Corruption and private participation projects in Central and Eastern Europe.

VerfasserJimenez, Alfredo
PostenRESEARCH ARTICLE - Report - Abstract

Abstract This paper investigates the role of host-country corruption in private participation projects in emerging markets. Privatization activities, especially in infrastructure development, were traditionally inaccessible to multinational enterprises, but they are nowadays encouraged in many countries. Prior literature on corruption finds two contradictory ("grease" and "sand") results when examining the consequences of corruption on investments. Drawing on a sample of 1185 projects from 1997 to 2013 in 18 Central and Eastern European Countries, our results show that higher levels of host-country corruption are associated with greater probabilities of failure. Our results also show that including local investors in the ownership structure of the project weakens the negative effect of corruption by reducing the liability of foreignness. In contrast, being a publicly traded project has no moderating effect in the effect of corruption in this region. Therefore, our results highlight that not all common strategies to deal with corruption are equally effective in this region.

Keywords Private participation projects [??] Corruption [??] Emerging markets [??] Central and Eastern European countries [??] Infrastructure projects [??] Uncertainty

1 Introduction

Private participation projects are defined as: "projects that have substantial contributions from private (domestic or multinational) enterprises" (Jiang et al. 2015, p. 295). Private participation projects are a "concession-oriented" (i.e. private sector is involved on a contractual basis and operates as "contractor") type of public private partnership, compared to other "organizational cooperation-oriented" projects in which there is a shared responsibility of public and private entities (Hodge and Greve 2007; Klijn et al. 2008).

Although privatization activities were historically largely inaccessible to multinational enterprises (MNEs), the situation today has radically changed and many governments actively offer this type of investment opportunity to MNEs (Henisz et al. 2005). For example, private ownership in infrastructure development has significantly increased, most notably in emerging economies (Ramamurti and Doh 2004).

Prior studies on private participation projects have focused on various topics including privatization method (Djankov 1999), state ownership (Doh 2000; Doh et al. 2004; Inoue et al. 2013), host country reforms (Henisz et al. 2005), political stability (Jiang et al. 2015) and government credibility (Ramamurti 2003). However, these studies largely overlook the role of corruption. In addition, most of these studies analyse projects in developed economies and the few that are focused on emerging economies mostly neglect Central and Eastern European countries (CEECs). This is a shortcoming, given that CEECs constitute an increasingly attractive region for investors and have thus witnessed a significant increase in foreign direct investment (FDI) flows in recent times (Gelbuda et al. 2006; Jimenez et al. 2013). Simultaneously, scholarly interest in this specific region has also grown and several studies highlight the importance of property rights (Smarzynska 2002; Bevan and Estrin 2004), industry (Resmini 2000), productivity and spillovers (Holland et al. 2000; Damijan et al. 2003; Peneder and Stehrer 2007), political risk (Jimenez et al. 2013) or knowledge orientation (Manea and Pearce 2006) as critical determinants of FDI. The topic of corruption, however, remains under-explored as the literature has focused more on other emerging markets such as China, India or Nigeria (i.e. Collins et al. 2008; Agbiboa 2012).

This paper aims to address the aforementioned gaps in literature by analysing the role of corruption in private participation projects in CEECs. More specifically, we seek to answer the following research questions: (1) how does host-country corruption affect the success of private participation projects in CEECs? (2) Is this relationship moderated by project-level characteristics, such as the inclusion of local investors or being publicly traded? To do so, we analyse a dataset of 1185 projects with foreign investors from 1997 to 2013 in 18 CEECs and find a strong negative association between host-country corruption and the probability of success. We also find that including local investors in the ownership of the project weakens the negative effect of corruption by reducing the liability of foreignness. Surprisingly, though, we find that constituting a publicly traded project does not have any moderating effect.

