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“You’ve got to get your corruption right.”

It was a typically nasty Beijing afternoon in August.  Millions of Chinese people were hard at it, chasing the next Yuan through the oppressive summer heat and choking pollution of Beijing’s Chaoyang District.  As I drove to a meeting with Jim, the company’s China consultant, taxis and filthy black German sedans darted across lanes and drove on the shoulder in a frantic, futile–and very Chinese–game of hurry-up and wait on the gridlocked Third Ring road.

Beside the road loomed the grimy, neglected skeleton of an unfinished office building.  Such monuments to commercial failure can be found all over Beijing.  I pointed to it and asked Jim what had happened.  He said something that I repeat to this day: “In China you’ve got to get your corruption right.”

Jim wasn’t advocating corruption, though in the twenty years he’d spent helping businesses like mine survive in China, he’d seen enough to write two very insightful, successful books targeted at Westerners seeking to do business there.  Jim was merely pointing out that in China, anyone who has failed spectacularly, such as the developer of that unfinished building, likely didn’t have the right relationships with the right government officials–relationships that usually arise from family connections and are carefully nurtured over many years by acts of mutual assistance.

The assistance doesn’t always involve cash.  So you need a construction loan or a building permit?  Well, you might be pleased to learn that the official issuing building permits needs help getting his one child into a good American university.  Perhaps you can help.  Perhaps that loan or permit isn’t going to take a year to obtain.  Is that corruption?  Hmm, you say. That sounds, well, kind of like Chicago.

So it probably is illegal.

So let’s say you’ve been sent by your company to live in China and start a company.  Before you shipped out you probably met with the lawyers.  They warned you, in typically obscure language and solemn tones, about the U.S. Foreign Corrupt Practices Act (FCPA).  This law makes it a Federal criminal offense to bribe foreign government officials–something that, if not strictly legal, is certainly an accepted business practice in China and much of the developing world.

The FCPA and its more recent U.K. sister, the Bribery Act, are both well-intentioned.  Accepted political and economic research, led by Yale’s Prof. Rose-Ackerman, demonstrates how corruption hurts a country.  It is politically corrosive, growth-defeating and economically inefficient.  But what if that is how business is done there?  Critics of these laws say they put U.S. and U.K. business at a competitive disadvantage.  Whatever your position, there is no doubt in my mind that the main flaw of the FCPA is its oh-so-American assumption that other countries have (or at least ought to have) economic and political systems that look like ours.  In the case of China, nothing could be further from the truth.

The Western sense that government officials are supposed to serve the people is still developing in China. While a government job in the U.S. is nothing particularly special, in China such a job carries prestige and power.  When a Chinese official controls access to a necessary government franchise such as a license or permit, it gives that official the ability to charge “rents” that a private business person can only envy.  It is not unusual, for example, for a local government official responsible for issuing building permits to also own a thriving family construction business.  Does that family business benefit from the government connection?  Or course it does. In fact, if the official didn’t use the power of office for his or her own benefit, he or she would likely be distrusted by peers.

In the West, bright lines separate the private and public sectors.  This is not true in China or in much of the developing world.  The boundaries are blurred to the point of legal irrelevance.  In China the officials and their families are in business in all places and at all levels.  The higher up you go, the more attractive the business opportunities.

So how does an American executive walk into the midst of this ancient system and succeed without getting himself and his company in trouble?  Well, in an ironic inversion of the Chinese model (where your money is made whild in government), the U.S. officials charged with enforcing our anti-bribery laws make their fortunes after government service.  Department of Justice and Security and Exchange Commission lawyers normally spend a few years enforcing the FCPA at government-level pay before jumping into lucrative private practice positions. Once there, according to the Wall Street Journal, they are happy to help American companies perform costly global compliance audits to stave off possible prosecution. “It’s one of the few … … crown-jewel practices right now”, says Dan Binstock, a Washington-based legal recruiter at Garrison & Sisson Inc., quoted in the article.

All this high priced lawyering is not surprising when you consider that under the FCPA, even the CEO of a company can be found personally liable for the acts of a company employee thousands of miles away and several levels down in the company chain of command.  And under the newer and stricter U.K. Bribery Act, proof of intent is not even required.

Recent years have seen several high profile FCPA investigations. Subsidiaries of Tyco International were found to have arranged illicit payments to foreign officials in more than a dozen countries.  Late last year the company agreed to pay $26 million to settle the SEC’s charges and resolve a criminal matter with the Justice Department.  Meanwhile, the Wall Street Journal reports that Wal-Mart pumped $51 million into an internal bribery investigation of its Mexico operations, and still remains the subject of some significant government scrutiny.

