David Wolf of Wolf Group Asia,did a post on the China Stock Blog, entitled, “Dirty Dealings In China: Lucent Was the Warning Shot,” [link no longer exists] discussing the United States’ Securities and Exchange Commission’s (SEC) investigation of Lucent for possible violations of the U.S. Foreign Corrupt Practices Act.

Wolf wonders whether China information the U.S. government gleans from Lucent will lead to more investigations of U.S. companies doing business in China.  Wolf talks of having “regularly” heard “rumors of shady deals and payoffs, stories of children of prominent Chinese officials setting up technology consultancies to act as bag-men between U.S. tech firms and telecommunications operators.” Wolf discusses how kickbacks are part of the fabric of doing business in China:

Indeed, you needn’t look very hard to find corruption in business in China.  A young lady here in the Hutong took a call from a reputable Chinese insurance firm yesterday.  The agent at the other end of the phone, mistakenly thinking that the car the woman was responsible for insuring was a company car, offered her a 30% discount on the insurance, and an immediate 20% kickback on the premium to be paid in cash to the woman.  This was not an offer between two people well-acquainted with each other.  It was done sight unseen as if nothing could be more natural in the course of business.

Wolf then discusses how Chinese PR companies pay reporters about 1RMB per character to run positive stories about their clients, of which 25% of those fees is, in turn, kicked back to the individual media relations person at the agency.

I am far from an expert in the Foreign Corrupt Practices Act (and the lawyer in my firm who I would consult on this is presently somewhere in the mountains of Mongolia (and completely inaccessible), but it is my understanding that the FCPA applies only to payments (either directly or indirectly) to government officials.  The FCPA’s anti-bribery provisions make it unlawful to offer or make a payment of anything of value directly or indirectly to a foreign official, international organization official, political party or party official, or any candidate for public office, for the purpose of influencing that official to assist in obtaining or retaining business (15 U.S.C. §§78dd-1 to -3).  A covered company can be held liable for payments made on its behalf by agents or distributors.

In countries like China, where so many of the largest companies are state-owned, the chance of a “business” payment violating the FCPA is great.

Wolf concludes his post by asking a question and issuing a warning:

How many executives are going to realize that it’s time to start cleaning up the nonsense – big and small – that’s taking place in their companies?

Lucent was the warning shot, folks.  Time to start taking care of business – before the Feds come calling.

One of the things I have always found troubling about Westerners doing business in emerging market countries is that they sometimes take an almost perverse pride in discussing payoffs to government officials.  It is as though their having paid a bribe is a symbol of their international sophistication and insider knowledge.  Yet, countless times when I am told of the bribe, I know the very same thing could almost certainly have been accomplished without a bribe.

I firmly believe paying bribes is not only bad for one’s sleep patterns, it is bad business.  And go ahead and call me naive, but I also believe that most American companies agree with me on this.  (I refer to American companies here because the overwhelming bulk of my conversations regarding bribery have been with those at American companies).

If you are interested in reading more about corruption in foreign markets, and why it is to be avoided, I suggest reading “Saying No To Corruption And Make It Your Market Advantage,” an excellent post on the Going Global blog.  He says don’t do it.  I concur.

What do you think?

  • I agree that it’s bad form to pay bribes. Americans shouldn’t be encouraging the corruption of other governments.
    I’m actually somewhat surprised that a big company like Lucent got caught up in a bribery scandal. When I was in law school, it seemed as if FCPA was discussed on a somewhat regular basis (although I admit to taking a lot of international law and international business type courses). It would seem that the first thing out of Lucent’s in-house attorney’s mouth when discussing international business deals with Lucent execs would be, “if you get caught bribing another government’s officials you can be hailed into court in the U.S., so don’t do it.” But then again, it always seems odd to me that so many people commit “white-collar” crimes. The risks seem to outweigh the reward.

  • Fern —
    Thanks for checking in.
    The reality is that so long as people think they can get away with something they will do it and executives at big companies certainly are not immune to this. In my experience, if those at the top of a company make it VERY clear they will brook no illegalities, illegalities within the company are much less likely to occur.

  • Thanks for the link to the post at Going Global. In fairness, my general experience is that most companies want to do the right thing and set out only with good intentions, but it can be a slippery slope out there. Hence the paramount importance of constantly reminding oneself all the ways in which corruption is a losing long term strategy.

  • Craig —
    Thanks for checking in.
    It can be a slippery slope and I think many companies are of the view that they have no choice but to slide down it. But, it is amazing to me the near unanimity among people like us who provide services for the companies doing business in emerging markets that the best companies never waver and those that do usually pay one way or the other.

