Articles,  Issue XXI, Jan 2021

Foreign Corruption by Multinational Corporations (MNCs): The Principal-Agent Problem, Liability, Compliance and Collective Action

Why do employees and management of MNCs engage in corruption? The principal-agent problem gives an answer, why employees and management of multinational corporations (MNCs) like Siemens AG, Diagnostic Products Corp and Pfizer engage in corruption in spite of knowing of its adverse consequences. This article considers whether individuals or corporations should be held accountable for foreign corruption of MNCs using the principal-agent problem and the effectiveness of collective action in combatting corruption.

 The investors or shareholders are principals and management and employees who control and run the business are their agents. The principals have a long-term focus on profit maximisation whilst the agents have a short-term focus linked to immediate increased remuneration (Wu, 2005; Pinto, et al., 2008). Securing a lucrative government contract in a foreign country may be beneficial to the business in the short term but be detrimental in the long term due to exposure to future legal, compliance, regulatory and reputational risks.

 There is a risk of “divergence of interests and objectives between the insider[s] and outsider[s]” (Wu, 2005, p. 155). The insiders, as agents, have more control of top management in the business and are therefore able to conceal corruption from shareholders, the outsiders (Wu, 2005).  This results in asymmetric information between the agents and the principals. The agents possess more information than the principals regarding the operations of the MNC in the foreign country. Consequently the principals face challenges in monitoring the actions of the agents, and as a result,  the agents pursue their own interests (Marquette & Peifer, 2015). This may be attributed to geographical and temporal factors as MNCs operate in multiple countries.

Pinto, et al. (2008, p. 688) suggests that corruption in organisations takes two forms, “an organisation of corrupt individuals (OCI)” with a few bad apples and “a corrupt organisation (CO)”. A CO is a group collectively acting for the benefit of the organisation. Both of these manifestations are attributable to the failure by the organisation to inhibit such corruption by implementing relevant processes (Pinto, et al., 2008).

The cases of Siemens AG, Diagnostic Products Corp and Pfizer in relation to corruption in the pharmaceutical industry in China illustrate this point. Local management made specific arrangements to conceal bribery by doctoring financial reports (Rose-Ackerman & Tan, 2015). This is characteristic of a CO. In addition to this, elements of an OCI can also be observed in these cases as it was specific individuals who engaged and bribed the government officials to meet their sales targets and increase their remuneration (Rose-Ackerman & Tan, 2015).  There was a disregard of corporate governance in particular financial reporting to conceal corruption, and this undermined accountability and transparency (Wu, 2005). If the MNCS had set up processes to ensure good corporate governance, including accurate reporting, they could have inhibited and/or detected corruption.  The MNCs knew China was a high-risk market with weak institutional structures for the enforcement of anti-corruption, and they should have enhanced their monitoring proportionately (Rose-Ackerman & Tan, 2015).

The distinction between an OCI and a CO is that the former benefits the individual whilst in the latter individuals act collusively for the benefit of the organisation (Pinto, et al., 2008). The individuals in a CO also derive personal benefit from their collective acts.  If the corporation attains its goals, they are rewarded with bonuses. The “bad apples” and the corporation itself must be held liable for corrupt activities in foreign countries in instances where corruption benefits both. They are all culpable as the corporation fails to prevent corruption and the individuals execute the corrupt actions.

The UK Bribery Act 2010 (UKBA) Section 7 takes cognisance of this phenomenon and takes into account the corporation’s adoption of adequate measures to prevent corruption by its associated persons. These include employees and top management engaging in corruption in business activities. The United States Sentencing Commission and the Securities and Exchanges Commission  considers an effective compliance program as a mitigating factor in criminal charges including charges under the Foreign Corrupt Practices Act of 1977 (FCPA) against corporations (Chen & Soltes, 2018). Having an adequate or effective compliance program as a defence or mitigating factor acknowledges that in certain instances corporations will have done enough to prevent corruption (Chen & Soltes, 2018). In these cases it is the rogue individuals who need to be punished and not the corporation (Chen & Soltes, 2018).

Only adequate and effective compliance programs should let MNCs off the hook in instances of bribery. Having a detailed and lengthy code of conduct does not automatically translate into compliance in a corporation. Stöber, et al. (2009) found that the design elements of the code of conduct were crucial for its effectiveness.  For example, a program may be ineffective if the training delivery is not tailored to employees’ roles and responsibilities (Stöber, et al., 2019; Maesschalck & Bertok, 2009). Non-compliance will persist despite having a strong and detailed code of conduct due to poor socialisation (Stöber, et al., 2019).

Corporations, including MNCs, make calculated cost and benefit assessments when deciding to engage in foreign corruption. They consider the likelihood of detection, the magnitude of the financial loss due to legal action and regulatory censure. Where the benefit from corruption exceeds the costs, the corporations make a conscious decision to proceed with corruption (Rose-Ackerman & Tan, 2015). In this case the MNC’s engagement in foreign corruption is deliberate, and they must be held responsible for it.    In addition, corporations must be held responsible for corruption by foreign subsidiaries and third parties acting on their behalf in these foreign countries even when they claim not to have been aware of it.  This will prevent circumvention of the law by transferring businesses to jurisdictions with less stringent anti-corruption requirements (Rose-Ackerman & Tan, 2015).  That is why the FCPA and the UKBA have extra-territorial effect (FCPA 15 U.S. Code § 78dd–1; United Kingdom Bribery Act, 2010 S.12 (2) and (3)).

