Corruption – The disease that kills new business

No Corruption

No Corruption (Photo credit: Ann Douglas)

What is Corruption?

Corruption can defined as “the misuse of entrusted power for personal benefit”. It can also be described as letting personal or family relationships influence economic decision making, be it by private economic agents or by government officials. Corruption is always kept more or less secret and therefore is the individual behavior of corrupt agents almost impossible to observe systematically in real life. You know it when you are subjected to it.

The objectives of government are vital to the understanding of the diverse negative effects of corruption on the public service. Corruption renders governments unable or unwilling to maximize the welfare of the public for personal or the gains of a small group of people.

A corrupt principal creates allocation inefficiencies and cripples its credible commitment to effective policies, and opens the door to opportunism. Because corruption must be hidden from the public and is not enforced by courts it entails transaction costs, which are larger than those from legal exchange. This suggests that corrupt contracts are primarily relational contracts where legal exchange serves as a basis for sealing and enforcing corrupt agreements. Legal exchange not only provides for corrupt opportunities, but for the necessary enforcement mechanisms. Examples of such legal exchange are long-term business exchange, belonging to the same firm or political party or being embedded in social relationships. The latter may even comprise the engagement in charitable institutions. Reform should not only focus on limiting opportunities for corrupt behaviour but also on impeding the enforcement of corrupt agreements.

Two types of Corruption

According to transparenecy International there are two types of corruption that one can encounter “According to the rule”- and “Against the rule”-Corruption.

“According to the rule” constitutes a situation where an individual receives an illegal payment for something he/she is required to do by law – for example when a state official solicit bribes from a company for expediting a routine public service. “Against the rule” refers to a situation where a bribe is paid to obtain a service that the receiver is not authorised to provide but gains access to through a bribe. For example skipping the queue to gain access to a prestigious school or gaining a permit for which would normally would not be granted. Both of which are deemed as counterproductive to positive social and economic development.

There is no way to know how widespread corruption really is and the level of impact on financial and social development. As a Social Risk corruption is properly one of the first things that organisations investigate when investigating possible investments in a region or country primarily because there is a direct link between the perceived level of corrupt behaviour and general social issues like crime, rule of law, healthcare, etc.

When evaluating social risk in a region Transparency International, EBRD, OECD, IMF and the UN good sources for your assessment pared with local sources such as trade groups, the embassy in the region, government business development initiatives, etc.

Links on more information on Corruption and its impact:

http://www.ebrd.com/pages/about/integrity/reports.shtml

http://gateway.transparency.org

http://www.unodc.org/unodc/en/corruption/index.html

http://www.oecd.org/corruption/

http://www.whistleblowers.org

http://www.dfid.gov.uk/R4D/PDF/Outputs/SystematicReviews/Corruption_growth_SR_Report_Final_Revised-v2_SO.pdf

www.u4.no

Articles:

Bishop, T.J. and Hydoski, F.E. (2009), Corporate Resiliency: Man- aging the Growing Risk of Fraud and Corruption. Hoboken, NJ: John Wiley & Sons, 51–208.

Uslaner, E.M. (2008), Corruption, Inequality, and the Rule of Law: The Bulging Pocket Makes the Easy Life. New York: Cambridge University Press, 30–249.

Svensson, J. (2005), “Eight Questions about Corruption,” Journal of Economic Perspectives 19(3): 19–42.

Weitzel, U. and Berns, S. (2006), “Cross-border Takeovers, Corrup- tion, and Related Aspects of Governance,” Journal of International Business Studies 37: 786–806.

Luo, Y. (2006), “Political Behavior, Social Responsibility, and Perceived Corruption: A Structuration Perspective,” Journal of International Business Studies 37, 747–766.

Cuervo-Cazurra, A. (2006), “Who Cares about Corruption?” Journal of International Business Studies 37: 807–822.

Jensen, N. et al. (2010), “Understanding Corruption and Firm Responses in Cross-national Firm-level Surveys,” Journal of International Business Studies 41: 1481–1504.

Removing Cash is effective Anti-Corruption management

scott-schaefer-politics

scott-schaefer-politics (Photo credit: ScottSchaefer)

How do you systematically combat corruption when it seems to be found everywhere? In many countries around the world corruption is part of how business is being done, how you deal with officials and how you get things done. In a lot of places you will hear that it is part of the culture that there is nothing one can do about the phenomenon because the system as a whole would not work if there were no one to skim the cream so to speak.