  • It’s really bad for Wolf to extrapolate the omnipresence of kickbacks in individual levels to the corporate level. One problem China had to solve is how to motivate the workforce from a communism entitlement mindset to be competitive. Fixed salary with defined rules for bonus don’t really work. Leveraging the personal entrepreneurial spirit was one of the tactics you could see deploy everywhere. The examples Wolf had in the article regarding to the PR firms and insurance sales. How do these companies motivate people to work hard? Bonus judging by the middle managers would simply bring the kickbacks problem from outside to inside the companies. Plus, without the trust on the integrity of the company’s accounting, profits sharing scheme for bonus allocation doesn’t work here.
    I am very sure the management of the insurance or PR companies know exactly what’s going on there but that’s probably the best tactic they have to motivate their workforce. Kickbacks at this level are most practical measurement of performance based bonus. I think this also help to explain how the twenty somethings in China having only RMB 2000 salary on the book can easily afford to change RMB 4000 cellphone frequently.
    The kickbacks in the individual level is really not far from performance based bonus in the US companies. Giving out bonus this way help the Chinese companies to avoid the lack of trust of company accounting and risk of office political fight.

  • FCPA deals with mostly nationalized industries in which American have powerful players. aerospace, military, telecom, power, steel and petroleum are primary example. Unlike the development in the US, most of these industries are nationalized in most countries until recently. The companies are protected and often time, their direction are not market driven and instead policy driven. This makes it very easy to bribe the politicians/officials to gain unfair advantage and often time, necessary practice.
    Not to justify the practice but these industries also have the most powerful lobbyists in Washington. The core competence of telecom is lobbying. Lobbying, campaign contribution and promise of seats on the boards or high level management are all legal in the US but I see the practices are really borderline bribery.

  • Dirty dealings in China

    Dan Harris, of China Law Blog, has writting an interesting post on bribery in China inspired by this one by David Wolf last month. Both pieces are well worth reading, but the bit I particularly liked in Dan’s post was this:
    One of the things I hav…

  • David Li (I) —
    Thanks for checking in.
    I disagree with you. Companies are responsible for the actions of their employees and the actions of a company’s employees reflect back on the company.
    I do however, agree that giving bonuses based on subjective criteria would, as you say, “bring the kickbacks problem from outside to inside the companies. Plus, without the trust on the integrity of the company’s accounting, profits sharing scheme for bonus allocation doesn’t work here.” But the solution to that is a well run company with safeguards. I realize this is not always possible, but top companies achieve it.
    You say that you are “very sure the management of the insurance or PR companies know exactly what’s going on there but that’s probably the best tactic they have to motivate their workforce,” and I tend to agree that the companies probably know. But I do not think they like it. Companies generally do not like what they cannot control and they cannot control this and I disagree with you that kickbacks are a good measurement of performance.
    You may be right that “giving out bonus this way help the Chinese companies to avoid the lack of trust of company accounting and risk of office political fight” but that just show that the companies lack control over their own employees and I cannot believe many companies would think this a good thing.

  • David Li (II) —
    I tend not to be a big fan of politicians/lobbying either.

