How Corruption Pays for Wal-Mart

"The point is, ladies and gentleman, that greed, for lack of a better word, is good. Greed is right, greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit."
-- Gordon Gekko, Wall Street

Wal-Mart  (NYSE: WMT  ) , fighting to be the world's largest retailer, may have succumbed to the pressures of greed, as it continues to investigate accusations of bribery in Brazil, China, India, and Mexico. When a company is pushed to grow, it can be a lot easier to pay the right official than obtain the required permits.

However, such bribes have many societal costs. Corruption skews the economics for competing businesses, making the ground anything but level, and compromises the government's integrity. Corruption can force governments into shaky fiscal situations, like Greece, or stunt economic growth, like India. But for the offending firm, it just may make sense to pay whatever fines and legal costs may be imposed while bribing its way to growth.

Is this the case for Wal-Mart?

An international bribery primer
The Foreign Corrupt Practices Act makes bribery in foreign countries illegal, and was written into law in 1977 after Lockheed  (NYSE: LMT  ) , before merging with Martin Marietta, admitted to paying at least $22 million in foreign bribes. These bribes led to 20 indictments in Japan, including the conviction of the Japanese prime minister, trials of defense ministers in Italy, and an investigation of a Dutch prince. Of course, Lockheed wasn't alone in this practice. Early in 1977, the Securities and Exchange Commission had sued 30 other companies for foreign bribes, while 300 had admitted to "questionable payments abroad," according to the Wilmington Morning Star.

Even with the U.S. setting the example, it took the rest of the world 20 years to enact similar legislation. But now, with the Organisation for Economic Co-operation and Development's 1997 Anti-Bribery Convention, most foreign firms play under the same rules as American firms.

The punishments for violating these laws can vary. Siemens  (NASDAQOTH: SIEGY  ) , which bribed its way into mobile phone contracts, national identity card production, power plant construction, rail contracts, and medical equipment contracts, paid $1.6 billion in fines in 2008 along with $1 billion for the internal investigation and reorganization. On the other hand, Oracle  (NYSE: ORCL  ) paid a $2 million penalty in August 2012 to settle with the SEC over "failure to prevent a subsidiary from secretly setting aside money off the company's books that was eventually used to make unauthorized payments to phony vendors in India."

Bribe officials, build faster?
In April, allegations surfaced that Wal-Mart spent $24 million to bribe Mexican officials. In November, Wal-Mart disclosed that its internal investigation was also looking into bribery cases in Brazil, China, and India. While India remains a small market, with only 15 stores as of the end of January, Wal-Mart has over 2,000 stores in Mexico, over 500 in Brazil, and 370 in China.

Source: Wal-Mart Annual Reports, 2004-2012.

The costs
To figure out whether corruption would pay for Wal-Mart, we need to figure out whether the benefits outweigh the costs. We'll have to make educated guesses for this calculation because of missing information, but it can give us some idea of how much Wal-Mart might have benefited overall from any illegal bribery.

On the side of costs, Wal-Mart has spent $99 million through mid-November for its current investigation. Add in the costs of the actual bribes, using Mexico as the maximum benchmark and at least $1 million per country for the low estimate. Add the cost to find replacements for offending employees and other company reorganization, potential fines -- ranging from Oracle's $2 million to Siemens' $1.6 billion -- and additional legal work, and the total costs might look something like this:

Activity Cost (in millions)
Investigation $99
Bribes $27 to $96
Reorganization $50
Legal $100
Fines $2 to $1,600
Total $278 to $1,945

In total, costs could range from roughly $275 million to almost $2 billion, with the largest question being how big of a fine Wal-Mart might pay.

The benefits
Alleged bribing likely would have led to faster growth, with stores opening more quickly. We can use three courses of alternative growth: slowing the growth rate by 10%, 25%, and 50%. Wal-Mart reports financials from its international segment as one, but we can get a rough estimation of operating income from the four suspected countries by taking the proportion of international stores from those regions and multiplying that by international operating income.

This gives us estimated income from Brazil, China, India, and Mexico from 2004, from which we can apply the different growth cases:

Case 2004 2005 2006 2007 2008 2009 2010 2011 2012 Total
Estimated operating income 1.19 1.64 1.64 1.95 2.35 2.45 2.61 3.13 3.28 20.25

10% slower growth

1.19 1.59 1.59 1.87 2.21 2.30 2.43 2.86 2.99 19.05

25% slower growth

1.19 1.52 1.52 1.75 2.01 2.08 2.18 2.50 2.60 17.37

50% slower growth

1.19 1.41 1.41 1.55 1.71 1.75 1.80 1.98 2.03

14.85

Source: Wal-Mart Annual Reports, 2004-2012; author's calculations. Numbers in billions of dollars.

The total differences over the nine years, not taking inflation into account, amount to the following:

If no bribery slowed growth by... Wal-Mart would earn this much extra through alleged bribery
10% $1.2 billion
25%  $2.88 billion
50% $5.4 billion

The final cost-benefit analysis
Taking the low estimate of costs of about $275 million, Wal-Mart would come out ahead even if the alleged bribing sped expansion by only 10% -- potentially by a rough $1 billion. On the other hand, if Wal-Mart pays a Siemens'-size fine for total costs around $2 billion, alleged bribing will have had to speed growth by about 15% for extra operating income to make up the cost.

For the risks involved for violating international law, I would imagine even the 15% accelerated growth is a reasonable number to assume. Which means, for Wal-Mart, alleged bribery costs and benefits are likely either a wash or reasonably profitable. And this doesn't take into account the benefits of grabbing market share before competitors, which will be important for decades to come.

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Read/Post Comments (3) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 10, 2012, at 8:21 PM, madmilker wrote:

    Named in the allegations...

    Lee Stucky

    Michael Fung

    Michael T. Duke

    Wal-Mart de Mexico("Walmex")

    Wal-Mart International

    Jose Manuel Aguirre Juarez

    Thomas Hyde

    Craig Herkert

    International Produce Limited

    Jose Luis Rodriguezmacedo Rivera

    Wal-Mart Stores, Inc ("Walmart")

    Eduardo Castro-Wright

    Sergio Cicero Zapata

    Thomas Mars

    Maritza I. Munich

    Wal-Mart de Mexico S.A.B. de C.V ("Walmex")

    H. Lee Scott Jr

    Pablo Alegria Con Alonso

    Eduardo Solorano Morales

    and all it takes to fire them all....

    ["There is only one boss. The customer. And he can fire everybody in the company from the chairman on down, simply by spending his money somewhere else."] --Sam Walton

    Being greedy may get one there faster but being more greedy will take that one from there just as fast .....even faster.

    Character may be a little slow but it's having to deal with all the makeup that greed left in its way.....

  • Report this Comment On December 13, 2012, at 8:52 PM, betty15 wrote:

    I thought there was something in the US like innocent until proven guilty. I guess the Motley Fool doesn't agree with the US justice system. So far it is my understanding that the Mexican government has dismissed 3 of the 5 charges.

  • Report this Comment On December 13, 2012, at 9:26 PM, TMFHelloNewman wrote:

    @betty15

    If you'll notice, I made sure to make it clear Wal-Mart was not proven guilty with plenty of 'alleged' used. This was a hypothetical look at the costs and benefits of such an alleged crime -- if it did occur.

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