Research discovers that companies in corrupt areas face loss of shareholder value
Political corruption can breed distrust among citizens, but it turns out to be bad for businesses as well, according to recent research by an Arizona State University professor.
Companies located in areas with high levels of political corruption were found to be worth less than similar companies in low-corruption areas, according to Roger White, assistant professor of accountancy at the W. P. Carey School of Business. His research was published in the Journal of Business Ethics.
“It’s easy to think about this internationally when we think about some terribly corrupt country with maybe a corrupt governor coming in and expropriating a lot of business assets, loading it up and taking it to the mansion,” he said.
“It doesn’t happen that severely here, but there are hundreds of political officials convicted of corruption on an annual basis.”
For example, in 2006, former Alabama Gov. Don Siegelman was convicted of bribery after the CEO of a health care company donated $500,000 to his campaign and the governor gave the CEO a seat on the hospital regulatory board.
To measure corruption, the research teamBesides White, the other authors were Nerissa C. Brown of the University of Illinois, Jared Smith of North Carolina State University and Chad Zutter of the University of Pittsburgh. counted political corruption convictions in federal district court on a per capita basis. Washington, D.C., came in first, followed by districts in eastern Louisiana, Kentucky, Mississippi, Tennessee, South Dakota, Alabama, North Dakota, central Louisiana and southern New York. Arizona came in 55th.
“There’s a ton of stuff that goes on in zoning boards,” White said. “We see bribes for government contracts, bribes for preferential treatment.”
Is that actually bad for business? Not necessarily.
“There’s some international evidence that goes both ways,” he said.
In some countries, businesses can use cash to fast-track a zoning decision or work around regulations, to their benefit.
“But there’s also evidence that when you have government officials wandering around with sticky fingers, it slows private businesses, who are less likely to expand or grow,” he said. “The expected returns have to be a lot higher to build a new factory if I know I have to bribe somebody at the zoning board to build this thing.”
And White’s team found that to be the result in their research.
“Firms that are located in corrupt areas in the U.S. tend to have lower firm values,” he said.
Other researchers have created financial models that can predict the stock market value of companies based on income, assets, peer companies, profitability and other factors. White and his team took one of those models and plugged in the corruption variable to discover that corruption negatively affects how shareholders view a firm’s value.
And the ill effects spread.
“It’s not just the business that engages in this political corruption that throws sand in the wheels of commerce, they do so for everybody else too,” White said.
“Everybody else pays more for labor and for trucks and raw materials because my business stays around only because I’m willing to pay bribes. And if I didn’t pay bribes, then I couldn’t compete and my business went under, all the resources I’m sucking up, the labor, the materials, would flow to everybody else at lower rates and they would be able to provide lower prices to customers.”
The researchers also looked at how monitoring affects the value of companies in corrupt areas.
“Every public company traded on the major stock exchanges in the United States has to have their financial statement audited by a certified audit firm, and we think of the biggest and best accounting firms as the Big Four: KPMG, Ernst & Young, Deloitte and PricewaterhouseCoopers. They do the best job in terms of enforcing accounting standards,” he said.
White and his co-authors found that strong monitoring in corrupt areas can negatively affect firm value.
“These guys have a lot of influence and they force you to disclose a lot and give investors and shareholders a lot of info about your company. That’s helpful for investors but it’s also if a politician sees your company has a lot of cash flow and a lot of money at the end of the month, this cash is going somewhere so why not have a little come to me?
“So you don’t want a real stickler for an auditor if you operate in a corrupt area. You want someone who’s going to allow you to be a little fuzzy and not be completely explicit on where your money is and how much you have and where it’s going and when it’s coming in.”
And finally, the research found a moderating effect of corruption: political competition. The value of a firm in a corrupt area was not affected when power in state government was divided among the two parties.
“If you’re in an area with political competition, government officials can get away with a lot less. In a purple state like Arizona, if I’m pushing the envelope and get a bad reputation, I could legitimately be voted out of office,” White said.
“That limits the effects of political corruption in terms of stymieing business. So even if you’re a firm believer in one party, you want there to be credible competition on the other side of the aisle because it helps keep everybody in check.”
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