Honest firms in corrupt environments: Firm efficiency, foreign ownership, and CEO gender

Jan Hanousek, Anastasiya Shamshur, Jiri Tresl 18 September 2017

a

A

Corruption imposes significant costs on many countries, and the international community goes to great lengths to combat it. Conventional wisdom suggests that corruption reduces efficiency by giving an unfair advantage to firms with a higher propensity to behave in a corrupt way and connected to officials willing to accept bribes (Acemoglu et al. 2005, Svensson 2005). Studies focusing on the macroeconomic effects of corruption have found that it has an adverse effect on investment (Mauro 1995, Mo 2001), foreign direct investment, and capital inflows (Wei 2000). Corruption has also been shown to reduce country-level productivity and economic growth (e.g. Mauro 1995, 1998, Mo 2001). Negative effects of corruption on firm-level productivity are studied in Hanousek and Kochanova (2016).

There is also a strand of literature that highlights a positive effect of corruption. Leff (1964), among others, argues that corruption gives individuals or firms an opportunity to work around misguided government policies, rigid laws, bureaucratic bottlenecks, and red tape (e.g. Lui 1985, Meon and Weill 2010). The empirical evidence supportive of a positive effect of corruption on firm performance is mainly limited to certain regions in Asia, as those economies are based on relationships (e.g. Rock and Bonnett 2004), and where contracts are not well-enforced and capital is scarce (Rajan and Zingales 1998). Empirical evidence outside of Asia is very limited. Only Fungacova et al. (2015) find that bribery aids access to bank credit in Eastern and Central Europe.

Why study firm efficiency and how is it measured?

Most papers that analyse the effects of corruption on firm performance focus on accounting performance measures (e.g. Fisman and Svensson 2007), which might be easier to manipulate (Demsetz 1997, Schulze et al. 2001). In contrast, we look at the effect of corruption on firm efficiency, where firm efficiency is defined as the ability of a firm to produce the most output with a given amount of inputs. From this perspective, the stochastic frontier analysis employed, and in particular the distance from the production frontier, could be understood as a distance from ‘best practice’. The input-output figures are also less likely to be influenced by accounting manipulations.

Who runs the show?

We examine firm attributes that are likely to be associated with a lower propensity to bribe, i.e. honest firms. An extensive literature in international business argues that foreign-controlled firms plausibly exhibit such lower propensity, in part because they are less likely to know whom and how to bribe in the local market (Calhoun 2002). Foreign-controlled firms that are also headquartered in low corruption countries are also more likely to adopt business practices from their home country and thus avoid corrupt practices. Further, not only CEO nationality, but also CEO gender could be important. Firms run by a female CEO may be reluctant to engage in criminal activities such as bribery (Dollar et al. 2001, Swamy et al. 2001). This could be due to factors including the relative exclusion of women from networks traditionally dominated by men (Goetz 2007), higher risk-aversion than men (Charness and Gneezy 2012), aversion to the risk of getting caught and penalised (Levin et al 1988), higher reciprocity in the context of gift-exchanges (e.g. Buchan et al. 2008), and higher aversion to competition than men (e.g. Croson and Gneezy 2009, Buser et al. 2014). Thus, firms run by female CEOs and/or with foreign controlling owners, especially those that are headquartered in low corruption countries, represent our honest firms.

The corruption environment

We then examine the influence of two environmental characteristics on the efficiency of firms, the first of which is the mean level of corruption as perceived by firms operating in that environment. The second characteristic we examine is the variance in perceptions of corruption within a given environment. We create the corruption environment using the EBRD-World Bank Business Environment and Enterprise Performance Survey (BEEPS), which is known to be the most granular database on corruption (Svensson 2003). The mean level of corruption proxies for the expected corruption in an environment, while the variance proxies for the uncertainty and heterogeneity of corruption. The higher the variance, the bigger the dispersion of opinions on what the corrupt practices are. Thus, corruption is more difficult to forecast, and also higher heterogeneity indicates the presence of stakeholders not engaged in corruption.

Honest stakeholders in corrupted environments

Firm efficiency is, on average, lower in environments characterised by a high level of corruption, and this is even more so for honest firms. As shown in Figures 1 and 2, a 1% increase in the average level of corruption leads to a 2.04% decrease in average firm efficiency. However, greater variance in corruption perceptions is associated with greater efficiency. A 1% increase in corruption perception variation improves firm efficiency by 0.61%. The corruption heterogeneity in the environment shows that not all firms are willing to accept the business practices. i.e. corruption isn’t a necessary tax. By focusing on honest business practices, productivity can increase.

Figure 1 Effect of a 1% increase in average corruption on firm efficiency

Figure 2 Firm efficiency effect to 1% increase in variance of corruption perception

The effects are stronger for foreign-controlled firms, especially if their headquarters are located in low-corruption countries and/or run by female CEOs. For instance, while a 1% increase in the average level of corruption leads to a 3.16% decrease in efficiency of foreign firms, this effect jumps to 4.53% for foreign-controlled firms that come from low-corruption countries. These results are consistent with the idea that a foreign firms’ propensity to behave corruptly is affected by the cultural norms of their home countries, the legal restrictions they are subject to, and their relative lack of local market knowledge. If the corporation is run by a female CEO then efficiency goes down by 2.80 %, which is consistent with the literature on gender studies and law breaking. At the same time, only foreign firms can be more efficient if there is a greater variation in perceptions of corruption.

