Bribes and Firm Value Stefan Zeume* - University of Virginia Bribes and Firm Value Stefan Zeume* This

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  • Bribes and Firm Value

    Stefan Zeume*

    This Version: April 2014

    Abstract

    I exploit the passage of the UK Bribery Act 2010 as an exogenous shock to UK firms’ cost of using bribes to study whether the ability to use bribes creates firm value. First, I find that UK firms operating in high corruption regions of the world display negative abnormal returns upon passage of the Act. A firm operating exclusively in the most corrupt regions suffers a 6.2% drop in value compared to a firm operating exclusively in the least corrupt regions. The effect is stronger for firms that are not already subject to US anti-bribery regulation, are not part of corporate social responsibility indices, operate in concentrated industries, and have better governance. Foreign firms subject to the Act because they have a UK subsidiary also exhibit negative abnormal returns. Second, I identify real effects of the Act. Relative to comparable continental European firms, UK firms expand their subsidiary network less into high corruption regions and their sales in these regions grow six percentage points more slowly.

    JEL Classification: G30, G34, G38, K22

    Keywords: valuation, regulation, corruption, corporate governance

    ∗ Finance Department, INSEAD, Boulevard de Constance, 77300 Fontainebleau, France, Tel: +33160729124, Email: stefan.zeume@insead.edu. I am especially grateful to my dissertation committee Morten Bennedsen, Denis Gromb, Maria Guadalupe, and Urs Peyer for numerous valuable suggestions and insightful comments. I have benefitted from discussions by Dragana Cvijanovic, Ferdi Gul, Dev Mishra, Jeff Ng, Xiaofei Pan, Fausto Panunzi, David Parsely, Jillian Popadak, Andreanne Tremblay, and from comments by Daniel Bens, Pramuan Bunkanwanicha, Adrian Buss, Gavin Cassar, Woo-Jin Chang, Lin Chen, Bernard Dumas, Pushan Dutt, Alex Dyck, Lily Fang, Antonio Fatas, Sven Feldman, Vyacheslav Fos, Federico Gavazzoni, Nicola Gennaioli, Xavier Giroud, Jarrad Harford, David Hémous, Gilles Hilary, Jeremy Horder, Raj Iyer, Jon Karpoff, Ambrus Kecskes, Ralph Koijen, Massimo Massa, Maxim Mironov, Amine Ouazad, Daniel Paravisini, Paolo Pasquariello, Joel Peress, Tarun Ramadorai, Raghu Rau, Ana Maria Santacreu, David Schumacher, Edmund Schuster, Carsten Sprenger, David Thesmar, Branko Urosevic, Theo Vermaelen, Hannes Wagner, Charlie Wang, Franco Wong, Eric Zitzewitz, as well as participants at conferences (AFA 2014, AFBC 2013, AFBC PhD Forum, Asia FA, CFA-JCF-Schulich Financial Market Misconduct, FMA Europe, London Transatlantic Doctoral, MIT Asia Conference in Accounting, National Bank of Serbia Young Economists’ Conference, Young Scholar Symposium in Corporate Finance and Governance at Renmin University) and seminars (Bocconi, ESCP, ESSEC, HBS (Accounting & Management), HEC, INSEAD (Finance, Economics), LSE (Law), Nanyang Technological University, Norwegian School of Economics, Rutgers, UIUC, University of Hong Kong, University of Michigan (Ross), University of Oxford, University of Toronto (Rotman), University of Washington, UT Dallas). I would like to thank GAP Books, particularly Alan Philipp, for very generous help with subsidiary data for 2013 and FTSE for providing FTSE4Good UK index constituents for 2008. Remaining errors are my own.

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    1. Introduction

    The use of bribes is pervasive in business. According to a survey of more than 11,000 firms from 125

    countries, one third of firms use bribes to secure public procurement contracts, paying 8% of the contract

    value on average (D’Souza and Kaufmann 2011).1 Some developed nations have implemented unilateral

    regulation punishing the use of bribes yet other nations, notably China and India, have not.2 Opponents of

    such regulation argue that bribes are indispensable for doing business in certain areas or industries and that

    unilateral regulation puts affected firms at a competitive disadvantage.

