The effects of private sector corruption on business and what to do about it (lesson for VET)


by Linda Ray, Demand Media,

Corruption inevitably leads to a diminished business climate when the public trust is put at risk, according to Stanford Graduate School of Business. Corruption can take many forms that can include graft, bribery, embezzlement and extortion. Its existence reduces business credibility and profits when professionals misuse their positions for personal gain.


When resources are tampered with and used improperly, the efficiency of a business suffers. Insufficient resources are available to effectively run the business and maintain its levels of operations. When the news about corrupt business professionals breaks, customers lose respect and trust, requiring company officials to spend valuable time and resources to monitor the fallout and reassure clients the company is still viable. Legal fees, penalties and public relations efforts reroute important resources form the core business and lead to an inefficient use of company funds and personnel.

Lost resources

In addition to the inefficient use of resources, corruption can have a number of other economic impacts on business. Employee ranks often are inflated to cover up the corrupt professional’s activities. The cost of increasing employee ranks in addition to any embezzlement that is going on is passed on to consumers in the form of higher prices. Prices also can be inflated when corruption takes place outside a company in the form of corrupt government officials who take bribes. Consumers pay the costs of vendor corruption when purchasing agents require payoffs, or when vendors skim profits and raise prices to cover their illegal activities.

Related Reading: Effects of Technology on Business Communications

Weakened development

Investors are skeptical of doing business with companies and municipalities that are known for corruption. Whether you are seeking investment to grow your firm or you sell investments for a living, you will have a much harder time finding willing investors when bribes or in-kind favors are required, or your business has a history of corruption within its ranks. Competition is unfairly affected when investors’ risk is multiplied by changing business climates that follow corrupt business practices. Due diligence is defeated when the facts change according to the current levels of corruption. Practical investors steer clear of businesses with a corrupt history.

Increases crime

The results of corruption in business add to the burgeoning roles of crime-fighting government agencies, police departments and internal investigators. The trickledown effect of corruption usually ends up feeding black market interests, and may even support the efforts of organized crime as the activities infiltrate various business levels.

Corruption begets continued criminal activity when it goes undetected. The effects of corruption in emerging third world countries is evident and widespread, but even in America, where competition and greed can outweigh the good of society, corruption fuels the growth of criminal enterprises and eventually affects the society in which the business operates.

Part two – Corruption prevention

Extract: UNITED NATIONS INDUSTRIAL DEVELOPMENT ORGANIZATION, Corruption prevention to foster small and medium-sized enterprise development,

In the course of the two-day Expert Group Meeting on Small Business Development and Corruption, held in Vienna on 6-7 March, 2006, potential measures and tools were discussed to support smaller businesses to fight corruption in their business operations. Those include measures that are directed specifically at the SMEs themselves, and initiatives that need to be launched by other institutions tailored to the needs of small companies.

This part of the publication will only provide an overview of the discussions that took place in this context and summarize the main aspects that arose. Detailed information will be provided in a separate document that will be published after a series of planned missions and focus group meetings on that particular topic in Colombia, Croatia, Indonesia and Malawi.

In general, private sector anti-corruption strategies are linked closely to corporate social responsibility (CSR) practices focusing on internal measures that are implemented by the individual company. However, when assessing appropriate tools for SMEs, the analysis provided in the first part of this publication clearly shows that more needs to be done in that respect. Even though internal measures are usually implemented more easily and quicker in SMEs than in large companies, internal codes of conduct and compliance programmes alone are in many cases not helpful for SMEs, as they usually lack either the resources or the market power to stand by their zero-tolerance policies.

In particular, they risk being driven out of their market by competitors that do not adhere to such standards. One way to support those companies that do not have the power to tackle the problem alone is collective action. Measures that need to be taken in order to enable SMEs to defend themselves in a better way when faced with corruption need to be taken at three levels, namely the micro, the meso and the macro level. On the “micro level”, measures adjusting business practices to be applied internally by SMEs need to be addressed. Article 12 of the United Nations Convention against Corruption is specifically addressed to the private sector. It requires State Parties that take measures that prevent corruption involving the private sector, enhance accounting and auditing standards in the private sector and provide penalties for failure to comply with such measures.

Such measures include, for instance, the development of standards and procedures designed to safeguard the integrity of companies, including codes of conduct promoting honourable business standards and the use of good commercial practices by contractual partners. The introduction of a code of conduct prohibiting all forms of corruption is the one of the main tools applied internally by companies in order to prevent and sanction corruption. Many large companies that are subject to greater public scrutiny have introduced some sets of ethical standards. However, the situation of SMEs seems to be quite different.

