Transcript 2. Definitions and Opportunities

Anticorruption and the Design of Institutions 2012/13
Lecture 2
The Briber‘s Dilemma
Prof. Dr. Johann Graf Lambsdorff
Literature
ADI 2012/13
 Lambsdorff, J. Graf (2007), The Institutional Economics of Corruption and Reform:
164-189.
Further Reading:
 Brunner, K. and W.H. Meckling (1977), ”The Perception of Man and the Conception
of Government," Journal of Money, Credit and Banking, IX (1), 70-85.
 Friedman, M. (1970), ”The Social Responsibility of Business Is to Increase Its Profits,”
New York Times Magazine, September 13. Reprinted in L.P. Hartmann, Business Ethics,
(Chicago: Irwin/McGraw-Hill), 246-51.
 Lambsdorff, J. Graf (2013), “Corrupt Intermediaries in International Business
Transactions: Between Make, Buy and Reform,” European Journal of Law and
Economics. Retrieve online at: http://www.icgg.org/literature/Lambsdorff_EJLE.pdf
 Shearman & Sterling (2012), FCPA digest. Cases and Review Releases Relating to
Bribes to Foreign Officials under the Foreign Corrupt Practices Act of 1977, ed. by N.
Waites and A. Walker, Shearman & Sterling LLP, online retrievable.
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1. The Prisoner‘s Dilemma
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 Bribing always involves two sides, a briber and a bribee. In a seminal
contribution Friedman [1970] claims innocence for businesspeople, as their
sole responsibility is to increase profits.
 Brunner and Meckling [1977: 82-4] consider it defendable for business
people to disregard morality and pay bribes, when this is part of a maximizing
strategy.
 Industrial bodies of exporting countries often point to high levels of
corruption in less developed countries when defending their strategy to
condone bribery. Some even claim a cultural acceptance of these practices
abroad.
 By contrast, people from less developed countries point to the difficulty of
establishing an honest administration and a transparent political environment
when low-paid public servants are constantly offered side payments by
business people from industrial countries.
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1. The Prisoner‘s Dilemma
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1. The Prisoner‘s Dilemma
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 A crucial question regards the interaction between competition and
morality: Can a high standard of ethics survive? Is it the bottom line or
the moral code that wins out?
 Assume that two equally qualified firms compete in a public tender,
yielding a profit of 100. The tender board consists of 7 members. Each
firm has the possibility to pay a bribe worth 10 to one of them in
exchange for a favorable vote. The resulting probability of winning can
be depicted from following matrix.
Probability of
winning
Competitor
Firm
Bribe
No Bribe
Bribe
50 | 50
65 | 35
No Bribe
35 | 65
50 | 50
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1. The Prisoner‘s Dilemma
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 Considering the probability of obtaining the profit (100) and the
costs of bribing (10), the following matrix determines the expected
profit.
Expected profit
Competitor
Firm
Bribe
No Bribe
Bribe
40 | 40
55 | 35
No Bribe
35 | 55
50 | 50
 The matrix reveals that bribing emerges as the dominant strategy.
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1. The Prisoner‘s Dilemma
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 Also in reality bribing may sometimes be the individually dominant
strategy. One obtains an edge over competitors who do not pay, and
looses by rejecting a payment when all others bribe.
 But jointly the firms are worse off, because the costs of bribing lower
their overall profit.
 The overall decrease in profit arises because each firm disregards the
damage that its bribing strategy imposes on the competitor.
 There are two solutions to the problem.
 Corporate liability: the payoff to the matrix is changed by penalties
imposed on the firms.
 Collective action: Firms unite in their efforts to fight corruption.
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1. The Prisoner‘s Dilemma
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 Imagine the calculus of a firm’s employee who is given a bonus
payment if he secures the contract for the firm.
 Such a payment would act as an inducement to engage in bribery.
 In an NBER paper (http://www.nber.org/papers/w12274) Bertrand,
Djankov, Hanna and Mullainathan (2007) investigate the effect of
bonus payments on the behavior of Indian applicants who wanted to
obtain a driver’s license. One group was given free driving lessons,
another a bonus payment for obtaining the license within 32 days.
