By Matthew Stephenson, Professor, Harvard Law School

This post originally appeared at the Global Anticorruption Blog.

Several months ago I did a couple of posts (here and here) on the Transparency International USA report from a couple months back on verification of corporate anti-corruption compliance programs. That report also got me thinking about a more general question: Should governments provide a subsidy (perhaps in the form of a tax credit) for businesses — particularly small and medium-sized enterprises — to support spending on the design, evaluation, and testing of their anti-bribery compliance programs?

I haven’t yet come across anything that advocates for something like this, so let me make a tentative case for why it might be a good idea:

The basic justification is straight out of Econ 101: Investments in compliance have “positive externalities” — that is, they have socially desirable effects that the companies that invest in compliance can’t capture as profits. So, all else equal, the companies will tend to invest too little (from a social point of view) in compliance — which is, after all, expensive.

One way to deal with this — what we do now — is to impose penalties on companies for the harms that result from compliance failures. (After all, in this case the principal “positive externality” associated with an effective compliance system is a reduction in the probability of the large “negative externality” that results from corporate bribery.) In a perfect world, that should do the trick: If we set the expected penalty (discounted by the probability of detection) at the right level, then firms should have an incentive to invest optimally in compliance and other forms of prevention.  But there are a couple reasons that in the real world, this isn’t working (and isn’t likely to work).

  • First, the expected penalties a firm faces for failing to prevent bribery are likely to be far too small to induce optimal investment in compliance. Although I’m not aware of any research on this precise question (which would involve estimating the social harm of bribery, and the marginal effect of additional investment in compliance), related research — which I’ve discussed in an earlier post — suggests that to deter all foreign bribery, FCPA sanctions, or the probability of detection, would need to increase by almost an order of magnitude.
  • Second, there’s a lot of evidence to suggest that human decision-makers (including corporate executives) tend to under-weight the significance of very-low-probability events (unless they’ve experienced those events personally, or know someone who has, or can call to mind a particularly vivid example). If a firm hasn’t had to deal with an FCPA investigation or similar, its senior executives (outside of the compliance department) are likely to underestimate the probability of running into trouble with bribery. This is especially likely to be the case for small or mid-sized firms with less experience expanding into foreign markets.

So, if the stick alone won’t work, how about the carrot? Particularly for small and mid-sized firms, that find it harder than giants like GE or Exxon to absorb the fixed costs associated with designing, implementing, and regularly testing a corporate compliance program, why not offer a tax credit for legitimate expenditures on compliance services?  After all, the U.S. government offers all sorts of tax incentives to get business (especially small businesses) to spend more on things like general research & development, clinical testing of orphan drugs, compliance with the Americans with Disabilities Act, investing in low-income communitiesstarting employee pension plans, and providing childcare for employees. (There are also specialized credits for particular industries, including subsidies for things like maintaining railroad tracks and training mine rescue teams.) So why not a credit for expenditures associated with anti-bribery compliance programs, or legal compliance more generally?

Of course, it may be harder to verify that money spent on compliance services actually works, compared with some of these other tax credits. But it’s unlikely that many companies would have an incentive to waste money on pointless compliance exercises. After all, a well-designed subsidy wouldn’t cover all the costs, and as long as a firm was spending something on compliance services, it would presumably have an incentive to spend that money effectively. The subsidy would just encourage them to spend more.

Doing something like this could have a number of benefits. Most obviously, it would increase the total amount spent on compliance. It would be a boon (in a good way) to firms offering compliance consulting services. The businesses eligible for the subsidy would clearly benefit too. And it would send the signal that the government isn’t just in the business of threatening and punishing, but wants to give a hand to businesses — especially smaller businesses — that want to enter emerging markets but face higher costs of doing so because of corruption risk.

Of course, there are downsides too — most obviously, the lost government revenue and the risk of fraud and abuse. There are probably additional disadvantages and complications that would occur to me if I thought about this longer.  But I guess the only point I want to make in this post is that I think it’s worth thinking about. Couldn’t the business community, the compliance industry (the various law, accounting, and consulting firms that supply compliance-related services), and the anticorruption advocacy community come together behind a proposal for something like this?