  • Few top companies have archived it and the list get changed all the time. Jim Collins made a good book sales describing these companies http://www.jimcollins.com but few of them last. Top companies’ top managers are increasingly responsible to no-one but the analysts and fund managers of Wall-Street. That’s how we got Worldcom and Enron. With the stay of CEO cutting shorter and shorter, it’s never in their interest to look after employees, customers or even stock holders. Few executives are going to allow their practices to become as transparent as the open book management of Jack Stack (http://www.amazon.com/Great-Game-Business-Jack-Stack/dp/038547525X ). The MBA schools all like us to believe that if we hire enough MBAs, doing enough business process reengineering, hire enough internal control management, we can all archived the level of fairness.
    Well, human nature gets in the way and rumors travels faster then light in Chinese community. A friend of mine working for a big multinational in Shanghai has a rumor floating about her getting big bonus because she was sleeping with a manager in Beijing whom she had married to for two years! Even the company has fairly transparent policy on their accounting and their bonus were based on sales archived.
    Corporate culture matter and a lot of Western companies have great traditional of company men like the IBMers who were “gay” in dark suits and sang companies songs in the 60s and 70s. Japanese salarymen embraced and extend that culture. The underlying trust is loyal to the companies and companies will take care of you. The lifetime employment contract IBM and so many Japanese companies were proud of. As IBM and Japanese companies are abandoning the policy, China had to struggle hard to break free from the similar contract under communism to boost its economy.
    Right now, people in their 20s are expected to change on average jobs 15 times through out the lifetime. Business gurus are advocating flat organizations to give more power everyone in the companies. Companies have to lose control at the bottom to trade for creativity.
    I actually see the “kickbacks” practice in China to evolve in its own direction into the flat organization worlds. Well, using kickbacks may not be the best term, let’s try to picture companies as a factories/wholesellers of their products and the employees as entrepreneurs on the market selling the products. That’s actually not very different from the travel agents, car sales and insurance sales of the old in the US.
    Yes, it’s kind of annoying for us used to uniform pricing world to see place like China which bargain for everything in everywhere. I have to admitted that I was shocked at first. However, majority of the Chinese customers already assume the stores mark up the price for bargain and anyone who doesn’t bargain is sucker. The price difference between agents are not reflected on companies as unfair but mostly on individuals’ ability to bargain.
    Chinese companies have actually addicted to this type of tactic, swarming the markets with commission based sales. Most often this is dubbed as the “Surrounding the cities by the farms.” Ningbo and others overwhelm the MEN (Moto/Ericsson/Nokia) with the commissioned sales force in the secondary/thirdary cities and country sides. Companies don’t lose control over their employee, instead it helps them to trim their workforce with unpaid independent sales force. Companies also save the tiers of middle managers whose main jobs are controls.

  • Ed Hillier

    Reading these posts reminded me of one of my old students in China, who was the Financial Controller for the Chinese subsidiary of an American company in the hi-tech field. At one time, he habitually used to arrange for ‘sweeteners’ to be sent to his contact at the tax office, which were paid for by the company. As time went on, and the company took a stricter and stricter line in order to protect itself from FCPA liability, he was no longer able to do this, but faced a dilemma. The relationship with the tax official was very useful, but could not be maintained without the sweeteners. So, what he did, and what I guess many Chinese employees would do, even high level employees, is pay for the sweeteners out of his own pocket. The money didn’t come from the company, and my ex-student changed his frame of reference by considering the relationship he was maintaining to be his own personal asset which he could take with him if he ever moved into a new job.
    So, the interesting thing is how far the FCPA will drive bribery out of sight, rather than eliminating it.

  • Mr. Li —
    Thanks for checking back in. Okay, so bribery happens frequently in China and it is extremely difficult to stop. I agree. But are you saying everyone should just give up? Do you not believe that bribery drains companies and slows economies, even if just a little?

  • Mr. Hillier —
    Thanks for checking in. That is a great story and one I am sure has been duplicated countless times around the world. It also highlights a problem with bribery and that is that once it is given, it becomes an entitlement and is nearly impossible to cut off.
    Here’s my story and I am sure this story has also been duplicated countless times around the world. I am aware of a company that started out paying one bribe to an official. Soon, the official had a new boss who came to the company and said he was aware of the bribe to his underling and he wanted his cut too. Within years, this company was paying bribes to countless people throughout this ministry and other ministries and knew no way to stop. It eventually got so expensive they pulled out of the country.
    I remember seeing a split frame cartoon many years ago and in the first frame there were two people looking out the window at a bridge. The title of this frame was: “Asia.” A government official was saying to the other person, “see that bridge over there, I got 10% of it.” The second frame was titled: “Africa” and there were two people looking out over an empty field. The government official was saying to the other person, “see that bridge over there, I got 100% of it.”
    I am personally aware of countless companies that have chosen not to go into a country because of bribery and countless companies that have left a country because of bribery. I am also aware of countless companies based in corrupt countries that underreport their income and stash money outside the country just to avoid having to pay bribes.
    China is booming, no doubt, but bribery saps economies and creates inefficiencies. Once it takes force, it is extremely difficult to eradicate, but it must be done.
    Does anyone really think Shanghai will become the financial center of Asia wtih China’s present state of corruption?