In my mind there is at least one successful way that will insure the reduction of corruption significantly and that is by removing cash as the main means of payment from society. Cash is the fuel that ensures that corruption can flow freely and if one is able to reduce the amount of cash one can combat the most visible forms of corrupt behaviour and maybe even affect other forms of corrupt behaviour higher up the favours-for-cash food chain.

Corruption is operationally defined as the abuse of entrusted power for private gain (Transparency International) and can be found in two forms:

  • “According to rule” corruption – Which is corrupt behavior that ensures that people of power uphold the laws and rules that they have been entrusted with because to their position in society. F.eks. getting permits within a reasonable timeframe or speeding up bureaucracy.
  • “Against the rule” corruption – Is when a member of the public is able to ensure that a government official does not enforce rules. f.eks. A fine or penalty.

The cost of corruption is four-fold: political, economic, social, and environmental and the more advanced society becomes the more advanced is the corruption that one finds. From police officers taking small bribes to make up of the lack of adequate pay to election fraud through paid ballots.

It is my argument that societies that are not very advanced and therefor have a high degree of cash or natural economy, will be more prone to the two forms of corruption that ones where electronic transfers are more common. Another argument for removing cash in order to reduce corruption is that cash is most common at the bottom of the “food chain”. By cutting off the supply to higher levels in the chain and more damaging types of corruption one is able to reduce the impact as a whole.

We now have low-cost technological systems that can ensure that there is a less of a need for cash in society but more importantly these systems can be made available in developing and emerging markets thanks to telecommunication and improved systems of control. Systems like the ATM or home banking have found its way into the mainstream of all societies around the world and at affordable prices for everybody. Especially if one takes into account that a more transparent system will ensure that the cost of a credit card, interconnection and security systems are covered by the positive impact.

There are of cause challenges to reducing cash and as a technology it cannot be replaced in some parts of the society simply because it is the cheapest alternative. But by strategically targeting government and educational institutions, banking and international business there will be significant gains to be had through relative small investments for all parties involved.

Videos on three areas of sustainability

The struggle for a better environment and a place for all of us to live.

A video on anti-corruption and not least some of the most hidden aspects of how it affects our lives I think it is a great interpretation by Saudi Arabian students. Thanks

Remembering that fraud also have many faces and that just because it is wrapped in a nice looking package it is still cheating and lying creating a asymmetric system of knowledge.

Combating Corruption, Bribery and Fraud

For the past few months I have been working on a project that should end up in a management system that would support the 10th principle of the Global Compact.

While we in many ways have embraced the potential that these changes have brought with them, there are also worries that the face of corruption and fraud will change in much the same way. Just as new possibilities for wealth creation have emerged, so have new avenues and possibilities for Bribery, Fraud and corruption.

Some efforts have been made to combat the increase in corrupt behaviour, which in themselves are good and live up to some of the very principles that we think highly off. But at the same time, there seems to be no decline in world corruption or fraud for that matter.

The 10th principle of the UN Global Compact concerns the subject of Corruption and how organisation deals with the subject. According to UNs own communication, this has been and continues to be the most difficult area to work with. While most signatories of the GC have identified the area as being a major obstacle in their work, very little evidence has been found that companies are effectively combating corruption. For instance only 20% of signatories had an anti-corruption policy that related to their own supply chain.

The OECD Convention on Bribery of Foreign Public Officials in International Business has created a framework from which business, governments and NGO can work together to combat corruption. And while the charter does subscribe a way for business to understand and articulate how corruption affects their operation it does not give any concrete advice on how anti-corruption work should look like in the field.

The aim of the Copenhagen Charter is to remedy this discrepancy and create a real, tangible and systematic approach to anti-corruption work in business and organisation in general. Based on these guidelines I have been part of the process of formulating and creating a working platform from which such work could be undertaken. The process have led us to a point were we now have 13 core principles and a auditing-system from an were BFC effort can be undertaken.

The principles are:

  • Ensure that a Code of Ethics or Code of Conduct is implemented which is inline with international institutional norms and which promote high ethical standards.

Codes of ethics form the backbone of the organisations work against corrupt and fraudulent behaviour. It formulates the practical guidelines that all employees need to follow within the organisation in order to comply with the guidelines set by the board and executive management. Both corruption and fraud can be difficult to identify and employees in the field need to know exactly what the corporate policy is for accepted behaviour for receiving or giving gifts or how to bid for contracts. A Code of Conduct helps the employee take decisions and identify situations, which can lead to issues of concern.