    In this paper, I seek to assess whether the ability to use bribes creates firm value. This is challenging

    because most bribes remain undetected. The empirical literature has studied detected cases, allowing cross-

    sectional analysis but raising selection concerns.3 I address the challenge that most bribes remain

    undetected by exploiting the unexpected passage of the UK Bribery Act 2010 on March 25, 2009. First, I

    find that UK firms operating in high corruption regions of the world display negative abnormal returns

    upon passage of the Act. A firm operating exclusively in the most corrupt regions suffers a 6.2% drop in

    value compared to a firm operating exclusively in the least corrupt regions. The effect is stronger for firms

    that are not already subject to US anti-bribery regulation, are not part of corporate social responsibility

    indices, operate in concentrated industries, and have better governance. Foreign firms subject to the Act

    because they have a UK subsidiary also exhibit negative abnormal returns. Second, I identify real effects of

    the Act. Relative to comparable continental European firms, UK firms expand their subsidiary network less

    into high corruption regions and their sales in these regions grow six percentage points more slowly.

    Event study methodology requires that the passage of the draft of the UK Bribery Act came as a surprise

    with substantial impact for firms. This is plausibly the case. First, the passage on March 25, 2009 was not

    1 These summary statistics are based on the 2006 Executive Opinion Survey conducted by the World Economic Forum. 2 For instance, in 1977, the US passed the Foreign Corrupt Practices Act (FCPA) which imposes regulatory fines on firms found having bribed foreign public officials. 3 See Cheung, Rau and Stouraitis (2012) and Karpoff, Lee and Martin (2013).

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    covered in the media during the weeks prior to this date. The media only covered the passage on the event

    day and the days thereafter. Second, the monetary and personal fines associated with breaking the Act go

    well beyond expectations, in particular well beyond previous UK legislation, requirements of the OECD

    Anti-Bribery Convention, and comparable US legislation. The Act imposes potentially unlimited monetary

    fines on corporations found to have used bribes4 and individuals responsible for bribery inside and outside

    the UK. Also, the Act prohibits the use of facilitation payments5, which goes beyond comparable

    regulation. Third, contrary to prior drafts of anti-bribery regulation, the Act also applies to foreign firms

    with UK operations. This makes it harder for UK industry lobbyists to argue that solely UK firms are at a

    competitive disadvantage vis-à-vis foreign competitors.6

    I am testing whether firms operating in high corruption regions are more or less negatively affected by the

    UK Bribery Act. My key explanatory variable Corruption Exposure measures firms’ exposure to high

    corruption regions. To construct this measure, I combine hand-collected data on the country of location of

    firms’ subsidiaries from Dun&Bradstreet’s Who Owns Whom 2008/2009 book series with Transparency

    International’s Perceived Corruption Index (CPI). I define a firm’s Corruption Exposure as the weighted

    average of its subsidiary country CPIs. The weight for each subsidiary country CPI is determined by the

    number of subsidiaries in that country relative to the total number of subsidiaries. Firms with a large

    fraction of subsidiaries headquartered in regions with high corruption levels score high on the Corruption

    Exposure measure.7 The key dependent variable is firms’ abnormal stock return around the passage of the

    Act. My findings are largely based on 645 listed UK firms for which abnormal returns and subsidiary data

    are available; robustness tests consider 2 791 predominantly European firms.

    4 The Act comprises active and passive bribery. Active bribery is defined by the Act as offering, giving, or promising to give a financial or other advantage to a person in exchange for that person to improperly perform a relevant function. This includes bribery of foreign public officials and other firms. Passive bribery is defined as receiving or agreeing to receive a financial or other advantage in exchange for improperly performing a relevant function. 5 Facilitation payments (commonly known as grease payments) are payments that induce government officials to perform tasks they are otherwise obligated to perform anyway. 6 Previous drafts of anti-bribery regulation in the UK were aimed solely at UK firms, making it easy for UK industry lobbyists to argue that such regulation would put British firms at a competitive disadvantage. 7 Corruption Exposure weighs each subsidiary equally. Arguably, the probability of bribery activity being detected might increase in subsidiary size. For robustness, I collect data on firm sales by geographic region and results still hold.

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    If firms use bribes as an investment to create firm value, the passage of costly anti-bribery regulation

    should destroy firm value.8 Alternatively, managers might use bribes for their personal benefits9: in this

    case, anti-bribery regulation punishing individual managers for the use of bribes would create firm value.

    Confirming that bribes are indeed used to create firm value, my first main finding is that UK firms with

    higher corruptio