  • Well, let’s distinguish two kind of briberies: governmental and corporate.
    For the governmental ones, I think it was positive for China when it was transforming from communism to capitalism. The corrupted ones were the effective ones eager to help business. However, as the government successfully moved into capitalism, their effective wears off and the crack down started. The taking down of Shanghai party secretary is the big warning shot coupling with Shenzhen’s experiment on performance bonus for the officials. I think that’s the trend for governmental. I don’t think it will evolve into the official/lobbists/management/board directors revolving door in the US.
    For the corporate “bribery,” I don’t think that’s going to change as it’s accepted norm. I think it engages the workforce as the benefit of hard work can easily be reflected in personal incomes. The practice is also much easier to understand then work ethic and professionalism. I think the relationship between employers/employees will evolve into more of a partnership. It works well right now since most Chinese companies are basically sales organization without deep R&D but may hurt in the long run as China moved to move innovative driven economy. However, it may not as the sales organizations become bigger and maturing of the venture funding.
    Looking at the relationship between established and startups these days in the US as a model. Big established companies like Google, CISCO, Pfizer, GE and others are not innovative from inside but depend on acquisitions for infusion of innovation.
    It’s still down to economy and what’s the best way for all players to benefit.

  • Mr. Li —
    You are right to distinguish between the two types of bribery, but wrong to think either is efficient. Those companies you mention are still innovative and they manage that while remaining essentially corruption free. And since when has bribery spurred innovation?

  • I think the bribery to the government officials had been effective in the 80s and probably early 90s. A lot of first generation Chinese business were basically kicked off my entrepreneurs and the officials in their pockets. It was a time when ideology was not completely switched to capitalism and there was still resisting hardliner in the government. The corrupted officials were the capitalist ones. I had several domestic brands owners told me that they prefer those taking bribery because those don’t were the lazy ones. Things began to change in the late 90s when the first generation has accumulated enough of their wealth and capitalism had entered full swing. Government started to shifted its attentions to the corruption. Corrupted officials became the used tools and the purge started in the costal cities. Shenzhen, Xiamen, Fuzhou and others have started to deal with corruption. In 2002, large numbers of Fuzhou’s official fled to Los Angeles but they were negotiate with the government now about returning. I guess it’s hard for them to get used the quiet suburban lives in Orange County. Shenzhen basically legalized the bribery as the performance bonus capping at USD$2 millions a year.
    The first generation rich in China are low key and cooperating with the government. I am not sure if it’s planned or by accident. However, the bribery/corruption has been a tool for the transition from communalism to capitalism. And the history of bribery and corruption has been a great purging and control tools for the central government.
    I wouldn’t say bribery is effective today but it has served a historical purpose. However, since Guanxi/Connection has been emphasized in so many “Doing business in China” books, there are cons preying on new companies whether domestic or foreign.

  • I don’t mean to list those companies (GE, Cisco, Pfizer) as example as bribery spur innovation but their current strategy of innovation to provide a way for the Chinese companies to grow without correcting the kickback seeking behaviors.
    Kickback seeking behavior has its roots in the first generation Chinese workforce entering the market after reform. Work ethic/professionalism were non-existence and the possibility of swinging back to communism from capitalism was still there. The kickback seeking ones were the aggressive capitalist ones. Thus, more useful then their communist comrades. Chinese companies are revenue driven instead of profit driven and love those who can increase sales. The employee of the month is the best at increase sales as well as his/her pocket. This becomes a norm in the general corporate culture.
    The practice was good for sales driven companies producing OEMed or pirated low tech products. However, it becomes problem as more R&D are required to turn companies into innovation driven ones. Nobody wants to stay in the R&D as there is no benefit in it. Take Chinese IT companies as example. Most of their average age of engineers are like 23 who are basically kids barely out of college and have no experience executing any project but homework. China started to pump out software engineers in early 90s. Where are the older 30 something engineers? Either become project managers (facing customers) or change jobs.
    As the innovation become more important for these companies, the imbalance pay off between front and back end workers have to be corrected. It’s hard transition. However, Chinese companies may not have to take it because of the innovation by acquisition strategies practiced by a lot of American companies today.
    GE under Jack Welch has been on shopping spree. Cisco has been doing that for decades. BEA has a nickname “Built Entirely on Acquisition.” The M&A bugs bite the big pharma in the 90s when FDA approval of a new drug cost passed $1 billion. They started to work with VC backed biotech startup to lower the risk. IBM, Oracle, Microsoft, Google and other have also on shopping spree.
    Innovation by Acquisition gave aggressive engineers another way out. Instead of moving to management, they can keep on being engineers. Companies get the benefit of having VCs sharing the risk of innovation. This may give established Chinese companies with aggressive sales tactic a strategy without risk of changing internal corporate culture.
    We have started to see this in the online game market as well as IT market. VC crazy about China like this as well. M&A gives new exit strategy and Chinese companies are cheaper to fund.
    Bribery does not spur innovation but greed does. 😉 Bill Gates is incorporated into the Shanghai High School text book for a good reason. Just hope the teachers will show his antitrust deposition video as supplement. 😉

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