  • Organisations implement a sufficient level of financial and operative independence. Furthermore the organisation needs to implement internal and external audit coverage with the aim of uncovering corruption and possible fraud.

Auditors should be able to operate freely within the organisation. Even though most audits do not uncover corruption or fraud, is the independence of auditors send a powerful message to would-be whistle-blowers that an independent and unbiased system of control exists.

  • Develop a system that encourages both employees and managers to communicate and report, to the relevant independent body all irregularities. Implement a procedure that ensures that these reports will be taken serious by the receiver, who has the power and authority to do investigate the claim.
  • Implement an effective communicative system with local and regional authorities that ensure that the organisation’s work is transparent and auditable by both governmental and organisational auditors.

Working together with local and national governmental agencies will enable one to create a system which is transparent and auditable not only by the organisations own auditors but also from third parties. Third parties will have other ideas and insights into local conditions, which is hard to get insight into as an international corporation.

  • Organisations need to work with government officials and organisations in order to create guidelines and systems for disclosure of governance practices and transactions between the two parties.

It is the obligation of both the company and the governmental agencies that it works with to disclose as much information about their transactions as necessary to prevent dishonest behaviour. However, a system is needed in order to efficiently and effectively spread information to the relevant stakeholders’, in this case governmental agencies, who have a interest.

  • Designated and qualified staffs within the organisation have to play an active role in evaluating the efficiency and effectiveness of financial and internal control systems on a regular basis. On a regular basis they need to follow up on recommendations related to Corruption and Fraud Detection.

Like any other monitoring system, a systematic approach to anti-corruption and fraud monitoring and detection, needs some form of efficient mechanism for updates. The ways in which these types of acts are committed is constantly changing and is being developed mainly because corruption and fraud is a crime in most countries and perpetrators have to develop their techniques in order not to be prosecuted.

  • The organisation needs to focus its control and audit strategies more on areas and operations prone to fraud and corruption by developing effective high-risk indicators, which can be effectively measured and managed.

What gets measured gets managed is a old saying within management, but one needs to know what to measure before an effective system can be put into place. Every company and industry is different and subject to their own dynamics and business culture. Within fraud and corruption there are no universal system that can just be implemented.

In order to effectively combat devious behaviour one must incorporate the dynamics of the business if one is to be successful. It is therefore essential that any system is based on local and industry knowledge and that people with the appropriate competencies are involved in the formulation of the systems indicators.

  • Use multiple communications means to distribute your audit reports and invite stakeholders to participate in the investigation and establishment of a transparent organisation.

One of the most effective anti-corruption and fraud systems that can be implemented is to invite everybody to look inside, so that a critical look can be taken on the audit process. An auditor who thinks he knows everything knows nothing and by inviting stakeholders to participate in the continued investigation, one can create a basis of continued evaluation and transparency in the organisation.

  • Communicate in a language that stakeholders of the organisation understands

If you communicate in a way, which alienates your audience, you will never be able to reduce corruption in your organisation. One might argue that using technical language will be more accurate and the from a legal point of view it would be more correct but the fact is that if you want people to read and understand what you are trying to say, then the reporting needs to be understandable.

  • Use a network approach to combating corruption and fraud.

White-collar crime is a cross border discipline and as with the rise of globalisation, there is a need for business to learn, share and exchange knowledge from other parts of the world. No organisation is an island and if the business is divided on the fight on corruption and fraud it will ultimately loose the battle. Using a network approach and gartering resources from all levels of the organisation to be the eyes and ears of the organisation enables a much more effective intelligence on what is going on. While the information gathered might not directly lead to disclosure of crime, it highlights areas where there could be parts of the system which are not transparent and therefore can be subject to covering up wrong doing.

  • Ensure that systems for the effective exchange and proliferation of knowledge are ensured both inside and outside the organisation.

Like the network approach can be used to gather information, it can also be a effective way to communicate with all parts of the organisation. In the information age, organisations need to have a reliable system for communicating with key stakeholders in order to combat rumours and getting a voice in a otherwise overcrowded media scene. If a company is branded as being corrupt or subject to large-scale fraud, it can cost its ability to conduct business and if it needs to establish channels of communication after the event, it will often be too late.

  • Ensure that the systems for evaluation and incentives for management are established which support anti-corruption and fraud efforts in order to motivate employee ethical behaviour.

