Anticorruption and the Design of Institutions 2008/09
Lecture 2
The Briber‘s Dilemma
Prof. Dr. Johann Graf Lambsdorff
Literature
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 Lambsdorff, J. Graf (2007), The Institutional Economics of Corruption
and Reform: 164-189.
 Case Study: BAE-Systems and the OECD-convention:
 2007 TI Progress Report: Enforcement of the OECD Convention on
combating bribery of foreign public officials:
http://www.transparency.org/global_priorities/international_conventions/
projects_conventions/oecd_convention
Further Reading:
 Brunner, K. and W.H. Meckling (1977), ”The Perception of Man and the
Conception of Government," Journal of Money, Credit and Banking, IX
(1), 70-85.
 Friedman, M. (1970) ”The Social Responsibility of Business Is to
Increase Its Profits,” New York Times Magazine, September 13. Reprinted
in L.P. Hartmann, Business Ethics, (Chicago: Irwin/McGraw-Hill), 246-51.
The Bureaucrat’s Choice
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Decision tree for a potentially corrupt businessperson
r
Pay bribe
- Penalty
- Bribe
(Corrupt service
confiscated)
1-r
Corrupt service
- Bribe
Do not pay
a bribe
No corrupt
service
1. The Prisoner‘s Dilemma
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 Similarly, to the calculus of public servants (see lecture “The
Economics of Corruption”), the following condition states whether a
risk-neutral business person will pay a bribe:
V  (rPd+B+Td)/(1-r),
 with V being the value of the corruptly provided service and r the
probability of detection. B is the value of the bribe. Detection results
in confiscation of the favor and a penalty on the side which
demanded it, Pd. There might be transaction costs arising, Td.
 A high risk of detection, r, or severe penalties, Pd, induce
businesspeople to abstain from paying bribes.
 Another approach would be to increase transaction costs or to
make sure that public servants have little to distribute. If V is
sufficiently small, the calculus would equally lead businesspeople to
prefer legality.
1. The Prisoner‘s Dilemma
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 There exists a controversy as to which side has greater responsibility.
In a seminal contribution Friedman [1970] argues that the sole
responsibility of business is to increase its profits.
 Brunner and Meckling [1977: 82-4] consider it defendable for business
people to disregard morality and pay bribes, when this is part of a
maximizing strategy.
 Industrial bodies of exporting countries often point to high levels of
corruption in less developed countries when defending their strategy to
condone bribery. Some even claim a cultural acceptance of these
practices abroad.
 By contrast, people from less developed countries point to the
difficulty of establishing an honest administration and a transparent
political environment when low-paid public servants are constantly
offered side payments by business people from industrial countries.
1. The Prisoner‘s Dilemma
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1. The Prisoner‘s Dilemma
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 A crucial question regards the interaction between competition
and morality: Can a high standard of ethics survive? Is it the bottom
line of the moral code that wins out?
 Assume that two equally qualified firms compete in a public
tender, yielding a profit of 100. The tender board consists of 7
members. Each firm has the possibility to pay a bribe worth 10 to
one of them in exchange for a favorable vote. The resulting
probability of winning can be depicted from following matrix.
Probability of
winning
Competitor
Firm
Bribe
No Bribe
Bribe
50 | 50
65 | 35
No Bribe
35 | 65
50 | 50
1. The Prisoner‘s Dilemma
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 Considering the probability of obtaining the profit (100) and the
costs of bribing (10), the following matrix determines the
expected profit.
Expected
profit
Competitor
Firm
Bribe
No Bribe
Bribe
40 | 40
55 | 35
No Bribe
35 | 55
50 | 50
 The matrix reveals that bribing emerges as the dominant
strategy.
1. The Prisoner‘s Dilemma
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 Also in reality bribing may sometimes be the individually
dominant strategy. One obtains an edge over competitors who do
not pay, and looses by rejecting a payment when all others bribe.
 But jointly the firms are worse off, because the costs of bribing
lower their overall profit.
