Foundations of Texas and the ROE from a Best Practices Compliance Program

by Thomas Fox

On March 2, we here in the great state of Texas celebrated the 180th founding of our Republic, which occurred in 1836 with the aptly named settlement of Washington-on-the–Brazos, where delegates signed the Texas Declaration of Independence. Tomorrow, March 5, we will celebrate one of the moments defining what it means to be a Texan, the fall of the Alamo. Usually, I use this date to recall former Head of the Department of Justice (DOJ) Foreign Corrupt Practices Act (FCPA) unit Chuck Duross’ comment that Chief Compliance Officers (CCOs) are the Alamo of their company. I should note that Duross cited it to convey the concept that CCOs are the last line of defense in a company against bribery, corruption and other associated illegal acts, not the part of the Alamo legend where everyone is slaughtered for their standing up for their beliefs.

Today I want explore the March 2 anniversary as my starting point to think about the Holy Grail of compliance, that being the Return on Investment (ROI) for your compliance program. In an interesting The Accounting Review academic paper, entitled “An Analysis of Firms’ Self-Reported Anticorruption Efforts”, the authors, Paul M. Healy and George Serafeim, looked at the issue of not simply profitability of companies, which had more robust anti-corruption compliance programs but also what was the direct effect on the companies’ return on equity (ROE) in countries that were perceived to have a high incidence of corruption, under the Transparency International – Corruption Perceptions Index (TI-CPI). Although the piece was very math heavy, it yielded some very interesting results.

The first finding was that companies with good governance tended to have more robust compliance programs. The authors noted, “Managers of firms with independent and engaged board oversight may take anticorruption laws and enforcement seriously and adopt/enforce policies to deter corruption.” Conversely, they noted, “some investors, boards, and managers may jointly view corruption as an unavoidable cost of doing business in certain parts of the world, yet engage in cheap talk in an effort to reduce regulatory costs.” This good governance was more than simply tone at the top. It was also measured by board independence and board oversight of a company’s compliance program.

Not surprisingly, in countries where there is a low risk for corruption, there was not much difference in the sales growth for companies with robust anti-corruption compliance programs and those businesses feature in the authors’ ‘cheap talk’ category. However, when it came to growth in countries that had a high propensity of corruption, there was a dramatic difference.

While it was laid out in table form, the authors’ explained, “Using the across-firm segment classification, the estimates imply that for the median sample company, a 10 percent increase in sales in low corruption geographic segments increases ROE by 17 basis points (0.10 * 1.738), whereas a 10 percent increase in sales in high corruption segments decreases ROE by 7 basis points (0.10 * 0.733). Using the within firm geographic segment classification, the estimates imply that a 10 percent increase in sales in low corruption geographic segments increases ROE by 14 basis points, whereas a comparable sales increase in high corruption segments decreases ROE by 10 basis points. Therefore, the effect on company ROE from increasing sales in high versus low corruption segments is -24 basis points.”

Translating that into language for a lawyer or compliance practitioner, this means there is a negative relation between investments and a company’s return on that investment in high countries where the company did not have an effective compliance program. This is true even in the face of increased sales growth. For firms that had as high as 10% growth in high-risk countries, if they did not have a robust compliance program in place, the negative ROE was between 24 to 30%. As the authors stated, “for firms with high residual anticorruption ratings and sales growth in corrupt geographic segments is positive and significant… Firms with high residual ratings that grow sales in high corruption geographic segments, therefore, do so without lowering their ROE.

Having been raised in an academic household, when quantitative types say the following, “The magnitudes of the estimated coefficients are economically interesting”; it is a HUGE deal. These findings are equally large and important for the CCO or compliance practitioner. The authors conclude by making several observations. First, companies that have more robust compliance programs are from countries that have more robust enforcement and monitoring. Second, the more robust your compliance program is the lower your sales growth may be but the higher your overall return in a high-risk country will be going forward. Finally, even if a company sustains high sales grow in a high-risk country, if it does not have a robust compliance program, the sales will drop off dramatically and may well lead to negative ROE.

All of this information points to companies that are on the Ethisphere list of the World’s Most Ethical Companies and their financial performance. They have better than average financial performance because they are better run. They are on this list because they have robust finance internal controls that include compliance internal controls. To mix metaphors, robust internal controls around compliance do not slow you down but allow you to go faster and move more safely into high-risk countries.

So the next time some business type tries to say that following the law by having a robust FCPA anti-corruption compliance program in place hinders business, you can correct him. Spikes in sales in high-risk countries do not translate into sustained growth and without an effective compliance program in place your company may actually lose money.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Thomas Fox, Compliance Evangelist | Attorney Advertising

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