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The Impact of Anti -Bribery Enforcement Actions on Target Firms. D. Scott Lee Lincy Professor of Finance Lee School of Business Univ. of Nevada, Las Vegas. Gerald S. Martin Assoc. Professor of Finance Kogod School of Business American University. Jonathan M. Karpoff
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The Impact of Anti-Bribery Enforcement Actionson Target Firms D. Scott Lee Lincy Professor of Finance Lee School of Business Univ. of Nevada, Las Vegas Gerald S. Martin Assoc. Professor of Finance Kogod School of Business American University Jonathan M. Karpoff WAMU Chair in Innovation Foster School of Business University of Washington
Anti-bribery efforts worldwideFrom Trace International’s Global Enforcement Report 2011 Impacts of anti-bribery enforcement
U.S. anti-bribery enforcement actions on the rise(1978 through June 2011) Total = 109 (excludes 44 actions not involving publicly traded firms) Impacts of anti-bribery enforcement
What happens to these firms? Impacts of anti-bribery enforcement • “Even a single incident [of an FCPA bribery charge] can lead to irreparable economic hardship and reputational damage that may adversely affect the overall stability and competitiveness of any business.” – Pricewaterhouse Coopers • “…the puny size of the penalties [for bribery] could provide an incentive for managers to stretch the rules.” – Fortune magazine
Our questions • How costly is it to be targeted for bribery enforcement? • What is the nature of the cost? • Fines and penalties? • Investigation expenses? • Foregone bribery-dependent revenues? • A general loss in reputation? Impacts of anti-bribery enforcement
Why is this important? Impacts of anti-bribery enforcement • For firms, an optimization issue: • How much should a firm spend on anti-bribery compliance and control? • For regulators, an enforcement puzzle: • Are reputational costs small or large? • If reputational loss is small, then deterrence depends on legal and regulatory actions.
What do I mean by REPUTATION? • Reputational capital is the present value of favorable business terms received from those who trust you to not act opportunistically to their detriment. • customers • suppliers • employees • investors Impacts of anti-bribery enforcement
Reputational capital is: • An asset, just like the firm’s physical plant and people. • Created by investment, just like a building is created by investment. • Affected by random events, good and bad luck, and things outside the firm’s control (like a building’s value). A damaged reputation can be repaired by investment. • Sometimes it warrants the investment (Tylenol) • Sometimes it does not (Arthur Andersen) Impacts of anti-bribery enforcement
United States v. Faro Technologies Inc. (2008) • Sells computerized measurement devices and software • In 2005, Faro’s subsidiary paid $533,163 to managers of China state-controlled firms to obtain sales contracts worth $4.9 million. • In June 2008, Faro agreed with DOJ and SEC to: • $1.1 million criminal penalty • $1.4 million disgorgement • Prejudgment interest of $439,637 • Retain an independent compliance monitor Impacts of anti-bribery enforcement
Who gets charged? Large manufacturing firms Impacts of anti-bribery enforcement
Why do firms pay bribes? Impacts of anti-bribery enforcement
How large are the bribes?What are the expected benefits to bribe payers? Fuzzy concept, frequently not the NPV Impacts of anti-bribery enforcement
Where are the bribes paid? China (n=24) Iraq (n=26) Nigeria (n=30) Impacts of anti-bribery enforcement
Market value losses What accounts for these losses? Confounding news/associated charges Fines and penalties Investigation costs Lost bribe-related business Reputational losses Impacts of anti-bribery enforcement
1. Effect of simultaneous fraud charges The largest hits involve financial fraud Impacts of anti-bribery enforcement
2. Fines & penalties imposed in bribery enforcements Impacts of anti-bribery enforcement
3. Investigation and legal expenses Impacts of anti-bribery enforcement
5. Is there much of a reputation loss? Impacts of anti-bribery enforcement
Summary • Bribery charges are associated with a relatively small but significant loss in market value • Why? • Confounding news/associated charges - Yes • Fines and penalties - Yes • Investigation costs – Yes • Foregone bribe-related business - Yes • Reputational losses – No Direct costs matter, and more than explain the market value losses Indirect costs do not matter, on avg. Impacts of anti-bribery enforcement