 The overall decrease in profit arises because each firm disregards
the damage that its bribing strategy imposes on the competitor.
 There are two solutions to the problem.
 Corporate liability: the payoff to the matrix is changed by
penalties imposed on the firms.
 Collective action: Firms unite in their efforts to fight corruption.
1. The Prisoner‘s Dilemma
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 Imagine the calculus of a firm’s employee who is given a bonus
payment if he secures the contract for the firm.
 Such a payment would act as an inducement to engage in bribery.
 In an NBER paper (http://www.nber.org/papers/w12274) Bertrand,
Djankov, Hanna and Mullainathan (2007) investigate the effect of
bonus payments on the behavior of Indian applicants who wanted
to obtain a driver’s license. One group was given free driving
lessons, another a bonus payment for obtaining the license within
32 days.
 Those who were given a bonus were less qualified in driving, less
often participated in the official test and more often engaged local
agents to arrange things.
1. The Prisoner‘s Dilemma
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Table 1: Obtaining a License, By Group
Comparison
Bonus
(1)
(2)
Obtained License
0.48
0.71
Days to Obtain Permanent License
48
32
Took RTO licensing exam
0.29
0.38
Failed Independent Exam
0.61
0.64
Total Expenditures
1120
1140
Paid Direct Bribe
0.01
0.02
Hired Agent
0.78
0.80
Notes: Sample includes the 409 individuals that obtained a license.
Lesson
(3)
0.60
53
0.51
0.15
964
0.01
0.59
1. The Prisoner‘s Dilemma
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 Codes of conduct are at risk of “window dressing”: While they
present the official policy, unofficially firms sometimes
communicate that acquisition of a contract is all what counts.
 The promise of a bonus supersedes moral considerations.
 This inofficial culture of bribery can only be changed by imposing
corporate liability.
 Once the risk of detection and fines exceeds 5, bribing ceases to
be the dominant strategy.
1. The Prisoner‘s Dilemma
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 Once firms have an incentive to
allow bribery, penalties must
concentrate on penalizing firms, not
only individuals.
 While quite often blacklisting of
firms and threats of contract
cancellation are mentioned in this
context, in the lecture “The
Economics of Corruption” it was
shown that monetary fines are
superior.
2. Collective Action
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International multilateral approach
 Unilateral approach: Foreign Corrupt Practices Act imposed in
1977, the USA: End tax deductibility and impose legal sanctions.
 Most trading partners did not follow the US lead, because
imposing stricter national regulation was seen to hurt their export
industry.
 This well resembles the problem of a prisoner's dilemma: while
all export nations may profit from transparent procurement and
good codes of conduct it is profitable to be the only one deviating
from such behavior.
2. Collective Action
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 A CIA report claimed that between 1994 and 1995 the US lost $ 36
billion worth of business deals due to bribery and corruption by its
competitors, inducing public complaints.
 About that time talks at the OECD started for a multilateral
approach.
 In May 1997, an agreement was signed by ministers of the 29
members of the organization (and further non-member countries)
to enact laws by April 1998 making bribery a punishable offence.
 All major countries have meanwhile ended the tax deductibility of
bribes and made bribing of foreign officials a legal offence.
2. Collective Action
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Will these laws be effective?
 Will firms start to understand the new rules?
 Will prosecutors start investigations in case of malfeasance?
 Will firms invent new methods for making payments which are
accepted under the existing legal standard, or which cannot be
prosecuted and appropriately penalized?
 Will firms just delegate the bribery to local agents or middlemen
and claim ignorance when this is uncovered?
 Will firms arrange deals via subsidiaries and off-shore companies
to keep them off their books?
2. Collective Action
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Transparency International’s Integrity Pact (IP)
 The IPs are developed for individual government (or
subdivision) contracts and should enable the bidders to abstain
from bribing.
 All officials involved commit to abstain from requesting or
accepting bribes or to unduly favor one bidder over another. This
commitment is assisted by disclosure of all relevant information
and potential conflicts of interest.
