The Impact of Anti-Bribery Enforcement Actions on Target Firms Jonathan M. Karpoff WAMU Chair in Innovation Foster School of Business University of Washington

The Impact of Anti-Bribery Enforcement Actions

on Target Firms

Jonathan M. KarpoffWAMU Chair in Innovation

Foster School of Business

University of Washington

D. Scott LeeLincy Professor of Finance

Lee School of Business

Univ. of Nevada, Las Vegas

Gerald S. MartinAssoc. Professor of Finance

Kogod School of Business

American University

Anti-bribery efforts worldwideFrom Trace International’s Global Enforcement Report 2011

Impacts of anti-bribery enforcement 3


U.S. anti-bribery enforcement actions on the rise(1978 through June 2011)

Total = 109(excludes 44 actions not involving publicly traded firms)

“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

5Impacts of anti-bribery enforcement

What happens to these firms?


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?

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.


Why is this important?

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


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)



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

Who gets charged?


Large manufacturing firms

Why do firms pay bribes?


How large are the bribes?What are the expected benefits to bribe payers?


Fuzzy concept, frequently not the NPV

Where are the bribes paid?


Nigeria (n=30)

Iraq (n=26)

China (n=24)

Market value losses


What accounts for these losses?

1. Confounding news/associated charges

2. Fines and penalties

3. Investigation costs

4. Lost bribe-related business

5. Reputational losses

1. Effect of simultaneous fraud charges

The largest hits involve financial fraud


2. Fines & penalties imposed in bribery enforcements


3. Investigation and legal expenses


5. Is there much of a reputation loss?


Summary

1. Bribery charges are associated with a relatively small but significant loss in market value

2. Why? 1. Confounding news/associated charges - Yes

2. Fines and penalties - Yes

3. Investigation costs – Yes

4. Foregone bribe-related business - Yes

5. Reputational losses – No


Direct costs matter, and more than explain the market value losses

Indirect costs do not matter, on avg.

Documents

The Impact of Anti-Bribery Enforcement Actions on Target Firms Jonathan M. Karpoff WAMU Chair in Innovation Foster School of Business University of Washington