Research findings reveal that in many cases smaller business units either do not feel comfortable introducing such codes, or do not expect any gains or advantages from doing so. One possible way of overcoming those problems could be the promotion of a code of conduct within a business association or an industry sector, instead of focusing on individual companies. This approach ensures that firms will not face competitive disadvantages when they no longer engage in corruption. Furthermore, by having a whole sector complying with certain standards, the impact on the business environment will be much greater.

Apart from codes of conduct, training employees was identified as an important measure for effective anti-corruption prevention to be introduced on the micro level. The drawback for smaller companies is that they lack the financial resources that often do not allow them to develop appropriate training materials, and face time constraints that prevent the conduct of regular training in an effective manner. For that reason, other institutions such as business associations, chambers of commerce or NGOs could play an important role in facilitating that process. Another tool to detect, and thus help deter, corrupt conduct is an appropriate reporting mechanism, for example, a telephone hotline that allows reports to be made anonymously. Available toolkits recommend that companies set up such a facility, which may be internally staffed or outsourced to a service provider.

However for smaller outfits this may not be practical or appropriate. Where there are a small number of employees working for a SME, and a relatively high degree of informality exists, anonymity might be difficult to guarantee. A further difficulty is that contracting a professional service provider for this purpose is often prohibitively expensive. These problems can be overcome if the task is fulfilled by an independent agency. In addition to that, the setting up of human resources policies that adequately reward ethical behaviour and appropriately sanction corrupt conduct was mentioned in this context.

Other measures to be introduced by SMEs include internal accountability and controls, financial recording and auditing, as well as external accountability requiring the public disclosure of information, so that watchdog groups and the media can monitor this information and complain in case of irregularities (compare with Article 12/2 UNCAC).

On the so-called “meso level”, the involvement of other institutions and organizations in the public and private sectors is of particular importance to the success of anticorruption efforts in the sphere of SMEs, as these businesses typically face a variety of human, financial and managerial resource constraints. Apart from that, taking into consideration the fear of SMEs in certain regions of facing severe disadvantages in a corrupt environment if they decide not to engage in acts of corruption, the active involvement of other bodies as well as collective approaches are essential. Business associations that bring together SMEs of a certain geographical region or business sector can support the anti-corruption initiatives launched by those enterprises and compliment them.

One of the most important ways that such associations can support SMEs is by acting as a focal point for, and a channel and coordinator of, collective action. They can also serve as platforms that reach agreements, make commitments to ethical standards, monitor adherence and carry out other joint actions to prevent corrupt practices. Furthermore, business associations can also assist SMEs by collecting information on reported acts of corruption, and establishing a complaints board for different industry sectors. The establishment of help-desks, giving advice to companies on specific cases or situations, is another option.

In addition to organizing and facilitating collective action, business associations in some countries have launched forms of corporate citizenship awards for different firm categories in recognition of ethical business conduct and anti-corruption compliance. If linked to certain incentives—for example, easier access to financing—they can demonstrate an excellent business case. In some cases, some of the above-mentioned tasks might be carried out by trade unions instead of business associations. It may well be that in certain countries, and on certain issues, unions will have more influence and power, and can consequently achieve greater impact.

Non-governmental organizations (NGOs) can also assist SMEs to combat corruption by conducting research, publishing information, educating businesses, raising awareness, and by taking on certain tasks suggested for business associations above. The usefulness of NGOs in this respect usually depends on the strength of the respective NGO, and the level of trust that it commands in the business world. In terms of improving business processes and ethics, encouraging entrepreneurship and promoting sustainable business growth, there are numerous examples of successful partnerships between SMEs and multinational companies, in particular those forming part of the UN Global Compact network.

In the context of assisting SMEs to combat corruption, these relationships can be enhanced in a variety of ways. Bearing in mind that the business case is one of the most important elements of any anti-corruption strategy for SMEs, some kinds of imposed compliance standards might work quite well with smaller companies if their supply chain partners—in many cases their main customers—demand adherence to these standards as a condition for doing business with them. By including a special clause in business contracts, allowing for the ending of the contractual relationship in cases where the company (SME) or its senior management was found guilty of corruption, is another option.

Furthermore, larger companies need to monitor their own employees, in particular in their dealings with contractors. Direct assistance can also be provided to SME subcontractors, by inviting their staff to attend ethics trainings for the employees in large enterprises. In addition to requiring certain forms of ethical conduct, larger companies can also assist SMEs in their individual corruption-related problems by utilizing their greater bargaining power and making themselves heard by the government. In particular, large multinationals that have invested a lot in a certain geographical region are good partners in this respect. Access to finance is one of the most severe problems that SMEs face, particularly in the developing world. If financial institutions linked anti-corruption compliance to certain incentives in terms of financing, it would create an excellent business case.