So what are the main take-aways?

Let’s deal with the easy part first. Yes, your company needs to have an active anti-corruption training program for everyone working overseas and everyone domestically who touches products, customers and financial reports from developing markets.  The same goes for the senior people you send on overseas trips to check up on things.  You may even want to re-consider the recent trend away from sending expats overseas and towards hiring native country managers. While hiring a local to run your China operation may be good from the standpoint of in-country relations, you’ll need a very strong, non-native finance person in place to keep your management out of trouble.  And now it’s not just the U.S. federal authorities that will be looking at you.  China has started prosecuting corruption by non-Chinese multinational corporations, as the global pharmaceutical company Glaxo Smith Kline recently learned.

Second, you may want to re-think merely extending your company’s existing corporate governance structure abroad, since it may unnecessarily subject your entire chain of command to FCPA liability.  Your lawyers would be delighted to share creative–and perfectly legal–ideas for Chinese capitalization, licensing and corporate governance.  If they aren’t, have them call me.

Now for the harder part.

The way we teach our American business leaders to avoid FCPA trouble comes in one of two, relatively limited, Western flavors: compliance and ethics.  The compliance approach is favored by lawyers, accountants and other absolutist types (of which I’m one) and works by informing those concerned of what the law is and how far they can go before breaking it. The ethical approach, taught in some business schools (mine included), gets us a little closer to our goal because it trains business leaders to think in terms of right and wrong (as accretive, of course, to knowledge of effective legal and financial compliance).  Unfortunately, neither the compliance nor the ethical approaches completely close the loop in places like China.

The reason FCPA compliance is likely to remain an expensive game of whack-a-mole for American global companies is that what we in the West call corruption is in fact part of the ancient commercial fabric of China and many developing countries. The issue isn’t legal and it certainly isn’t ethical. It’s cultural.

Easterners think differently than Westerners.  Among other stark differences in perception and processing, Easterners are uncomfortable with absolutes and universals, such as abstract legal rules that fail to take into account surrounding circumstances and relationships.  Prof. Nisbett, in his ground-breaking book, The Geography of Thought, reminds Americans (and most English-speaking Westerners) that they are the product of a unitary system of ethical values tracing back to the Greeks.

“We prefer to live by abstract principles and like to believe these principles are applicable to everyone.  To set aside universal rules in order to accommodate particular cases seems immoral to the Westerner.  To insist on the same rules for every case can seem at best, obtuse and rigid to the Easterner, and at worst cruel.

“This [Western] self–this bounded, impermeable free agent–can move from group to group and setting to setting without significant alteration.  But for the Easterner (and for many other peoples to one degree or another), the person is connected, fluid and conditional [emphasis added]. . .

“. . . there is great potential for conflict when people from cultures having different orientations must deal with one another.  This is particularly true when people who value universal rules [e.g. Westerners] deal with people who think each particular situation should be examined on its merits and that different rules might be appropriate for different people.”

It seems that culture is both the problem and the solution for your business in China.  Let me explain.

The Chinese are collectivists, as are people from many countries where corruption is a problem. Americans are off-the-scale individualists, according to Hofstede in his seminal study, Culture’s Consequences.  Tell an individualist American about the evils of corruption and you may modify his behavior.  If you appeal to his moral sense you may even move the dial on his values.  But nothing your company does is likely to impact his identity.  Those days–if they ever did exist in our culture–have gone the way of blue suits and red ties at IBM.

Like all collectivists, the Chinese derive much of their identity from the collectives in which they hold membership.  So here is the point: if you want to prevent your Chinese or other collectivist employees from engaging in illegal activity, don’t lecture them on some abstract American law.  Rather, envelop them in a corporate system that (1) behaves like a family–the only system they really understand and respect; (2) expresses zero tolerance for corruption and other illegal activity; and (here’s the clincher) (3) lives and demonstrates those values from the top to the bottom of the company.

You see, to a Westerner, the violation of a company rule may have legal, even ethical, consequences.  But it won’t impact their Western individualist identity–Nisbett’s “bounded, impermeable free agent.”  But if you can fight off the urge to cut corners and stay true to your Chinese cultural ethos, you will have done more than simply influence the behavior of your Chinese workers.  You will have formed their identity as members of your company.  You’ll be rewarded with committed, reliable, legally-compliant people.

