New Banditry, New Solutions

Kennan Institute event

Faced with a corrupt judicial system, what strategies do Russian businesses employ to resolve business disputes?  Lately, less murder and more litigation.

Faced with multinational firms who are liable under U.S. and U.K. laws for their Russian partners’ corrupt practices, how do Russian businesses gain access to international partners? Start putting in place anti-corruption compliance programs.

Those were some of the answers that came from experts from Russia and the U.S. had some answers at a recent panel discussion co-hosted by CIPE and the Kennan Institute, “Corruption and Business in Russian: National Problem, Regional Solutions.” Jordan Gans-Morse, an assistant professor of political science at Northwestern University, presented the results of his innovative research on how non-oligarchic firms are surviving in an atmosphere of endemic corruption. Against this backdrop, CIPE Moscow Program Officer Natalya L. Titova, joined by CIPE partners from St. Petersburg, Chelyabinsk, and Kaliningrad, spoke about a CIPE program in Russia that is helping regional businesses to meet international anti-corruption standards in order to join global value chains.

Gans-Morse began with a surprising finding: although the last decade saw no change in Russian firms’ perception of judicial corruption, it witnessed a dramatic increase in firms’ use of legal (as opposed to corrupt) remedies to settle property and contract disputes.

The number of annual cases initiated by firms in Russian commercial courts jumped from 202,782 in 1992 to more than a million in 2009. Over the same decade, the use of violence as a commercial solution decreased, with annual murders of business people dropping from 217 to 33. He was faced with a puzzle. Russia is widely considered corrupt and lacking in rule of law, yet violence and corruption in Russian business conflicts decreased and the use of law increased.

To explain this puzzle, he conducted 90 interviews throughout 2009 in Moscow and Siberia with 56 business people, 22 lawyers, and 12 private security agencies. In the summer of 2010, he surveyed a random sampling of 301 enterprises. His research revealed that the trends did not stem from changes in norms or legal reforms, but rather from changes in the Russian economy and within Russian firms.

Russian firms underwent three major changes over the past decade. First, more firms do business through banks, rather relying on cash. Firms that primarily used cash transactions were more likely to resort to illegal means of solving disputes, including mafia violence and back channel deals with court officials, bureaucrats, and law enforcement officers.

Second, ownership has consolidated at many firms, with 75 percent of industrial firms owned by a single majority shareholder. Consolidation is likely to lead to a longer-term outlook focused on reducing conflict and asset stripping, long-term investments, and the need for a stable, predictable business environment. Majority owners also have more at stake personally and are thus more likely to be risk adverse.

Third, and most significantly for CIPE, firms have come to rely more heavily on foreign financing, particularly foreign direct investment (FDI). Foreign finance impacts firms’ strategies both before and after investment. Before investment, firms must consider how their corruption-related reputation impacts their perceived value and attractiveness. After investment, multinationals are concerned about home country regulations, including the U.S. Foreign Corrupt Practices Act (FCPA) and the United Kingdom Bribery Act (UKBA). FDI also tends to attract top law and accounting firms that offer top-notch anti-corruption compliance services. Moreover, Russian employees that work at multinationals often move on to  big local Russian firms, bringing with them a shift in mentality about acceptable methods of doing business.

While Gans-Morse’s research revealing the increased use of legal methods by Russian firms is a positive sign, some of his other findings were troubling.  He found that private threats to property, prevalent in the 1990s, had been replaced by state threats to property. Even as violence from the private sector declined, businesses faced increased threats from state elements, particularly bureaucrats taking advantage of inspections and licensing.

One small business owner from Moscow told Gans-Morse, “[Fifteen years ago] it was easy to distinguish between bandity and non-bandity. Today, in Moscow alone, there are over 50 organizations that have the direct right to inspect and block the work of an enterprise.” State actors also initiated an increased number of unfounded raids for fraud and money-laundering, which led to business people being thrown in jail until they agreed to hand over assets. This corrupt environment puts pressure on firms to engage in corrupt practices because “everyone else is doing it.” Gans-Morse ‘s research revealed that mid-sized firms, employing 250 to 500 people, were the group most likely to use informal connections because they did not want laws and regulations to inhibit their business expansion.

Despite the greater likelihood of mid-sized firms using informal connections, recent trends provide strong incentives for them to avoid corrupt practices. Multinational companies face liability for corruption through laws such as the FCPA and the UKBA. Both laws include liability for third-party acts. If a multinational firm contracts with a supplier or vendor in another country, and an employee of that supplier or vendor pays a bribe, the multinational can face fines and criminal prosecution. Thus, a mid-sized company that wants to join global value chains needs to demonstrate its compliance with international anti-corruption standards.

Natalya Titova explained how CIPE’s Russia program is helping mid-sized companies do just that. CIPE will provide training for compliance consultants in regional chambers of commerce. This training focuses on establishing the importance of anti-corruption compliance for regional firms, identifying and mitigating risks, building a strong compliance program within a firm, and marketing compliance services to mid-sized firms. The chambers of commerce will then sell compliance services to mid-sized firms, helping them expand their global reach by reducing business risk.

Such efforts provide reason to hope that the next decade will bring even further decreases in corrupt practices by Russian firms and an increase in the culture of compliance.

Peako Jenkins is a Program Assistant for the Middle East & North Africa at CIPE.