 Those who were given a bonus were less qualified in driving, less
often participated in the official test and more often engaged local
agents to arrange things.
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1. The Prisoner‘s Dilemma
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Table 1: Obtaining a License, By Group
Comparison
Bonus
(1)
(2)
Obtained License
0.48
0.71
Days to Obtain Permanent License
48
32
Took RTO licensing exam
0.29
0.38
Failed Independent Exam
0.61
0.64
Total Expenditures
1120
1140
Paid Direct Bribe
0.01
0.02
Hired Agent
0.78
0.80
Notes: Sample includes the 409 individuals that obtained a license.
Lesson
(3)
0.60
53
0.51
0.15
964
0.01
0.59
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1. The Prisoner‘s Dilemma
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 Codes of conduct are at risk of “window dressing”: While they
present the official policy, unofficially firms sometimes communicate
that the acquisition of a contract is all what counts.
 The promise of a bonus supersedes engagement in favor of collective
interests.
 Private companies turn a blind eye to the bribery of their staff and
thus cultivate a culture of bribery. The underlying reason is that
bribery is the dominant strategy.
 Without stating that lack of morality or greed may not contribute to
explain behavior, this systemic issue appears most important.
 Corporate liability is crucial: Once the risk of detection and fines
exceeds 5, bribing ceases to be the dominant strategy.
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1. The Prisoner‘s Dilemma
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 May this also be achieved by help of fines imposed on individuals?
 Individuals may ask for a compensation of their increased risk, which
also accounts for bribing no longer being the dominant strategy for
companies!
o But individuals are more difficult to fine due to wealth
constraints.
o Individuals may be locked into their employment and be
forced to engage in bribery.
o Individuals may have a weaker bargaining position and
fail in being compensated for their risks.
o Individuals may not rationally calculate through the
increased risks they incur.
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2. Collective Action
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International multilateral approach
 Foreign Corrupt Practices Act imposed in 1977 in the USA to prevent
corporate bribery of foreign officials. This act includes three major parts:
1. It requires the keeping by corporations of accurate books, records, and
accounts; 2. It requires issuers registered with the Securities and
Exchange Commission to maintain a responsible internal accounting
control system; and 3. It prohibits bribery by American corporations of
foreign officials.
 Amendment imposed in 1988 with respect to the "knowing"
requirement: "simple negligence" or "mere foolishness" should not be the
basis for liability. Penalties to be imposed if managers "consciously
disregard" and should have known.
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2. Collective Action
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 However, for 20 years the FCPA remained a unilateral approach: Other
countries did not follow the US lead.
 Imposing stricter national regulation was seen to hurt their export
industry.
 This can be understood as a prisoner's dilemma at the country-level:
while all export nations may profit from low levels of corruption it is
profitable to be the only one deviating from such behavior.
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2. Collective Action
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 A CIA report claimed that between 1994 and 1995 the US lost $ 36
billion worth of business deals due to bribery and corruption by its
competitors, inducing public complaints.
 About that time talks at the OECD started for a multilateral
approach.
 In May 1997, an agreement was signed by ministers of the 29
members of the organization (and further non-member countries) to
enact laws by April 1998 making bribery a punishable offence.
 All major countries have meanwhile ended the tax deductibility of
bribes and made bribing of foreign officials a legal offence.
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The Economist (Ungreasing the wheels; 19.11.2009): Governments around the world are making life difficult for
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corrupt
firms.
3. Unilateral
Approaches
If ever a clash was inevitable between one country’s commercial law and another’s
business culture, it would be between America’s Foreign Corrupt Practices Act (FCPA),
which seeks to punish firms that bribe government officials, and China, where many
businesses are owned by the government and bribery is endemic. A recent spate of
prosecutions under the act of firms operating in China and other notoriously crooked
places has stoked fear in the heart of many executives. Nor is the crackdown limited to
America. On November 18th the British government became the latest to promise
tough new anti-corruption legislation, during the annual Queen’s Speech to Parliament.
In 2005 DPC Tianjin, the Chinese subsidiary of a Californian company that makes
medical equipment, admitted paying bribes to doctors and laboratory personnel.
