What investors can do to crack down on corruption

Investors are forcing the hand of companies in combatting corruption for fear that the issue, if left unchecked, could come back to haunt them

Volkswagen fraud
Massachusetts Attorney General Maura Healey announces lawsuits against Volkswagen for the sale of diesel vehicles fitted with ‘defeat devices’ 

A number of recent incidents have succeeded in shining a light on corporate corruption. In doing so, they have underlined the degree to which many have been allowed to misuse or abuse the trust placed in them by stakeholders up and down the value chain. In answer to the crisis, and for the first time in what seems like forever, investors are finally taking the issue seriously.

The LuxLeaks scandal made public hundreds of tax rulings and showed how over 350 multinationals had signed secret tax arrangements with Luxembourg, while the Petrobras scandal succeeded ultimately in toppling a president. Last year, Volkswagen’s market cap lost roughly $20bn as a result of its emissions scandal, while Turing’s ‘bad boy’ CEO Martin Shkreli was arrested on charges of stock fraud. These cases – while far apart in nature – are but a taster of the crisis gripping the corporate world, and while consumers are more skeptical of companies than in the past, negative perceptions will only take you so far.

Oversight and compliance have been paid more mind as a result, and much of the focus on governance has been driven by shareholders keen not to have their fingers burned like those before them. As much as corruption has been allowed to continue unfettered in years past, the issue threatens huge financial ramifications – not just for the offending companies, but for investors too if it’s allowed to go on.

The damage corruption does to a company
According to Lauren Compere, Director of Shareholder Engagement at Boston Common Asset Management: “Corruption can cause huge reputational and financial damage to companies.” The issue itself represents a five percent drag on global GDP each year and can add up to 10 percent to the cost of doing business globally, while adding even more in developing markets. Furthermore, she said, it can inhibit competition, siphon profits to the corrupt, and damage economic value. “Proactively engaging on anti-corruption measures helps to minimise these risks and protect value for companies and investors alike.”

Boston Common is more learned in these matters than most, and expects good corporate governance business practices from the companies in which it invests. “We actively engage as a firm and in collaboration with other investors – both at company level and at policy level”, said Compere.

Corruption represents a five percent drag on global GDP each year and can add up to 10 percent to the cost of doing business globally

Earlier this year, the firm was one of a 22-investor coalition, worth over half a trillion dollars collectively, that signed a letter calling on Congress to end shell company secrecy (anonymously owned, non-trading companies that can be used by owners for tax avoidance), as seen in the Panama Papers leak. Compere told World Finance: “Corporate secrecy and lack of transparency and accountability carries real risk for companies and investors – not to mention bottom line costs if corruption is involved.”

Also testament to Boston Common’s activity in this field was its contribution as part of a $1.7trn investor coalition in the period between 2010 and 2013, which engaged with 21 companies in 14 countries and encouraged them to demonstrate they had appropriate anti-corruption controls. Compere said the companies were assessed against as many as 50 indicators, all relating to their anti-corruption strategy, policy and management systems. As a result, 16 companies improved their score against the indicators, and the engagement was hailed as a fantastic result in terms of achieving greater disclosure of bribery and corruption risks.

Christina Hillesöy, Chairwoman of the Ethical Council and contributor to the project, said anti-corruption had been a key priority for the group, since corruption “undermines the legitimacy and sustainability of economic systems and provides huge risks to the companies we invest in”. Meanwhile Ann Byrne, CEO of the Australian Council for Superannuation Investors – again a major contributor to the project – told World Finance: “As long-term investors, we have a responsibility to address the impact that bribery and corruption has on investment returns, market volatility and uncertainty in company performance.”

Granted, there’s some way to go yet before companies embed anti-bribery and anti-corruption mechanisms as part of their corporate culture. Progress so far has been muted, and what little has been done has been clouded by a string of companies for which saying and doing are far-removed concepts. Tackling corruption can prove a costly endeavour, and for as long as spending on this subject is seen as a zero sum game, corporations are unlikely to commit with quite the same fervour as specialist agents like Boston Common.

Investors join the fight
As undeniably complex as the issue of corruption is, Compere is right to highlight the potential on the investor side to inspire change. After all, corporates are accountable to investors more than ever before; in light of this rising focus on governance and a concerted movement to stamp out corruption, calls from the investment community could well be the incentive companies so desperately need.

“The investment community has a critical role to play”, according to Compere. “A key part of an investor’s job is to know and understand risk. Understanding risk requires access to information. This means greater transparency and requires regular disclosure and uniform reporting from companies.” By engaging with companies and policymakers, she said, asset managers can push for companies to increase transparency, and thus reduce the opportunity to carry out corrupt practices.

Asked what the client response had been like to this line of thinking, Compere said many saw this willingness to engage as a valuable service in preserving their wealth. She explained: “Our clients work with us because we seek to invest in companies that have good corporate governance and sustainability practices. If a controversy arises, they expect us to proactively engage with the company to understand what happened and encourage them to change policies and procedures to prevent such incidents in the future, as was the case with our recent engagement with GlaxoSmithKline [GSK].”

Investors can ask companies for increased transparency and disclosure of how they are managing bribery and corruption risks

This is a reference to GSK’s crisis-hit operation in China, which was dogged by accusations of corruption when, following a 15-month investigation, it emerged bribes had been used to encourage doctors to prescribe certain drugs. The findings resulted in a $490m fine and a suspended three-year prison sentence for the firm’s former Head of Chinese Operations, Mark Reilly.

As the bribery scandal regarding third party intermediaries in China was revealed, Boston Common engaged GSK at the highest level to understand what actions and policy changes it was undertaking to eliminate the conditions and underlying incentives that allowed this to happen. The resulting policy changes included the adoption of a new compensation practice for sales professionals, and no longer making direct payments to healthcare professionals linked to prescription drugs and vaccines.

Model methods
As extreme an example as GSK is, a look at the case and the resulting reforms indicates exactly where the easy wins lie – certainly from the investor’s point of view.

Compere said: “An important first step investors can take is to ask companies for increased transparency and disclosure of how they are managing bribery and corruption risks, not only with their own employees but customers, suppliers, vendors, governments, and any other intermediaries.” Those with poor disclosure standards are more likely to have a culture in which corruption is allowed to play out unchecked, as well as a poor risk management processes on the whole.

Among Boston Common’s top recommendations for investors is that they should look or ask for reporting in line with international frameworks, such as the International Corporate Governance Network’s Statement and Guidance on Anti-Corruption Practices or the UN Global Compact’s Reporting Guidance on the 10th Principle Against Corruption. The Principles for Responsible Investment, of which Boston Common is a member, also issued recent guidance on engaging with anti-bribery and corruption with the UN Global Compact.

According to Compere: “Access to reliable and accurate information is a hallmark of well-functioning financial markets. Therefore we need policies that effectively ensure information is disclosed regularly and accurately.” Real and/or perceived pressures to meet targets can stand in the way of meaningful reforms, with many executives clinging to the opinion that tighter governance succeeds only in squeezing margins. The investment community has an important part to play in pushing against this misconception and in deconstructing attitudes about the perceived costs of implementing anti-corruption measures.

Success in convincing companies to share and not hide information is the crucial first step on the road to a transparent and sustainable organisation. Clearly, corruption can quickly become a financial burden for offending organisations. If the companies themselves refuse to commit, investors must make their voices heard – their interest in profit, after all, is the same as any company’s.