The fear and pressure of enforcement is necessary to drive corporations to comply with anti-corruption laws and regulations. Where the risk of legal action and huge financial sanctions is high, corporations will comply. However, there is room for intrinsic motivation for corporations to adopt effective compliance programs and comply. Empirical studies have shown that organisations with effective compliance programs are more profitable than their unscrupulous counterparts (Healey & Serafeim, 2019).  Therefore, sustainable long-term profitability, rather than just the fear of sanctions, may motivate compliance in corporations.  Furthermore, high-integrity companies in high-risk countries and industries are preferred by many employees who are even willing to accept lower pay (Healey & Serafeim, 2019).  This means integrity can attract talent, which will benefit the corporation. Healey and Serafeim (2019) state that “such companies and their leaders have the respect of their customers, regulators, and communities. They are more likely to prosper and endure.”

Collective action theory provides insights into factors that lead to corruption and this informs considerations of appropriate measures to combat corruption. This theory highlights “… the collective nature of corruption…and the very difficult challenge that anti-corruption efforts face in changing levels of distrust in society and norms that reinforce persistent patterns of systemic corruption” (Marquette & Peifer, 2015, p. 3).  By using this theory, for example, we understand that individuals and corporations are unlikely to participate in the pursuit of a common goal, where the benefits of the common goal is available even to those that do not participate in its pursuit (Marquette & Peifer, 2015). This is what is termed “free riding” (Marquette & Peifer, 2015). With respect to anti-corruption efforts, collective action therefore provides an opportunity to devise efforts that will diminish the effects of “free riding” and enable societies to devise effective anti-corruption measures. With proper safeguards and incentives, collective action is effective at combatting systematic corruption by diminishing recourse to “free riding”.

The Extractive Industries Transparency Initiative (EITI) is an example of successful collective action initiative. Its membership includes corporations, governments and Non-Governmental Organisations (NGOs). Its aim is to reduce corruption “… in resource-rich countries and increase transparency about payments by oil, gas, and mining companies” (Healey & Serafeim, 2019). Governments make disclosures of their revenues from extractive industries and the corporations involved also disclosure of the payments they make for engaging in this industry. As per Klitgaard (2014, p. 37) “…corruption follows a formula: corruption equals monopoly plus discretion minus accountability: C = M + D – A. To reduce corruption, reduce monopoly, limit official discretion and enhance accountability.” Collective action initiatives like EITI reduce corruption by limiting governments’ monopolies and discretion and by enhancing transparency. Empirical studies analysing data for over ten years in 186 countries involved in the EITI reveal a significant decrease in corruption in countries involved in this initiative especially those who started with high levels of corruption (Dávid-Barrett, 2019).

The foregoing illustrates how the agency problem explains foreign corruption in MNCs and why both individuals and corporations must be held responsible for foreign corruption as they both benefit from it.  The discussion clearly sets out instances in which a lengthy detailed code of conduct may still lead to non-compliance and discusses the effectiveness of collective action in combatting systematic corruption.

 

Reference List

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Dávid-Barrett, E., 2019. Business unusual: collective action against bribery in international business. Crime, Law and Social Change, 71(2), pp. 151-170.

Foreign Corrupt Practices Act of 1977 (FCPA) (15 U.S.C. § 78dd-1, et seq.)

Healey, P. & Serafeim, G., 2019. How to scandal proof your company. [Online] Available at: <https://hbr.org/2019/07/white-collar-crime#how-to-scandal-proof-your-company>[Accessed 4 December 2019].

Klitgaard, R., 2014. Addressing corruption together. Paris: Organisation for Economic Co-operation and Development (OECD)Symposium on Anti-Corruption.

Maesschalck, J. & Bertok, J., 2009. Towards a sound integrity framework:instruments, processes, structures, and conditions for implementation. Paris:Organisation for Economic Co-operation and Development (OECD). [Online] Available at:<https://ssrn.com/abstract=2652177> or <http://dx.doi.org/10.2139/ssrn.2652177> [Accessed 29 November 2019].

Marquette, H. & Peifer, C., 2015. Corruption and collective action. Birmingham: Developmental Leadership Programme/U4 Research Paper 32, 2015. [Online] Available at: <https://res.cloudinary.com/dlprog/image/upload/corruption-and-collective-action>[Accessed 10 December 2019].

Pinto, J., Leana, C. & Frits, P., 2008. Corrupt organisations or organisations of corrupt individuals? Two types of organisational level corruption. Academy of Management Review, 33(3), pp. 685-709.

Rose-Ackerman, S. & Tan, Y., 2015. Corruption in procurement of pharmaceuticals and medical equipment in China: the incentives facing multinationals, domestic firms and hospital officials. UCLA Pacific Basin Law Journal, 32(1), pp. 1-54.

Stöber, T., Kotzian, P. & Weißenberger, B., 2019. Design matters: on the impact of compliance program design on corporate ethics. Business Research, Volume 12, pp. 383-424.

United Kingdom Bribery Act, 2010.(c.23). London: HMSO.

Wu, X., 2005. Corporate governance and corruption: a cross-country analysis. Governance: An International Journal of Policy, Administration, and Institutions, 18(2), pp. 151-170.