At which point you can look your individualist, absolutist American lawyers in the eye and say, “Thanks.  Got it handled.”

DM

References

“FCPA Inc.: The Business of Bribery Corruption Probes Become Profit Center for Big Law Firms”. The Wall Street Journal. October 2, 2012. Retrieved from http://online.wsj.com/article/SB10000872396390443862604578028462294611352.html on March 3, 2013

Nisbett, R.E. (2003). The Geography of Thought. New York, N.Y.: Free Press

Hofstede, G. (1980). Culture’s Consequences. Beverly Hills, CA.: Sage Publications

Bring back the good jobs … from Switzerland

That’s right.  Not China.  Switzerland.  So you’re not talking about the much-lamented loss to China of union scale, blue-collar jobs from the fetid factories of America’s Rust Belt?  No.   So perhaps you won’t bore me with another rendition of that tiresome “America in decline” narrative parroted by gauzy-eyed revisionists who forget how America (like many industrial economies) polluted its way to prosperity in the first half of the 20th Century?

Nope.  Like me you may be old enough to recall the choking air of Gary, Indiana, the birth defects of Love Canal, and one that even the Chinese haven’t topped: a river that actually–and regularly–caught fire.  Ohio’s Cuyahoga River, according to a 1969 Time magazine article, “oozes rather than flows.”  A person unlucky enough to fall into it, said Time, “does not drown but decays.”

No, we don’t want those jobs back because, round about the early 1970’s, Americans decided that they had become prosperous enough to value–and afford–a healthy environment.  Getting there, of course, means environmental regulation, which makes things more expensive to manufacture here.  So since we all love to shop at Wal-Mart and enjoy low prices, we now let other people make our stuff–cheaply.  Those other people can pay their workers much less and they are far more relaxed about the environment.  So take a deep, healthy breath and exclaim “good riddance” to all of those “great” U.S. heavy industries and manufacturing jobs.

What I am talking about in this article is the tens of thousands of high paying executive jobs that have been quietly exported–in the name of lower corporate taxes–to the squeaky-clean towns near Zurich, Switzerland. It’s a breathtaking migration of people and corporate assets that is costing the U.S. billions in lost wages and corporate taxes every year.

You have heard about the likes of Google and Apple hoarding enormous piles of cash in their offshore companies and paying scandalously low corporate tax rates.  Hauled before congressional and Parlaimentary committees, surrounded by stiff accountants and lawyers, the CEO’s always state that their accounting practices are entirely legal.  Perhaps.  Still, according to some estimates, U.S. companies are holding more that $1trillion offshore, desperate to avoid repatriating cash to the very country where the revenue was primarily earned.

So you hear the politicians talk about closing tax loopholes and raising corporate tax rates.  But little is said about the jobs that are off-shored to make it possible for these American CEO’s to claim colorable legality.

Off-shoring jobs to avoid U.S. taxes is an accepted business practice that arises from the language and enforcement of the U.S. Tax Code.  Merely raising corporate tax rates on all U.S. corporations–including companies that don’t have the global footprint and accounting muscle to get out from under the high U.S. corporate tax rates–won’t help.  The solution is to reform the U.S. Tax Code so that companies aren’t incented–legally–to set up sham companies to avoid U.S. taxes.

I am not talking about Mitt Romney’s P.O. Box in the Cayman Islands.  I am talking about hundreds of employees “working” in Switzerland and other tax havens for American companies for the sole purpose of lowering the company’s U.S. corporate tax liability.

Let me explain.  Imagine that you are the CEO of a publicly-traded, U.S.-based corporation.  Your company may have operations and a bit of revenue trickling in from other countries, but most of your revenue comes from dollar-denominated sales in the U.S.  In one sense, that is a good thing.  You have only one currency to count and your company’s products and services receive the pricing benefit of a prosperous, stable–if not somewhat moribund for the moment–U.S. economy.

In another sense, those U.S. sales are a huge liability.  You’re getting hammered by the relatively high U.S. corporate tax rate.  So, isn’t everyone, you ask?  Well, what if I told you that some of your competitors are paying a substantially lower U.S. corporate tax because of creative–and legal–things they are doing with their foreign subsidiaries?

Interested?  Well, if you aren’t your board might ask you to consider a career in agriculture.  If everyone is doing something sneaky (and legal) in a competitive global marketplace then you really have no choice, right?  Wrong.  What’s happening is not right for the companies concerned because it rewards deception while creating nothing of value.  It is certainly not right for the U.S. Treasury.  Yet the broken U.S. Tax Code encourages and legalizes what is, in essence, dishonest–and legal–foreign tax avoidance behavior.  The system must be changed.

