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How to succeed in frontier markets while avoiding corruption

Developing and emerging markets often hold out the prospect of big rewards – and big risks. Tim Gocher shows how to avoid the traps

By Tim Gocher 06 September 2018

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Multinational corporations (MNCs) and international investors are expanding into frontier markets for both growth and impact. By 2020, low-income countries (including Ethiopia, Uganda, Cambodia and Nepal) will have populations of 700 million people and average GDP growth of 5.8%, compared to 1.8% for the EU and US. As a category, they are the fastest growing markets on earth. At the same time, the importance of wealth creation and environmental improvement is far greater than in developed markets. Creating quality employment in the world’s poorest countries gives security and hope. This impact matters to companies pursuing Sustainable Development Goals (SDGs). There is growing evidence that impact and sustainability also improve valuations.

In a previous article I described how investors entering frontier markets can reduce market-level corruption by stimulating a competitive and regulatory response. This follow-up is a practical guide to those investing in systemically corrupt markets, common in frontier markets and some developing/emerging markets with weak institutions. The examples and tips below, based on research with MNCs and investors, are about things investors can do themselves, rather than policy, legal or criminal justice reform. They underscore the importance of good governance.

Corruption: abuse of power for private gain 

Corruption is widespread in frontier markets and represents a reputational risk – and sometimes even personal criminal liability – for international investors. Think beyond bribes and brown paper envelopes. Corruption covers many sins, including embezzlement, theft within a company, tax evasion, even nepotism.

Transparency International (TI) defines corruption as “the abuse of entrusted power for private gain”. I would include skimping on environmental and social governance (ESG), health and safety and construction standards. If you have doubts about this, think of the 2013 Bangladesh garment factory collapse that killed 1,134.

Corruption can occur at the interface of public and private sector (for example, government procurement, tax evasion, obtaining licences), or between or within companies. It distorts resource allocation in an economy, depriving those who can’t or won’t play along – an especially cruel outcome in frontier markets, where extreme poverty is common.

From the moment of initial registration to interactions for visas, tax and regulation, investors in frontier markets face hurdles. Research shows a strong correlation between TI’s Corruption Perceptions Index (CPI) and the World Bank’s Doing Business index, which measures the regulatory ease of starting and running a business. These indexes also show a strong correlation with poverty - the more corruption, the harder it is to grow businesses that create jobs and broad-based prosperity.

This is because, as most recent empirical studies find, paying a bribe doesn’t speed up transactions, as you might expect. Instead, bribe-payers spend more time and money interfacing with government than non-bribe-payers. One estimate is that, at company level, a 1% increase in bribery is associated with a 3% decrease in growth. What’s more, when a bribe is paid, word quickly gets around, encouraging other demands.

At a market or country level, each time a low-paid bureaucrat benefits from corruption, there is an incentive to make regulations more complex and cumbersome – giving more opportunities to demand and offer pay-offs. Play this out over years or decades of rational yet unscrupulous decisions, with a participating private sector, and the bureaucracy metastasises into a labyrinth that stifles entrepreneurs and growth. Moreover, during this process non-corruptible and high-quality employees tend to leave until, as Susan Rose-Ackerman beautifully puts it, “High corruption and incompetence go hand in hand, reinforcing one another”. So, when you’re asked to produce an irrelevant document for the tenth signature, you don’t know whether it’s a demand for a bribe or simply failure to understand its relevance.

Avoiding corruption

How do international investors navigate the resulting thicket of bureaucracy without breaching corporate codes of ethics? In a market where corruption is systemic, what happens if a private sector actor can’t or won’t play the game? A growing number of international investors and MNCs operate with zero tolerance of corruption and make superior returns. Other than patience, which is always required, here’s how some of them do it.

1 Align the workforce and build trust. 

The first step is to hire locals, then train and develop them. Experienced companies establish a national staff association or similar to ensure participation in management decisions and avoid “them and us”. It is important to build a culture of disclosure and openness, with a whistle-blowing policy which may not be usual in local cultures, as is inculcating ESG and quality standards in all staff – not only for compliance but as a long-term, risk-management measure.

Have all staff sign an updated code of ethics/anti-corruption policy each year. It’s good policy to reward local staff through long-term employee stock option plans (ESOPs) or equivalent programmes to help avoid short-term temptation.

 

2 Dealing with governments is key. 


Get to know local leaders and progressive policymakers who either don’t play the game or at least value your brand and investment above self-interest. Pay your taxes – and not just for compliance: in countries where few companies are tax-compliant or large enough to make a difference to the treasury, you may be both. Use this influence to ease bottlenecks and lobby for reform. Embassies, aid organisations and NGOs are often well-connected and sometimes have clout. It serves all parties to cultivate competent civil servants and help them build capacity. It can be useful to co-invest with sovereign/multilateral- backed development finance institutions, who are experts in frontier markets, with strong anti-corruption policies.

3 Source local partners.


A local partner can be vital for market knowledge and immediate capacity; in some locations foreign direct investment restrictions may require one. Be aware that this can be the most important, and least reversible step. However, avoid seeking due diligence perfection (you may not find it); but do seek alignment of intent and a culture of full disclosure – warts and all. Partners who need access to international products/ quality/capital to achieve their goals know that compliance is necessary. In a minority equity position in a joint venture or an investee, it’s wise to take board seats, agree “affirmative rights”/veto on major decisions (rights issues, new debt, major contracts, etc.) and define and agree accounting checks. How hard did they negotiate? Easy negotiations can be a warning sign.

4 Look right down the supply chain 

Here lurk some of the biggest reputational risks. In tenders, ensure ESG, health and safety and quality are built into requests for proposals and insist on the same for all sub-contractors. Support this with training, capacity-building and random audits. As with partners, look for alignment and a culture of disclosure in local suppliers rather than perfection. Local firms may not have experience of your standards. Do a standards gap analysis, agree action plans, and provide training.

Conclusion


Successful frontier market investors build trust among local employees, stakeholders and governments. Trust should be viewed in broad terms, believing that an outcome is possible. In nations where there are few success stories from compliant businesses, this isn’t easy. But for many MNCs, investment funds and impact funds, frontier markets are a land of opportunity. Ultimately, if an employee, stakeholder or government official feels they will be better off by not engaging in corruption, they won’t bother.

Puneet Varshney, Managing Director of Coca-Cola Nepal, sums it up best: “We are committed to building an ethical business culture and have a zero-tolerance approach to corruption. By supporting government policy and complying with all regulatory and fiscal obligations, we contribute to stronger institutions and communities. This commitment not only helps us grow our business long-term, it also ensures we attract the best talent.”

This platform has enabled the company’s impressive business results. It posted return on equity of 29% in 2016-17.

Coca-Cola: Managing a code of ethics throughout the supply chain

Coca-Cola’s Supplier Guiding Principles are applied globally and are vital in frontier markets to combat any abuse of power throughout the supply chain. In the poorest nations, using local contractors is essential and stimulates the economy. Contractors need to complete an online form, monitored at company headquarters in Atlanta, Georgia. Any red flags are investigated. Contractors and all sub-contractors are required to provide documentary proof of anti-corruption compliance and observe good practice in the following from the code of ethics: freedom of association and collective bargaining prohibit child labour, prohibit forced labour and abuse of labour, eliminate discrimination, workhours and wages, provide a safe and healthy workplace, protect the environment, business integrity, grievance procedure and remedy, management systems for ensuring lawful compliance and respect for all human rights. Compliance is regularly monitored through independent third parties, along with training and capacity-building, with compliance results published in a Sustainability Report. 

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