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Corporations can shield themselves from local corruption by buying up other firms: study

Concordia’s Lawrence Kryzanowski examines strategies managers and CEOs employ to dodge rent-seekers
October 13, 2020
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Lawrence Kryzanowski: “Managers can either go along with rent-seeking by political actors, or they can take certain strategies to make themselves less attractive.”

According to the World Bank, almost one in five companies worldwide has received at least one request for a bribe or other type of rent-seeking. One in four is expected to provide gifts in exchange for government contracts.

The problem of corruption, or rent-seeking, is by no means limited geographically, ethnically or by level of economic development. It is endemic in most countries to varying degrees.

However, as a new paper published in The Financial Review argues, there are means corporations can adopt to avoid being the target of corrupt high-ranking officials.

“Managers and CEOs of firms have a choice,” says Lawrence Kryzanowski, professor of finance at the John Molson School of Business. He co-authored the article with Ashrafee Tanvir Hossain of Memorial University in St. John’s. “They can either go along with rent-seeking by political actors, or they can take certain strategies to make themselves less attractive.”

Bigger can be better

The authors argue that by acquiring other firms, a corporation will make itself less likely to be targeted by rent-seekers, for several reasons.

First, acquiring a firm usually costs a lot of money or a lot of stock. Using US Department of Justice statistics to assess relative corruption at the state and district level in the USA, Kryzanowski concludes that cash is the better option if the firm is operating in a state with high levels of corruption. If a corporation opts to spend cash on an acquisition or borrow cash to do so, it will lack the funds to pay off a predatory official.

“If you do your acquisitions with cash, you minimize your cash position,” explains Kryzanowski, the Senior Concordia University Research Chair in Finance. “And so you are not as attractive to the political actor.”

The researchers found this to be true even in states with high corruption rates. The net value added from acquisitions of firms in more politically corrupt states is lower than they are in states where governments are more transparent, but it is still positive.

“Managers are still making rational decisions in corrupt states,” Kryzanowski says. “They also obtain indirect benefits in terms of shielding against political corruption.”

Corporations should if possible try to acquire firms that are located in states with lower levels of corruption. If the firm can extend itself in a way where it lowers the average level of corruption it faces, they will see a direct benefit. Political actors, the researchers found, have a much more difficult time to rent-seek from firms that are geographically dispersed.

Political donations to powerful decision-makers were also helpful. “If a manager is more powerful, has more connections and has a chummy relationship with the political actors, they can use that network to avoid rent-seeking,” Kryzanowski adds.

Big deals

The researchers examined more than 15,000 acquisitions by almost 5,000 firms between 1990 and 2014. All the firms involved were publicly listed, there was a $1-million minimum value to each deal and the acquirer’s ownership moved from less than 50 per cent pre-deal to 100 per cent post-deal.

Looking at corruption convictions per 100,000 people between 1998 and 2017, the researchers found that New Hampshire, Oregon, Minnesota, Utah and Colorado were the least corrupt jurisdictions in the US. The most corrupt were Washington, DC, Louisiana, Mississippi, South Dakota and Kentucky.

The Social Sciences and Humanities Research Council of Canada (SSHRC) provided financial support for this study.
 

Read the cited paper: “Political corruption shielding and corporate acquisitions.”

 



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