The Real Cost of Bribery

It's a sad, quantitative fact that bribery runs so rampant in the world that it has become a Darwinian business tool. A July 2013 report from Transparency International finds that more than one in four people paid a bribe in the past year, based on a survey of 114,000 respondents in 107 countries. The World Bank estimates that the equivalent of $1 trillion is offered in bribes every year.

In the age of globalization, it's easy to see how giving into bribery might be competitively advantageous. In fact, research by Harvard Business School's Paul M. Healy and George Serafeim found that firms that launch anticorruption efforts grow their businesses more slowly than firms that don't, especially in regions where bribery is the expected norm.

“If you think of the cost [of bribery] as just fines and regulatory actions, you're missing a big piece of the puzzle.”

"We have a pretty good understanding of the benefits of bribery—facilitating entry into a market, for starters," says Serafeim, an assistant professor in the Accounting and Management unit. "But we still have a much more limited understanding about the costs of bribery."

That's why Serafeim recently set out to analyze the negative effects of bribery on corporate performance. The results of his study, detailed in the paper Firm Competitiveness and Detection of Bribery, surprised him. As it turns out, the biggest problem with corporate corruption isn't its effect on a firm's reputation or the regulatory headaches it causes. Rather, bribery's most significant impact is its negative effect on employee morale.

Initiation, Detection, And Response

Serafeim aimed to find out how bribery affected a firm's operations across four dimensions of competitiveness: its external business relations, its interaction with regulators, its public reputation, and the morale of its employees. (Each of these factors has proven to be crucial to a firm's standing in the competitive landscape.)

He hypothesized that the extent of the damage to a firm would depend on three factors: who initiated the under-the-table payment, how it was detected, and the way the firm responded to the bribe after it was uncovered.

To test the hypothesis, Serafeim evaluated data from the forensic services practice of PricewaterhouseCoopers, which provides global consulting services to companies dealing with potential legal issues. The firm annually surveys thousands of its clients about their respective issues. Serafeim focused on survey answers from 2009 through 2011, during which some 10 percent of respondents (about 500 respondents) anonymously reported that their firm had experienced a bribery incident. Many of the survey takers who had dealt with corruption worked for firms based in countries infamous for rampant bribery, including Russia, Ukraine, and South Africa. But there were also on-the-take reports from firms based in Australia, the United Kingdom, and the United States, where bribery is less common but still existent.

"Bribery is a global phenomenon, and people engage in this type of behavior all over the world," Serafeim says. "There are different magnitudes and different extents of bribery, but everywhere in the world you can find it. The idea that bribery doesn't exist in the developed world is a myth."

The survey included both hypothetical and reactive questions, asking respondents how they believed the detection of bribery would affect the firm and—in cases where it had actually happened—how bribery really did affect the firm.

Speculation Versus Reality

It turned out that speculation did not match the reality. Respondents guessed that their firm's reputation would be most negatively affected by bribery, followed in speculated impact by business relations, employee morale, and relations with regulators. But respondents who had actually dealt with the problem reported that employee morale was by far more significantly affected by bribery than any other factor.

That's important because studies have shown that employee morale is directly related to a firm's performance, including stock market returns. For instance, the consultancy Sirota recently surveyed 13.6 million employees in 840 companies about workplace morale. High-morale companies (those at which more than 75 percent of the workforce reported "overall satisfaction with their company") had significantly stronger year-over-year stock performance than companies with lower morale reports. These high-morale companies averaged a 15.1 percent improvement in their stock price from 2011 to 2012, compared with a 4.1 percent year-over-year improvement among the lower-morale companies.

Serafeim's findings also indicate that bribery could hurt a firm even if no one outside the organization ever found out about it.

People know each other and talk within an organization, Serafeim observes. "Information is hard to contain within a group of people, even if it's never officially reported," he says. "The lesson for managers is that bribery is more costly than you might think. If you think of the cost as just fines and regulatory actions, you're missing a big piece of the puzzle."

As Serafeim had hypothesized, the extent of bribery's impact on all four competitiveness factors depended on who committed the bribe, who discovered the bribe, and what the firm did in response.

On average, cases in which a senior executive committed the bribe had 64.9 percent more significant impact than those in which the briber was lower down on the corporate totem pole, according to the survey results. "Senior management is the ambassador of what the firm stands for—the culture of the firm and what people are incentivized to be doing," Serafeim says. "As a result, it sends a strong message about what the organization stands for."

That said, he notes that respondents reported at least a moderate negative effect even in cases where the bribery wasn't committed by an employee.

"The idea that whatever happens outside an organization is not going to impact the organization—it's actually not true," Serafeim says. "If your customers or suppliers are engaging in this type of behavior, it has an impact on the organization."

With regard to how bribes were discovered, Serafeim found that bribery cases detected by a firm's internal control systems (including tip-offs and whistle-blowers) had a far less negative impact than those detected by outside regulators.

"This sends a strong message that firms that invest in control systems are going to realize benefits," Serafeim says. "You're not just incurring costs by investing in these systems. There are benefits. Besides protecting reputation and morale, it also means that the firm is able to contain and control actions that its business allies or employees take."

And punishing the offending party proved to be good for business. "Dismissal of an employee that initiated bribery or cease of business relations with an outside party that initiated bribery is significantly associated with a lower likelihood of significant impact on a firm's reputation," Serafeim reports in his paper.

One thing that didn't seem to matter: the size of the bribe. Thirty-five percent of the bribes reported in the survey fell under $100,000, and they had just as much of an effect on competitiveness factors as the 16 percent involving amounts more than $500,000. "Size does not matter when it comes to bribery," Serafeim says. "Small or big bribing is bad business in the long term."