One of the major issues within corporate incentive plans is that they have often led to or initiated corrupt behaviour because of their design. The way in which companies compensate their managers and executives, have to be designed in a way that reduces the possibility of corrupt or fraudulent behaviour from occurring. This can example is through improved transparency in the incentive governance structure or third part validation of performance indicators. In high-risk regions, a managerial and specialist rotation program can also be in place in order to reduce the chance that top executives becomes too involved in the local business culture.

  • Ensure that the organisation proactively functions as an example to be followed on fraud and corruption through international committees and working groups.

The ability to be innovative and more efficient is not only limited to other areas of business but also just as much within the field of auditing and governance. As knowledge within the organisation about fraud and corruption is increased, so is the ability to find new ways and systems for efficient governance in these areas. Working cross-culturally and tapping into these streams of knowledge allows an organisation as a whole to progress and innovate new ways to manage these areas. A committee function allows for effective management and the development of best practice techniques that eventually can find its way into the Code of Ethics or as part of the audit process system.

You can download TheCharter here.

It is now that CSR have to prove its value

Cover of "Too Big to Fail: The Inside Sto...

Cover via Amazon

Europe and the US is standing on the brink of bankruptcy. Countries like Greece, Spain and Ireland have already over exceeded the boundaries for what can be accepted as good governance by any standard and the US is struggling with internal political issues that have the potential of destabilising the whole world. Unemployment is staggering high with Spain leading at over 21% unemployment and with a situation among younger people, which is even worse at over 40% having problems finding work. Together with the Greek currency bond being rated as junk by some of the big international rating companies the basic outlook bleak if not hopeless.

If the problems were only confined to a few countries it would not have matter that much but in a globalised world we are all interconnected and if these states fall into national bankruptcy we will all suffer. First of all will countries like Italy and Ireland be some of the first to go under a and these will be closely followed by others in the European region. And with 11 of the Euro 27 countries having unemployment rates in excess of 10 % (4 over 15%) there is little or nothing to buffer any kind of downturn.

There are of cause some economies that are doing better than others but in general economies are strained and there have been little in terms of economic recovery since the crisis in 2008. Basically the states have used up all or close to all their resources in order to cope with the last crisis and they will have close to zero chance of making it through another.

So why should companies care? Their obligations are not to the state or the currently sitting Government so why should they bail out the results of irresponsible economic practices.

Well first of all there will be a direct impact on business if they do nothing. A state in bankruptcy will not be ale to uphold its trade agreement with companies meaning potential huge losses. They will try to find similar products at a cheaper rate such as copy-medicine or they will stop treatment all together. There will be little or no investment in infrastructure in areas like energy, roads and water meaning that the ability to conduct an efficient business operation will be reduced.

On a longer term basis it will mean increased corruption and poor governance as countries will be unable to effective police its own laws. A bankrupt state will also men that the country will be less able to educate their own population which have a effect on business as they will be unable to recruit qualified people.

So what can business do? First of all they can start by paying tax in the countries were their operations and customers are. A significant number of companies in Europe and the US are not paying the tax that they should if companies like Google, IBM, Morgan Stanley, DHL and Apple. Companies that have gotten millions in government hand-outs or stimulus money as it’s called should start paying back and not continue to hide money away in tax havens. If they just paid the tax, as they should have done in the first place all our trouble would basically be over. Companies should not be overtaxed but they should at least pay the basic rate in the country that they are situated in. Transfer prising and other trick of the trade have to be governed in a way that will allow countries whom are providing the educated labour, markets, infrastructure and social systems benefits also gets the funds to maintain these systems. Tax systems have for too long been a competitive advantage and this issue have to be effectively resolved.

The biggest of the corporations need to live what it means to have economic power, which is bigger than most countries. Big multinational companies like Shell, Wal-Mart, Exxon Mobile, AXA, General Electric, IBM, Citigroup and Bank of America that are bigger economic entities than countries like New Zealand, Vietnam and Morocco have to live up to this responsibility. One cannot continue to act like a “normal” business when ones impact on demographics and society is so great. These entities are outside our democratic control and while I do not believe that they would willingly be engaged in wrongdoing I do believe that we need to increase transparency to the level that we have on governmental level in order for stakeholder to truly evaluate the performance of these companies. As Andrew Ross Sorkin so adequately put it these companies are simply “Too Big To fail” and in 2007-08 we saw what happens when they doo. Still today we have a hard time believing that companies like Enron and Lehmann Brothers do not exist.

