Transcript 4. The Briber's Dilemma - uni

Anticorruption and the Design of Institutions 2009/10
Lecture 2
The Briber‘s Dilemma
Prof. Dr. Johann Graf Lambsdorff
Literature
ADI 2009/10
 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.
1. The Prisoner‘s Dilemma
ADI 2009/10
 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.
1. The Prisoner‘s Dilemma
ADI 2009/10
1. The Prisoner‘s Dilemma
ADI 2009/10
 A crucial question regards the interaction between competition and
morality: Can a high standard of ethics survive? Is it the bottom line of
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
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.
1. The Prisoner‘s Dilemma
ADI 2009/10
 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.
1. The Prisoner‘s Dilemma
ADI 2009/10
 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.
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
1. The Prisoner‘s Dilemma
ADI 2009/10
 Codes of conduct are at risk of “window dressing”: While they
present the official policy, unofficially firms sometimes communicate
that acquisition of a contract is all what counts.
 The promise of a bonus supersedes moral considerations.
 This unofficial culture of bribery can only be changed by imposing
corporate liability.
 Once the risk of detection and fines exceeds 5, bribing ceases to be
the dominant strategy.
1. The Prisoner‘s Dilemma
ADI 2009/10
 Once firms have an incentive to allow
bribery, penalties must concentrate on
penalizing firms, not only individuals.
 While quite often blacklisting of firms
and threats of contract cancellation are
mentioned in this context, in the lecture
“The Economics of Corruption” it was
argued that monetary fines are superior.
2. Collective Action
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International multilateral approach
 Unilateral approach: Foreign Corrupt Practices Act imposed in 1977,
the USA: End tax deductibility and impose legal sanctions.
 Most trading partners did not follow the US lead, because imposing
stricter national regulation was seen to hurt their export industry.
 This well resembles the problem of a prisoner's dilemma: while all
export nations may profit from transparent procurement and good
codes of conduct it is profitable to be the only one deviating from such
behavior.
2. Collective Action
ADI 2009/10
 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.
2. Collective Action
ADI 2009/10
Will these laws be effective?
 Will firms start to understand the new rules?
 Will prosecutors start investigations in case of malfeasance?
 Will firms invent new methods for making payments which are
accepted under the existing legal standard, or which cannot be
prosecuted and appropriately penalized?
 Will firms just delegate the bribery to local agents or middlemen and
claim ignorance when this is uncovered?
 Will firms arrange deals via subsidiaries and off-shore companies to
keep them off their books?
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.
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.
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.
3. Unilateral Approaches
ADI 2009/10
 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$.
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.
3. Unilateral Approaches
ADI 2009/10
 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.”
3. Unilateral Approaches
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
ADI 2009/10
3. Unilateral Approaches
ADI 2009/10
 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:
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
 Consultancy contracts are repeatedly negotiated per unit of sales/revenue
 Commissions paid prior to sales or
incoming revenue
3. Unilateral Approaches
ADI 2009/10
Source: International Business Attitudes to Corruption – Survey 2006, Control Risks Group
3. Unilateral Approaches
ADI 2009/10
Source: International Business Attitudes to Corruption – Survey 2006, Control Risks Group
From news.com.au, April 11, 2001:
3. Unilateral Approaches
ADI 2009/10
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.“
Appendix
Discussions
1) Disregarding ethics, how would businesspeople and public
officials determine whether to engage in bribery?
2) What forces the bottom line of the moral code to win out?
3) Which are the two strategies for overcoming the prisoner’s
dilemma?
4) Do “good ethics” survive in reality? Why?
5) Discuss the subsequent case study! Why didn’t H. Davidson
discuss the dilemma with his superiors?
ADI 2009/10
The Wall Street Journal Europe, Career Journal (03.12.2002):
ADI 2009/10
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. […]”