N Vittal, former Central Vigilance Commissioner, in a recent book titled “Ending Corruption: How to Clean up India”, defines corruption as “the lack of integrity--whether intellectual, moral or financial”. International studies indicate that India falls among the bottom half of countries in the world in corruption rankings. Corruption reduces competitiveness of industry, leads to lower investments, misallocates capital, and increases income disparity--among other effects.
Measuring corruption, usually based on surveys
One of the key challenges to empirical research in the area of corruption is an appropriate measure of corruption. During the 90s, three different groups of measures appeared--indices like the International Country Risk Guide (ICRG), and Business International (BI) that were based on assessments of country experts. The next group were based on surveys of business people or the local public and these included indicators tracked by World Economic Forum (WEF), or the World Development Report (WDR). The last group was a set of “poll of polls”--the “Graft Index” of World Bank or Corruption Perception Index (CPI) of Transparency International. Given its amorphous nature, corruption measures tend to rely on surveys.
Survey of attitudes of Indian corporations
Between March and May 2013, E&Y along with FICCI conducted a survey among Indian businesses, and foreign companies operating in India. This survey was supplemented by inputs from private equity investors. The target companies surveyed had incomes between Rs 5000 crore, and Rs 10,000 crore. The report estimates that between October 2011 and September 2012, corruption related cases reported in the press (excluding large scams like 2G, commonwealth games and mining) led to potential loss to the Indian economy to the tune of
Rs 36,000 crore.
Some of the report's conclusions bear repeating:
1. “Strain on ethical behaviour: Alarmingly, a large number of respondents appeared to be comfortable with (or were aware of) unethical business conduct, including irregular accounting to hide bribery and corruption, gifts being given to seek favours and third parties being used to pay bribes.
2. Taking the easy way out: More than half of the respondents agreed that it is the lack of will to obtain licences and approvals the “right way,” which leads to bribery and corruption.
3. Need for greater enforcement of laws: Around 89 per cent of the respondents felt that there should be greater enforcement of laws to curb the proliferation of bribery and corruption.”
The survey further goes on to point out that 44 per cent of the respondents were in favour of legalising “facilitation payments”.
The other end of society
Centre for Media Studies (CMS), a not-for-profit think tank, has been studying corruption in India over years. In 2012, CMS revealed its 8th study in the series-- focussed on slums and basic services availed by residents of slums--and the amount of bribes to be paid to receive such services. Disturbingly, incidence of corruption has doubled over the period 2008-2012.
A lack of accountability
Vittal in his book identifies a lack of accountability as a key factor behind poor governance in India. He gives an example of dysfunctional governance. He states: “An example...is the Benami Transactions (Prohibition) Act, enacted in September 1988. Section 5 of the Act says that benami property will be confiscated by the government. Section 8 says that the government will prescribe the rules under which the confiscation will take place… over 20 years have passed, and the government has still not issued such instructions.”
The most corrupt sectors
The E&Y survey referred to earlier asked respondents to rank sectors based on perceived level of corruption. It is no surprise that sectors rated as most corrupt were those where government interface was the highest. Lowering government touch-points is definitely a way to reduce corruption.
Investment take-away
While making investment decisions, investors are forced to rely on financial statements as a source of information of how a company is performing. What happens when that document itself is not reliable? In the case of corrupt sectors, businesses, by their own admission, tend to distort financial reporting. If a management is willing to colour the accounts to adjust for bribes paid, is it likely that they will represent a true and fair picture in the account books for minority share-holders.
The irony is that even institutional investors who should know better are all too often prone to look the other way. The survey notes that “Around 93 per cent of the respondents representing PE firms indicated that accounting fraud is the most common fraudulent practice observed in India.” Despite this, “73 per cent of PE respondents' organisations do not conduct anti-bribery and corruption due-diligence before investing.”
As investors, it is important to realise that “audited” statements do not necessarily mean a true picture of a company's health. Investing in real estate companies is, for example, more a macro call on the sector--rather than a careful analysis of the financial statements. The financial statements reveal nothing of importance-- only a carefully crafted story that the management wants investors to see.
Correction has to start from the top
As India enters into another set of elections, it is important to realise that each one of us is impacted by corruption, and in most cases, negatively. If leaders we chose are honest, the system will start to correct itself. When voting, as in investing, choose carefully and avoid the rotten apples.
This article was originally published on December 06, 2013.
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