Third corporations have to integrate their CSR. A quick look at CSR reporting will show that most corporation still view their impact and responsibility to society as part of their everyday thinking. When managers and executives take decisions in big transnational companies we have too often seen that they do not have the necessary understanding and comprehension of the effect that their actions will have on society. Time and time again we have witnessed how highly professional business leaders have created situations which they themselves could not comprehend or even fully understood that had significant implication for a much wider group of people than original anticipated. Therefor the “Responsibility of the Businessman” as Bowen describes it needs to be embedded in the very basics of business thinking and education. We cannot keep on having CSR as a add-on to other activities that corporations are engaged in it has to be like Visser so will put it embedded in the corporate DNA.

Some might claim that these proposals are more or less communism or at least socialism in disguise. But I think that the facts speak for themselves when I say that the current way we are handling capitalism is not working to our advantage. I do not speak against people making money of their hard efforts or that some people are just smarter and better at doing business than others and should be rewarded as such. What I’m working for is business done on the basis of having talent and knowledge, which is hard if not impossible for others to duplicate. Not as it seems to be the case today that who ever is the one with the lowest moral and willingness to exploit the ability to withhold information to others that come out on top.

Identifying the fraudster

The 10th principle of the Global Compact states “Businesses should work against corruption in all its forms, including extortion and bribery.” But hand in hand with corruption comes fraud. In the so-called developed world we might have been able to reduce corrupt behavior to a large extend but instead we have given room for white-collar crime or fraud.

According to a resent survey done by KPMG there are able reason why business should be extra alert but also that there are tell-tale signs that are not being heard and followed by organisations.

“It is surprising that companies continue to ignore warning signs, particularly in light of the recession. While cost-cutting initiatives associated with the downturn may have played their part in the observed shift, such cuts may prove a false economy. While defenses are down, the fraudster sees the opportunity to capitalize. The need for companies to be vigilant has never seemed more important.”

So who is these fraudsters and how do one spot some of the characteristics of a fraud being committed.

He does typically not work alone. In most cases (61%) he (and yes it is a he) works with others in-order to do his crime. The fraudster can either work with internal parties or external contractors.

The fraudster is a male between the ages of 36 and 45 years, who works in the finance function or finance related role. The unique organizational position grants him access and knowledge about the internal controls and especially where the governance structure is weak and can be exploited.

He has been with the company for more than 10 years, and holds a senior management position. Such individuals will be better able to override controls and may have accumulated a good deal of personal trust enabling him to manipulate key organisational members in order to do his crime.

Evija Miezite, Associate Director, KPMG Baltics SIA, leader of forensic projects in Latvia, notes that “According to the survey, the typical fraudster most commonly works in the procurement or sales function. The finance function often plays the role of ‘policing’ these functions. We also note that in Eastern Europe, some 89 per cent of persons investigated, had been employed at the company for more than 3 years (of which more than half had been employed for longer than 6 years) and 52 per cent of the frauds had run for more than 3 years before they were detected.”

Another major problem is that organisations are very reluctant to communicate about the fraud being committed meaning that the perpetrator in practice can “shop” around in other organisations committing the same crime again and again.

How to loose 17 billion

Flag of Iraq, 1991-2004

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Not of American money. Not American money. I don’t think that you will find that anybody is arguing that there was corruption in the American programs.  – Condoleezza Rice, 2008

Throughout the U.S. occupation of Iraqbillions in tax dollars have been lost due to corruption and incompetence. Some of the most egregious losses have been via “American programs”:

– The Coalition Provisional Authority delivered 363 tons of cash on an airplane, totaling $12 billion, to Iraq “without assurance the monies were properly used or accounted for.”

– The State Dept spent $36.4 million dollars on weapons and equipment that could not be accounted for because “invoices were vague and there was no backup documentation“.

– Top contractor KBR came under fire last year from government investigators foroverpricing its contract by $2 billion, which, for example, included overstating labor costs by 51 percent.

– State Dept. employees testified in May 2008 that the U.S. “allowed corruption to fester at the highest levels of the Iraqi government,” resulting in the loss ofbillions in U.S. tax dollars.

Looking at how things have developed since and the numbers seem to just grow and grow and the number now is around 17 billion USD unaccounted for. One must just the Americans and their ability to loose things 🙂 I think that anybody else would be really, really upset and would have started throwing people in jail.