In addressing these research questions, our study contributes to literature on private participation projects by demonstrating the adverse effects of host-country corruption. Private participation projects usually involve a large number and range of stakeholders (Jiang et al. 2015). Due to the particular characteristics of these projects, they often involve not only managers and employees, but also external stakeholders including governments, banks, unions, institutions and even the local press. Due to the large number of potential interactions between the different internal and external stakeholders, the likelihood that the project will be affected by corruption is high, which makes private participation projects a very interesting setting to examine the impact of corruption on the success of these projects. In addition, the results of our moderating analysis show that including local investors reduces the negative effect of corruption but that constituting a publicly traded project does not, which demonstrates the particularly complicated nature of corruption in CEECs and suggests that policy makers and managers should pay extra attention to this phenomenon as not all common strategies to minimize it are equally effective in this region.

The present paper also contributes to literature on the effects of corruption, a field of research that has been mainly characterized by both a negative ("sand in the wheels") and a positive ("grease in the wheels") approach, without reaching a consensus. Our results contribute to this ongoing debate by supporting the negative view on corruption in the case of private participation projects in the CEEC region.

The remainder of this paper is structured as follows: in the next section, we conduct a literature review and set out our hypotheses. We then describe our sample, variables and estimation technique. Subsequently, we present our results and conclude with a discussion of our findings.

2 Literature Review and Hypotheses

Rose-Ackerman (2006, p. 14) defines corruption as "monetary payments to agents (both public and private) to induce them to ignore the interests of their principals and to favor the private interests of the bribers instead". According to the World Bank (2000), corruption is the abuse of power to obtain private benefits including, for example, payments of bribes, embellishment, favouritisms, inappropriate use of influence or irregular payments in public contracting. Other authors define corruption as "the abuse of entrusted power for private gain" (Cuervo-Cazurra 2016, p. 36). No matter which definition we take, scholars agree that corruption refers to a lack of respect for rules and regulations, a clear symptom of poor institutional quality (Kaufmann et al. 2003; Lee et al. 2010). Indeed, corruption is viewed as a critical institution (Peng et al. 2008) reflecting a country's legal, economic, cultural and political institutions (Svensson 2005; Godinez and Liu 2015).

Prior research has found contradictory results when examining the consequence of corruption on the success of investments (Cuervo-Cazurra 2008; Eren and Jimenez 2015). On the one hand, the "grease the wheels" perspective reports a positive effect of corruption on efficiency, as corruption can contribute to speeding up bureaucratic processes for those firms most willing to pay for them (Leff 1964; Olson 1993; Egger and Winner 2005). In contrast, the "sand the wheels" perspective reports that corruption can entail additional costs and uncertainty, thereby adversely affecting investment success (Mauro 1995; Wei 2000a, b; Brouthers et al. 2008). Generally, firms find corrupt countries less attractive due to the scarce protection of firm-specific assets, such as technology, brands, patents, and so forth (Brada et al. 2012). However, other studies have found no significant effects (Wheeler and Mody 1992; Alesina and Weder 2002; Busse and Hefeker 2005).

While the body of literature is not at all unanimous on the effects of corruption on investments, more recent publications have provided empirical support for the "sand the wheels" hypothesis (Lee and Weng 2013; Godinez and Liu 2015), suggesting that corruption has a predominantly negative effect on investments. This is especially true at the country level, given that corruption has been found to cause public policy distortions, slower information dissemination, unequal income distribution and enhanced levels of poverty (Ades and Di Tella 1997; Chen et al. 2010). Drawing on this evidence, and by considering the large number of stakeholders and interrelations that are involved in private participation projects (Jiang et al. 2015), we contend that the extra costs and uncertainty deriving from corruption may offset any potential gains related to the speeding up of bureaucratic procedures, thereby having a negative effect on private participation projects' success. Moreover, we believe that the negative effects of corruption are particularly pronounced in the case of private participation projects led by foreign investors, due to their lower familiarity with the local context. Foreign firms are subject to the "liability of foreignness" (Zaheer 1995), generating additional costs compared to domestic firms. A substantial amount of extant research demonstrates that foreign firms are relatively less able to interpret and understand local cultures, norms and...

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