rocked the business world with revelations it had been paying bribes for contracts on a massive scale—eventually admitting to payouts in 60 percent of its markets, totaling $130 million to $275 million a year. Shopping trips to Hong Kong were the least of it. For bigger ticket items, Solmssen says in the case, "you get a call from a consultant who knows all about your impending bid and offers to help. The clear message is you are not going to win unless you use me."

    “The thing that struck me is how little information there is on corruption because no one wants to talk about it”

    When he heard about the Siemens troubles, HBS's Paul M. Healy, the James R. Williston Professor and Senior Associate Dean for Research, saw a unique opportunity to examine an elephant in the room in the business world.

    The United Nations estimates that roughly a trillion dollars in bribes is paid annually worldwide. This increases the cost of investment in developing countries by at least 20 percent. And yet, companies are mostly silent on the subject.

    "The thing that struck me is how little information there is on corruption because no one wants to talk about it," says Healy, author of the multimedia case Fighting Corruption at Siemens. "In part, that's because it's illegal—no one wants to admit they were breaking the law."

    But there is also another unspoken reason for the silence, he says: the sense that it is just the cost of doing business, a necessary evil that must be borne if companies want to seriously contend for contracts in developing countries where the rule of law isn't as well enforced.

    In both anecdotal and empirical research, however, Healy has found that corruption may not be as necessary as it is perceived to be. In fact, at the end of the day, bribes may hurt a company's bottom line—and not just after being caught.

    The Cost Of Doing Business

    Siemens had moved aggressively into developing countries following World War II, when a German company was persona non grata to most of the Western world. Paying bribes to officials in a country became a regular business practice, firmly entrenched in corporate culture— and not against the law in Germany until 1999. The competitive environment and permissive culture both played a role in the future bribery scandal.

    "There are three elements that lead individuals in companies to get involved in corruption," says Healy. "First, they feel strong pressure to perform. Second, internal controls within their companies are not that strong. And finally, their companies allow them to rationalize their behavior." Even after the scandal broke, the mid-level Siemens executive who oversaw the bribes, Reinhard Siekaczek, justified them saying, "We did it for the company. It was about keeping the business unit alive and not jeopardizing thousands of jobs overnight."

    A financial analysis of the return on such contracts called those beliefs into question. "After completing a thorough audit to identify transactions where bribes occurred, Siemens discovered that many of these problem contracts were not very profitable," says Healy.

    The results were more stark for Montreal-based engineering and construction firm SNC-Lavalin, which Healy is researching for an upcoming case study. In a well-publicized incident, SNC-Lavalin allegedly paid a $22.5 million bribe to secure the $1.3 billion contract to construct the McGill University Health Centre in Montreal. The company billed the Quebec government for $191 million in cost overruns, for which it is unlikely to be reimbursed. In other contracts in North Africa, the SNC-Lavalin is struggling to stay in the black.

    "They underestimated the risk associated with paying bribes, but they also overestimated what they were going to make on profits," says Healy. "Most companies don't have the luxury of going back and saying what was the profitability of corrupt contracts versus contracts that were clean."

    In research conducted with HBS Jakurski Family Associate Professor George Serafeim, Healy found evidence supporting this trend more broadly. In a working paper published this year, the researchers reported that firms' reported anticorruption efforts generally matched up with independent assessments of corruption such as enforcement actions, independent directors, and more rigorous auditing.

    Furthermore, relative to firms with high anticorruption rankings, firms with low rankings had higher sales growth in regions associated with corruption—meaning they were more likely to receive contracts in those areas. However, those incremental sales were offset by lower margins and return on equity, negating the benefits of those higher sales.

    "This evidence suggests that multinationals that tolerate corruption are able to grow their business and get contracts in corrupt countries. But it appears that those contracts are less profitable," says Healy.

    A Necessary Evil?

    The experiences of Siemens and SNC-Lavalin also calls into question the assumption that bribery is a necessary practice in dealing in developing markets, says Healy. Despite cleaning up their acts, the companies have continued doing business in countries around the world, including those where they have paid bribes in the past. "Both companies acknowledge that there is clean business and dirty business in every country," says Healy. "Given their new tough stance on corruption, there are some contracts they can't go after, but there is still plenty of clean business they can."

    Their experience is supported by companies including GE, Statoil, and Fluor that have drawn a bright line internally against paying to play in foreign countries and that continue to operate successfully in countries where corruption is a problem. Of course, it makes it easier that those companies are industry leaders with unique products customers want regardless of any inducements, says Healy. But he suspects another factor is also at work.

    "People know they are not going to pay, and so eventually they stop asking," says Healy. "As Siemens's general counsel told me, 'Once you start paying bribes, you are committed.' You can never look back."

    The experiences of Siemens and SNC-Lavalin show that the first step toward changing that outward reputation, says Healy, is changing the internal culture. "Both companies have worked hard to change the tone at the top. It's harder to rationalize corruption if you are receiving a consistent message that we don't do this."

    In the wake of the bribery scandal, Siemens eventually paid $1.6 billion in fines to United States and European authorities. But it has also spent over $800 million on internal investigations, dismissed its CEO, fired some 500 employees, and offered amnesty to workers willing to come forward with details of corruption. SNC-Lavalin, too, has fired its CEO and is currently investigating other executives.

    Along with the change in tone must also come a change in practices, says Healy, including a tightening of internal controls regarding payments to business partners, a common way to launder bribes to officials. In the case of Siemens, the company changed its policy to require all partner contracts to undergo an approval process with oversight by compliance.

    The good news on corruption is that private citizens are coming forward as never before to expose corrupt practices—posting evidence of bribes paid through web-based platforms such as RosPil in Russia and I Paid a Bribe in India. "It's harder to conceal when you have cell phones and social media offering more ways of tracing and communicating such activities," says Healy. (He wrote an article article on such initiatives in the Harvard Business Review with HBS Associate Professor Karthik Ramanna.)

    If the most egregious forms of corruption are going to be rooted out, however, it will take more than citizens coming forward. It will take some of the largest corporations in the world breaking their silence as well.

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    Paul M. Healy
    Paul M. Healy
    James R. Williston Professor of Business Administration
    Senior Associate Dean for Faculty Development and Research
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