One possible support initiative would be to offer better loan conditions for companies that apply certain ethical standards. Another would be to provide special credit facilities for SMEs that have launched legal proceedings in corruption cases in order to help minimize resulting losses or damage to businesses due to extensive delays. Trade chambers were also identified as important players that could assist SMEs in their fight against corruption, for instance, by educating them in particular on the longterm costs of corruption, and help them to balance those against the short-term temporal gains that might arise. Sometimes chambers of commerce are assigned similar responsibilities and tasks as business associations.

However, it should be borne in mind that such chambers are usually involved to some extent in national politics, and therefore might not be the right bodies to implement some of the already identified anti-corruption tools. In a variety of surveys, SMEs have indicated that non-transparent laws and regulations, the inefficiency of courts, and a lack of transparency in public procurement systems and government spending, are the main factors that make corruption possible and create obstacles to the success of their business. Therefore the aforementioned initiatives that SMEs can take individually and collectively cannot replace or substitute a government’s responsibility to create a clean business environment and an incorruptible public sector “macro level”. Improving the business environment for SMEs requires a complex interplay between corporate and government action, and the creation of effective partnerships between the public and the private sector.

Frequently mentioned public sector tools to prevent and control corruption include an effective legal and regulatory framework and social policies, enhanced transparency and accountability, and the elimination of government-created barriers that foster cultures of rent seeking. While improvements in the fight against corruption at a national level will help businesses of all sizes, there are measures that can be taken that have particular relevance to SMEs. For example, certain funds could be made available in order to allow small businesses to go to court and claim damages caused by corrupt practices involving public officials. In cases when SMEs suffer financial or other economic damage as a result of acts of corruption, measures need to be taken to ensure that they have the right to initiate legal proceedings against those responsible for that damage in order to obtain compensation (UNCAC Art. 35).

These and other similar measures that assist SMEs in funding matters constitute an incentive to SMEs to actually use the existing mechanisms in the justice system. Furthermore, it is important that appropriate measures to provide protection against any unjustified treatment for persons who report acts of corruption are in place, as foreseen in Art. 33 of the UNCAC. In this context immunities from criminal action in case of self-incrimination could be considered to encourage reporting of corrupt activities (UNCAC Art. 37). Another common problem is the fact that in many cases SMEs are not even aware of the legal framework for dealing directly or indirectly with corruption in their respective country.

SMEs frequently face difficulties in accessing information on relevant legislation and in tracking amendments and changes of laws and regulations. In addition, smaller companies might not have the necessary know-how to be either able to interpret such legal texts correctly, or to make use of them when faced with acts of corruption. In order to increase awareness among SMEs in this respect, business associations, NGOs and other bodies that have better access to companies, can help by filtering the information and delivering it to them. Simple and accessible legal guides dealing with relevant issues that affect SMEs can also be made available. Furthermore, special consulting services should be provided to small businesses concerning anticorruption law, and ways to report cases of corruption, to initiate legal proceedings, and to claim damages.

The cooperation between the private sector and national authorities in general is of utmost importance, also in terms of reporting acts of corruption to national investigating and prosecuting authorities (UNCAC Art. 39). Public procurement is widely seen as an area that provides fertile ground for corruption. A decrease of corrupt practices in public procurement would particularly benefit SMEs because in a corrupt system they cannot compete with large companies, even if they fulfil all the technical requirements.

Article 9 of the United Nations Convention against Corruption deals with this issue. It requires State Parties to take measures to establish appropriate systems of procurement, based on transparency, competition and objective criteria in decision-making, that effectively prevent corruption. Another subject mentioned was the role of the media in terms of awareness raising. SMEs are usually not granted as much attention by the media as larger companies, and this affects the behaviour of those firms and that of public officials towards them.

The media cannot just play an important role when it comes to increasing the risk of getting caught for those engaged in corruption. It can also help with raising awareness and promoting good business practices. The most important moves would be to increase coverage of SMEs in general, and to cooperate with business associations and other institutions in terms of promoting their efforts. Due to the fact that a multi-stakeholder approach is required in order to have a positive impact on SMEs’ efforts to combat corruption, there is a need for coordination in order to avoid a duplication of efforts.

The role of UNODC and UNIDO could be seen in supporting relevant institutions, organizations and set-ups that are lobbying to change the environment SMEs are operating in and to assist SMEs to cope with corruption by facilitating and encouraging collective action to take place in an organized and efficient manner.




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