 The bidders commit to not offer or hand out bribes or other
favors and to not accept any inappropriate advantage.
2. Collective Action
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 Sanctions (to be negotiated) may include disciplinary or criminal
sanctions against officials, cancellation of contract, forfeiture of the
bid and blacklisting of bidder for future government contracts.
 But: Sanctions and regulations exist anyways
 An IP will only be effective if further sanctions can be tailored to a
certain project.
 Further actors (CEOs, Civil Society) can be involved.
 Trust among participants can be created.
 Assessments of effectiveness of IPs are biased because its
implementation already suggests a political will to contain
corruption.
3. Unilateral Approaches
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 Sometimes paying bribes is not the dominant strategy. Various
reasons suggest that paying bribes is a costly approach:
 A firm engaging in bribery might be exposed to denunciation and
extortion. It fears legal sanctions or a bad reputation and may be
forced to pay hush-money.
 Corrupt agreements cannot usually be legally enforced. A
potential risk is that public servants may fail to deliver after
receiving a bribe. Some firms may be more reluctant than others to
run such a risk.
 Bribes requested may rise with the propensity of a firm to pay.
3. Unilateral Approaches
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 The Wall Street Journal, Jan 31 2007, cites from the prosecutorial
investigation of M. Kutschenreuter, an executive manager at the
German Siemens: A former Saudi-Arabian local representative,
whose contract had been cancelled by Siemens, is supposed to
have blackmailed the firm. He requested more than 900 mio. US$ as
hush-money and threatened to pass on documents about
corruption in telecommunications contracts to the SEC otherwise.
In negotiations both sides agreed on a payment of 50 mio. US$.
3. Unilateral Approaches
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 A Hong Kong employee of the German Mannesmann was in
charge of paying bribes to Chinese officials in exchange for
contracts. It was later detected that he embezzled parts of the
money. But the firm did not bring the case to court, because the
employee threatened to expose the names of Chinese officials.
Being confronted with the death penalty in China, this would have
brought operation of Mannesmann in China to a standstill.
 A staff member of the Christian Democratic party in Hesse,
Germany, was alleged to have embezzled 1 Mio. DM of party funds.
But he was given impunity due to fears he may denounce the
party's illegal hidden accounts. The party even paid for his
gambling debts.
3. Unilateral Approaches
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 In a recent study about truck drivers in Indonesia, Bolken and
Barron (2007: 9-10) www.nber.org/papers/w13145, find that truck
drivers do not truthfully report to their companies about the bribes
they have to pay at checkpoints:
“By exaggerating bribe payments, drivers may be able to extract
more money from their bosses to pay bribes than they actually
need, and pocket the difference. In fact, we compared the amount
of bribes we observed on 40 trips between January 25th, 2006 and
February 20th, 2006 with twelve interviews we conducted around
the same time with drivers who had just completed their trips, and
found that on average the bribes drivers reported in interviews
were more than double the amount of the bribes we recorded by
direct observation.”
3. Unilateral Approaches
I have not taken any bribe
and I swear I’m not hiding
any money from you.
Those are false allegations
usually made during
elections to discredit our
party!
Laxman,
Times of India,
Nov. 13 2003
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3. Unilateral Approaches
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 Slush funds can be misappropriated by firm staff.
 The secrecy surrounding corrupt side-deals can be used by firm
staff to take their share. Employees are thus seduced to betrayal,
for example, by requesting a share of the bribes to be sent to their
own offshore bank accounts.