American prosecutors said this fell under the scope of the FCPA because health care in
China is government-run. Yet the Chinese government is involved in much of business
life. Last year, for example, Lucent paid a multimillion-dollar fine for “training” trips it
had arranged for executives from state-owned telecommunications firms that involved
visits to Las Vegas and Orlando, rather than factories.
This year Control Components, a manufacturer of valves for power plants, and several of its employees entered
guilty pleas related to bribes allegedly paid to employees at some of China’s biggest companies. These included
PetroChina, China National Offshore Oil Corporation, Jiangsu Nuclear Power Corporation, Guohua Energy
Investment Company, China Petroleum Materials and Equipment Company and Dongfang Electric Corporation. Two
recent cases have further widened the scope of the FCPA. In February ITT Corp settled charges related to payments
made by a subsidiary to various Chinese “design institutes”, which are linked to the government but do not make
big purchases of foreign goods. They do, however, set local product standards and thus can have a huge influence
over foreign firms’ sales in China. Last year AGA Medical Corporation of Minnesota pleaded guilty to bribing doctors
to push medical devices, and officials in China’s Intellectual Property Office to push patent approvals. Even though
the payments were made by a distributor, the courts still held the manufacturer responsible—a worrying precedent
for firms that use agents of different kinds.
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The two American agencies responsible for enforcing the FCPA, the Department of Justice (DoJ) and the Securities
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and Exchange Commission, have both made clear their intention to be even fiercer under the new ADI
administration
3.
Unilateral
Approaches
than they were under the previous one. “We will be intensely focused on rooting out foreign bribery in your
industry. That will mean investigation and, if warranted, prosecution of corporations to be sure, but also
investigation and prosecution of senior executives,” thundered Lanny Breuer, the new head of the DoJ’s criminal
division at a gathering of pharmaceutical bosses earlier this month. America recently prosecuted one of its own
public officials under the FCPA. However, although William Jefferson, a former congressman, was sentenced to 13
years for bribery, he was acquitted on the FCPA charge because the $90,000 in cash found in his freezer, allegedly
intended to pay off a Nigerian politician, was never handed over…
The fines imposed on firms are also getting bigger. In February American courts fined KBR, a construction firm, and
Halliburton, its former parent, $579m over bribes paid to obtain contracts in Nigeria. Last year they hit Siemens, a
German conglomerate, with an $800m fine—the biggest to date. The German authorities also fined Siemens a
similar amount.
That case has helped spur more zealous pursuit of corporate bribery in Europe, says Richard Dean of Baker &
McKenzie, another law firm. In September British prosecutors secured their first big conviction, of Mabey &
Johnson, a bridge-building company, over bribery of foreign government officials. But prosecutors are still weighing
politically charged allegations of bribery involving BAE Systems, a defence contractor, and foreign officials. The
British government says its proposed new law will close several loopholes and make prosecutions easier.
American prosecutors have made it clear that they will be more lenient with firms that confess possible lapses,
rather than waiting to be caught. This month a defence contractor, DynCorp International, did just that. But that
means investing in internal monitoring, which can be expensive. Scanning e-mail alone can cost $200-400 an hour if
done by a law firm, and $50-90 an hour even if a legal outsourcing firm such as the Clutch Group is used. American
lawyers worry that local prosecutors will remain tougher than their counterparts in other rich countries, putting
American firms at a competitive disadvantage and deterring foreign firms from listing their shares on American
stockmarkets. As one lawyer puts it, “They are catching up, but not that fast.” That may be true. But the more
striking trend is that it is getting harder for firms all over the rich world to get away with bribery, which must be a
good thing.
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2. Collective Action
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Will these laws be effective?
 Will countries enforce the
new rules? The evidence
reveals major differences
across countries, see
Transparency International
(2012).
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2. Collective Action
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 Will companies change behavior in response to government
enforcement of the respective laws? Or will they invent new methods
for making payments which are accepted under the existing legal
standard, or which cannot be prosecuted and appropriately penalized.
o Delegate the bribery to local agents or middlemen and
claim ignorance when this is uncovered?
o Arrange deals via subsidiaries and off-shore companies
to keep them off their books?
o Exploit the “knowing”-requirement but avoiding redflags to be documented.