Summary

Obtaining data on bribery is difficult due to its illicit nature. However, an ‘anonymous’ survey from the World Bank exists that specifically asks managers and owners in the CEE region about bribery practices. From that survey, we follow the existing literature and create more granular corruption measures to gauge the effects of different characteristics of bribery environments on the efficiency of honest firms.

The results are, on the one hand, expected, but they also reveal some new and quite interesting insights. While firms tend to be less efficient in high bribery environments, honest firms suffer even more. Our proxy for honest firms are those who are either controlled by foreign subjects, especially those who come from low corruption countries, and/or those who are run by female CEOs. If a corruption environment is characterised by a greater dispersion in corruption perception then honest firms are less penalised since there is room to conduct business honestly.

References

Acemoglu, D, S Johnson, and J Robinson (2005), “Institutions as a Fundamental Cause of Long-Run Growth” In P Aghion, and S N Durlauf (eds.) Handbook of Economic Growth ,Amsterdam: North Holland.

Barney, J (2002), Gaining and sustaining competitive advantage, Upper Saddle River, NJ: Prentice Hall.

Buchan, N R, R T Croson, and S Solnick (2008), “Trust and gender: An examination of behavior and beliefs in the Investment Game”, Journal of Economic Behavior & Organization, 68 (3-4), 466-476.

Buser, T, M Niederle, and H Oosterbeek (2014), “Gender, Competitiveness and Career Choices”, Quarterly Journal of Economics, 129 (3), 1409-1447.

Calhoun, M A (2002), “Unpacking liability of foreignness: identifying culturally driven external and internal sources of liability for the foreign subsidiary”, Journal of International Management, 8 (3), 301-321.

Charness, G, and U Gneezy (2012), “Strong evidence for gender differences in risk taking”, Journal of Economic Behavior & Organization, 83 (1), 50-58.

Croson, R, and U Gneezy (2009), “Gender differences in preferences”, Journal of Economic Literature, 47 (2), 448-474.

Dal Bó, E, and M A Rossi (2007), “Corruption and inefficiency: Theory and evidence from electric utilities”, Journal of Public Economics, 91 (5), 939-962.

Demsetz, H (1997), The economics of the business firm: seven critical commentaries, Cambridge University Press.

Dollar, D, R Fisman, and R Gatti (2001), “Are women really the “fairer” sex? Corruption and women in government”, Journal of Economic Behavior & Organization, 46 (4), 423-429.

Fungacova, Z, A Kochanova, and L Weill (2015), “Does money buy credit? Firm-level evidence on bribery and bank debt”, World Development, 68, 308-322.

Goetz, A M (2007), “Political Cleaners: Women as the New Anti‐Corruption Force?”, Development and Change, 38 (1), 87-105.

Hanousek, J and A Kochanova, (2016), “Bribery Environment and Firm Performance: Evidence from Central and Eastern European Countries”, European Journal of Political Economy, 43, 14-28. See also here on VoxEU.org.

Hanousek, J, A Shamshur, and J Tresl (2017), “Firm efficiency, foreign ownership and CEO gender in corrupt environments”, Journal of Corporate Finance, Based on CEPR Discussion Paper No. 10500 (2015).

Henisz, W J (2000), “The institutional environment for multinational investment”, Journal of Law Economics and Organization, 16 (2), 334-364.

Leff, N (1964), “Economic development through bureaucratic corruption”, American Behavioral Scientist, 8 (3), 8-14.

Levin, I P, M A Snyder, and D P Chapman (1988), “The interaction of experiential and situational factors and gender in a simulated risky decision-making task”, The Journal of Psychology 122 (2), 173-181.

Lui, F T (1985), “An equilibrium queuing model of bribery”, Journal of Political Economy 93 (4), 760-781.

Mauro, P (1995), “Corruption and growth”, Quarterly Journal of Economics, 110 (3), 681-712.

Mauro, P (1998), “Corruption and the composition of government expenditure”, Journal of Public Economics, 69 (2), 263-279.

Mo, P H (2001), “Corruption and Economic Growth”, Journal of Comparative Economics, 29, 66–79.

Rajan, R G, and L Zingales (1998), “Financial Dependence and Growth”, American Economic Review, 88, 559-586.

Rock, M T, and H Bonnett (2004), “The comparative politics of corruption: accounting for the East Asian paradox in empirical studies of corruption, growth and investment”, World Development, 32 (6), 999-1017.

Schulze, W S, M H Lubatkin, R N Dino, and A K Buchholtz (2001), “Agency relationships in family firms: Theory and evidence”, Organization Science, 12 (2), 99-116.

Svensson, J (2003), “Who must pay bribes and how much? Evidence from a cross section of firms”, Quarterly Journal of Economics, 118 (1), 207–230.

Svensson, J (2005), “Eight questions about corruption”, Journal of Economic Perspectives, 19 (3), 19-42.

Swamy, A, S Knack, Y Lee, and O Azfar (2001), “Gender and corruption”, Journal of Development Economics, 64 (1), 25-55.

Wei, S J (2000), “How taxing is corruption on international investors?”, Review of Economics and Statistics, 82 (1), 1-11.

a

A

Topics:  Productivity and Innovation

Tags:  production, efficiency, honesty, Corruption

Full Professor at CERGE-EI; Research Fellow at the William Davidson Institute, Michigan Business School; Research Fellow, CEPR

Senior Lecturer in Finance at Norwich Business School, University of East Anglia

Assistant Professor at Central Michigan University; Researcher at CERGE-EI

Events