Here is how the system works.  The tax “science” involved is called transfer pricing–to many a black art.  It is practiced by a relatively small group of highly-compensated tax consultants from the usual firms. Transfer pricing and the tax treaties it functions under allow multi-national companies to lower their total corporate tax profile by attributing revenue from a high tax jurisdiction (like the U.S. or the UK) to a country with a lower taxation rate. Here’s the kicker: in order for the fiction to operate legally, the parent company needs to “sell” taxable assets to its subsidiary company in a low tax country, say Switzerland or Ireland.  Then the people in the Swiss company “own and manage” those assets on an ongoing basis, whilst making those assets available–for a price–to the parent company’s U.S. customers.

Imagine sending your CFO to Switzerland to meet with the authorities of several cantons (counties) in and around Zurich.  They all want you to site your company in their canton.  They like the foreign tax avoiders, whose workers are healthily underworked, well behaved, educated and prosperous.  The companies they work for pay their taxes and meet their obligations–something very important to the Swiss.  The tax rates the Swiss offer are very competitive.  Indeed, some companies have moved their Swiss AG’s two or three times in an effort to secure the lower tax rates offered by neighboring cantons.

Let’s say that our CFO’s visit went well and pretty soon your company has chosen a canton, hired a real estate consultant, and entered into a lease for some suitably impressive office space in a building overlooking beautiful Lake Zurich.  You retain a Swiss accountant, a Swiss lawyer, hire a Swiss office manager.  You build out your office.  You buy furniture, rent copiers and telephones.  You contract with a janitorial service and hire several English-speaking office assistants.  Pretty soon you are spending lots of Swiss Francs, but you’re still not done.

“Jesus is Coming, Look Busy” goes the bumper sticker.  So it is with the IRS.  If you have set up a Swiss company to avoid U.S. corporate taxes you must impress the IRS with your piety and industry. Under the relevant tax regulations and treaties, in order for your company to reap tax benefits, it is not enough to merely have a Swiss address.  You need to have people–lots of them, all with believably senior resumes, drawing nice packages and sporting impressive job titles–looking very busy “owning and managing” the taxable assets (technology, information) that the U.S. parent has “sold” to the Swiss subsidiary in an “arm’s length” transaction.

It’s all a big show.  If done correctly it is legal.  Hundreds of U.S. and UK companies are doing it right now.  Most of these companies have little or no market presence in Switzerland or the other offshore havens.  They are simply there, in collusion with the local and national government, to get a lower tax rate on revenues earned in their home market, which alone justifies the millions of dollars pumped out of the U.S. and into the Swiss economy to maintain the Kabuki theatre.  They may shrug and say, “well, it’s legal,” but no self-respecting tax or finance professional will tell you it’s not dishonest.

What’s worse, it sends high-value American management jobs overseas to merely “look busy.”  These expats have their homes purchased by the company or managed for them while they are overseas.  They have their stuff shipped or stored at company expense.  They get nice apartments in Switzerland and send their kids to private international schools–all on the company.  Generous car and travel allowances permit them to travel extensively in Europe or go home frequently–all in the name of less tax.

[Note: But Americans will always be, well, so American.  One Texan from a company I know wanted to have his Chevy Suburban shipped to Switzerland.  No one in HR, apparently, told him about the high gas prices in Switzerland, the narrow streets in Europe or the likely frowns of the hyper-vigilant Swiss.  Yes, the Swiss do like the “free” corporate tax they get from your company and the cash you spend in their shops and restaurants, but they don’t like gas-guzzling American cars and aren’t above tapping on your car window and wagging their finger if they catch you warming up your Chevy for too long on a cold winter morning in Zug.]

But I digress.

There is a lot of talk in Washington these days of raising tax rates charged to U.S. corporations.  That won’t fix the problem.  What those well-intentioned people need to understand is that given the choice between paying a high tax and spending the same amount on high-flying accountants to avoid the tax, corporations will choose the latter every time.

What we need is a U.S. corporate tax policy that doesn’t reward companies for off-shoring high value jobs just to keep from paying tax rates that are out of whack with the rest of the developed world.  Bring those Americans home. They will be much happier with their baseball and Chevrolets.  Let the Swiss go back to what they do best, which–call me simple–always seems to involve money and a bit of high-minded finger-wagging.

DM