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2. Collective Action
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Transparency International’s Integrity Pact (IP)
 The IPs are developed for individual government (or subdivision)
contracts and should enable the bidders to abstain from bribing.
 All officials involved commit to abstain from requesting or accepting
bribes or to unduly favor one bidder over another. This commitment
is assisted by disclosure of all relevant information and potential
conflicts of interest.
 The bidders commit to not offer or hand out bribes or other favors
and to not accept any inappropriate advantage.
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2. Collective Action
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 Sanctions (to be negotiated) may include disciplinary or criminal
sanctions against officials, cancellation of contract, forfeiture of the bid
and blacklisting of bidder for future government contracts.
 But: Sanctions and regulations exist anyways
 An IP will only be effective if further sanctions can be tailored to a
certain project.
 Further actors (CEOs, Civil Society) can be involved.
 Trust among participants can be created.
 Assessments of effectiveness of IPs are biased because its
implementation already suggests a political will to contain corruption.
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3. Unilateral Approaches
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 Sometimes paying bribes is not the dominant strategy. Various
reasons suggest that paying bribes is a costly approach:
 A firm engaging in bribery might be exposed to denunciation and
extortion. It fears legal sanctions or a bad reputation and may be forced
to pay hush-money.
 Corrupt agreements cannot usually be legally enforced. A potential
risk is that public servants may fail to deliver after receiving a bribe.
Some firms may be more reluctant than others to run such a risk.
 Bribes requested may rise with the propensity of a firm to pay.
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3. Unilateral Approaches
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 The Wall Street Journal, Jan 31 2007, cites from the prosecutorial
investigation of M. Kutschenreuter, an executive manager at the
German Siemens: A former Saudi-Arabian local representative, whose
contract had been cancelled by Siemens, is supposed to have
blackmailed the firm. He requested more than 900 mio. US$ as hushmoney and threatened to pass on documents about corruption in
telecommunications contracts to the SEC otherwise. In negotiations
both sides agreed on a payment of 50 mio. US$.
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3. Unilateral Approaches
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 A Hong Kong employee of the German Mannesmann was in charge of
paying bribes to Chinese officials in exchange for contracts. It was later
detected that he embezzled parts of the money. But the firm did not
bring the case to court, because the employee threatened to expose
the names of Chinese officials. Being confronted with the death
penalty in China, this would have brought operation of Mannesmann
in China to a standstill.
 A staff member of the Christian Democratic party in Hesse, Germany,
was alleged to have embezzled 1 Mio. DM of party funds. But he was
given impunity due to fears he may denounce the party's illegal hidden
accounts. The party even paid for his gambling debts.
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3. Unilateral Approaches
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 In a recent study about truck drivers in Indonesia, Bolken and Barron
(2007: 9-10) www.nber.org/papers/w13145, find that truck drivers do
not truthfully report to their companies about the bribes they have to
pay at checkpoints:
“By exaggerating bribe payments, drivers may be able to extract more
money from their bosses to pay bribes than they actually need, and
pocket the difference. In fact, we compared the amount of bribes we
observed on 40 trips between January 25th, 2006 and February 20th,
2006 with twelve interviews we conducted around the same time with
drivers who had just completed their trips, and found that on average
the bribes drivers reported in interviews were more than double the
amount of the bribes we recorded by direct observation.”
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3. Unilateral Approaches
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I have not taken any bribe
and I swear I’m not hiding
any money from you. Those
are false allegations usually
made during elections to
discredit our party!
Laxman,
Times of India,
Nov. 13 2003
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3. Unilateral Approaches
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 Slush funds can be misappropriated by firm staff.
 The secrecy surrounding corrupt side-deals can be used by firm staff
to take their share. Employees are thus seduced to betrayal, for
example, by requesting a share of the bribes to be sent to their own
offshore bank accounts.