 Internal auditors can hardly distinguish between bribing in favor
of the firm and employee fraud. The red flags of the two misdoings
are similar:
3. Unilateral Approaches
Red Flags Employee Fraud
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Red Flags Bribery
 Extravagant lifestyle
 Vices such as gambling, drugs, stress
 Ego and status above hierarchical position
 Short vacation and unexplained hours
 Financial and organizational pressure
 Ongoing transactions with related parties and middlemen or with firms whose sole
rationale is to do business with your own company
 Believing that the firm does not prosecute or even tolerates secrecy and cooked
books
 Excessive magnitude of decentralized and autonomous authority
 Frequent cash transactions or payments to third parties other than the indicated
payee. Too many transactions in even thousands of dollars
 Consultancy contracts are repeatedly negotiated per unit of sales/revenue
 Commissions paid prior to sales or
incoming revenue
3. Unilateral Approaches
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Source: International Business Attitudes to Corruption – Survey 2006, Control Risks Group
3. Unilateral Approaches
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Source: International Business Attitudes to Corruption – Survey 2006, Control Risks Group
From news.com.au, April 11, 2001:
3. Unilateral Approaches
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For Jakub Bierzynski, the wake-up call was of a personal nature. Head of the
Warsaw-based media planning company OMD-Poland, a US-Polish joint
venture, Bierzynski was confronted by corruption last year when two big
international clients separately demanded bribes of "hundreds of thousands"
for two advertising contracts. "It was like a very cold shower. I asked myself
if I could do business in a corrupt environment," says Bierzynski, who had
incorrectly assumed his firm's US mother company afforded him a degree of
protection from kick-backs. The answer was no. "This is what scared me the
most (that despite OMD and the clients all being international companies),
they would dare to ask for a bribe," he says. "Leaving aside the moral
connotations of (giving bribes), I have no skills in giving bribes. I have never
done it before, I don't know how much, I don't know to whom and I don't
know in what situations I'm supposed to give bribes, so I am losing in that
competitive field and I am sentenced to death in the business world.”
Instead, the 34-year-old channeled his outrage into a proposal to launch an
anti-corruption business association unprecedented in central and Eastern
Europe, in which members would pledge not to offer or receive bribes.“
Appendix
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Discussions
1) Disregarding ethics, how would businesspeople and public
officials determine whether to engage in bribery?
2) What forces the bottom line of the moral code to win out?
3) Which are the two strategies for overcoming the prisoner’s
dilemma?
4) Do “good ethics” survive in reality? Why?
5) Discuss the subsequent case study! Why didn’t H. Davidson
discuss the dilemma with his superiors?
The Wall Street Journal Europe, Career Journal (03.12.2002):
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“In3.
1994,
Howard Davidson
faced his crucible. At the time, he was an investment banker,
Unilateral
Approaches
working in an Asian country. He was on the verge of pulling off a prestigious $500 million
(502.8 million euro) stock offering for an Asian utility. "We invested $11 million in the deal and
pre-sold the issue," recalls Mr. Davidson, now a financing consultant for the Institute, a
management-consulting firm in Redwood City, California. "At the last minute, I was
approached by a government official." The official's message: Give him a kickback or forget
the deal. "To him, it was as logical as day follows night," Mr. Davidson says. It would have
been simple to comply.
He felt he couldn't even share the decision with superiors at the bank. What if they
ordered him to pay up and push on with the offering? And with other people involved, how
could he be sure the whole sordid mess wouldn't leak to the press? […]
In the end, he declined and the deal was pulled, resulting in a lot of heat for his company
from an unknowing public. Press critics wondered aloud if the company knew how to pull off a
deal of that magnitude in a foreign land. The decision turned out well for Mr. Davidson, who
finally confided in his superiors afterwards. The company's senior executives felt he'd made
the right call, and he wound up with a promotion after his division went on to a "great year"
anyway, he recalls.
But it could have been a disaster. In another, less-ethical, get-the-job-done-at-any-cost
culture, he could have been pushed aside, ignored or outright vilified by co-workers and his
career could have come to a dead halt. […] In a highly competitive world, there's
considerable pressure to adopt that point of view. When bosses talk about doing "whatever it
takes" to make a sale, the salespeople see that as an easily decipherable code. Translation:
"Do whatever you have to, as long as it doesn't come back on me." There's also social
pressure to "go along with the gang." People who don't are ostracized. […]”