 Internal auditors can hardly distinguish between bribing in favor of
the firm and employee fraud. The red flags of the two misdoings are
similar:
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3. Unilateral Approaches
Red Flags Employee Fraud
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Red Flags Bribery
 Extravagant lifestyle
 Vices such as gambling, drugs, stress
 Ego and status above hierarchical position
 Short vacation and unexplained hours
 Financial and organizational pressure
 Ongoing transactions with related parties and middlemen or with firms whose sole
rationale is to do business with your own company
 Believing that the firm does not prosecute or even tolerates secrecy and cooked books
 Excessive magnitude of decentralized and autonomous authority
 Frequent cash transactions or payments to third parties other than the indicated payee.
 Too many transactions in even thousands of dollars. Numbers don’t’ follow Benford’s law.
 Consultancy contracts are repeatedly negotiated per unit of sales/revenue
 Commissions paid prior to sales or
incoming revenue
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3. Unilateral Approaches
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Benford’s Law
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From news.com.au, April 11, 2001:
3. Unilateral Approaches
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For Jakub Bierzynski, the wake-up call was of a personal nature. Head of the Warsawbased media planning company OMD-Poland, a US-Polish joint venture, Bierzynski
was confronted by corruption last year when two big international clients separately
demanded bribes of "hundreds of thousands" for two advertising contracts. "It was
like a very cold shower. I asked myself if I could do business in a corrupt
environment," says Bierzynski, who had incorrectly assumed his firm's US mother
company afforded him a degree of protection from kick-backs. The answer was no.
"This is what scared me the most (that despite OMD and the clients all being
international companies), they would dare to ask for a bribe," he says. "Leaving aside
the moral connotations of (giving bribes), I have no skills in giving bribes. I have never
done it before, I don't know how much, I don't know to whom and I don't know in
what situations I'm supposed to give bribes, so I am losing in that competitive field
and I am sentenced to death in the business world.” Instead, the 34-year-old
channeled his outrage into a proposal to launch an anti-corruption business
association unprecedented in central and Eastern Europe, in which members would
pledge not to offer or receive bribes.“
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Appendix
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Discussions
1) Explain how competition between firms that may engage in
bribery can lead to a socially undesirable outcome.
2) Which are the two strategies for overcoming the prisoner’s
dilemma?
3) How may exporting companies circumvent an anti-bribery
legislation?
4) What is the “knowing”-requirement?
5) What may motivate companies to unilaterally stop bribery?
6) Discuss the subsequent case study! Why didn’t H. Davidson
discuss the dilemma with his superiors?
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The Wall Street Journal Europe, Career Journal (03.12.2002):
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Unilateral
Approaches
“In3.
1994,
Howard Davidson
faced his crucible. At the time, he was an investment banker, working in
an Asian country. He was on the verge of pulling off a prestigious $500 million (502.8 million euro)
stock offering for an Asian utility. "We invested $11 million in the deal and pre-sold the issue," recalls
Mr. Davidson, now a financing consultant for the Institute, a management-consulting firm in
Redwood City, California. "At the last minute, I was approached by a government official." The
official's message: Give him a kickback or forget the deal. "To him, it was as logical as day follows
night," Mr. Davidson says. It would have been simple to comply.
He felt he couldn't even share the decision with superiors at the bank. What if they ordered him
to pay up and push on with the offering? And with other people involved, how could he be sure the
whole sordid mess wouldn't leak to the press? […]
In the end, he declined and the deal was pulled, resulting in a lot of heat for his company from an
unknowing public. Press critics wondered aloud if the company knew how to pull off a deal of that
magnitude in a foreign land. The decision turned out well for Mr. Davidson, who finally confided in his
superiors afterwards. The company's senior executives felt he'd made the right call, and he wound up
with a promotion after his division went on to a "great year" anyway, he recalls.
But it could have been a disaster. In another, less-ethical, get-the-job-done-at-any-cost culture, he
could have been pushed aside, ignored or outright vilified by co-workers and his career could have
come to a dead halt. […] In a highly competitive world, there's considerable pressure to adopt that
point of view. When bosses talk about doing "whatever it takes" to make a sale, the salespeople see
that as an easily decipherable code. Translation: "Do whatever you have to, as long as it doesn't come
back on me." There's also social pressure to "go along with the gang." People who don't are
ostracized. […]”
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