Determinants underlying incidence and amount of bribery an evidence from manufacturing firms in vietnam

Abstract Using a panel data set from the Small and Medium Enterprise SME Surveys from 2005 - 2013, this study investigates the factors which influence the incidence of bribery and the si

VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

DETERMINANTS UNDERLYING INCIDENCE AND AMOUNT OF BRIBERY: AN EVIDENCE

FROM MANUFACTURING FIRMS

IN VIETNAM

BY

VU THI THUONG

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, November 2015

VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

DETERMINANTS UNDERLYING INCIDENCE AND AMOUNT OF BRIBERY: AN EVIDENCE

FROM MANUFACTURING FIRMS

IN VIETNAM

A thesis submitted in partial fulfilment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

me with essential skills for doing research, especially the skills of using econometric tools Besides, I truly appreciate the time he devotes to this thesis to carefully review my final thesis draft and help me rearrange thesis structure reasonably as well as correct errors and inappropriate words usages It must take me a longer time to complete this project without his invaluable sources of help.

From my sincere heart, I would like to thank all lecturers in VNP who equipped me with useful knowledge to conduct this thesis as well as to serve my job in the future Especially, I would like to express my special thanks to Prof Nguyen Trong Hoai, Dr Pham Khanh Nam and Dr Truong Dang Thuy who always travel with me during the two years of my Master program, share their practical profound insights and inspire the love of scientific research

Next, I would also like to thank all my friends here at VNP, especially Vu Thi Khanh, Le Huu Nhat Quang for their enthusiasm of sharing data processing techniques with me; Bui Minh Khoi, Nguyen Huong Nguyen for their spiritual encouragement during these stressful and difficult moment I also want to say thanks to VNP officers for their restless assistance

I would like to express my special thanks to Da Nang University Campus in Kon Tum who has given me advantages to accomplish my Master program I also want to thank my colleague – Nguyen Thi Phuong Thao for her great support me during my writing of this thesis

I am deeply and forever indebted to my parents and my sister for their love, support and encouragement throughout my entire life

Abbreviations

CIEM Central Institute for Economic Management CPI Corruption Perceptions Index

OLS Ordinary Least Squares

PCI Provincial Competitiveness Index

SMEs Small and medium enterprises

TI Transparency International

WB

UNDP

The World Bank

United Nations Development Programme

Abstract

Using a panel data set from the Small and Medium Enterprise (SME) Surveys from 2005 -

2013, this study investigates the factors which influence the incidence of bribery and the size of bribe payment among formal and informal firms in Vietnam Due to censored nature of the data on bribes and sample selection bias, this paper applies Heckman two - step procedure which was proposed by Heckman (1979) to correct these problems This study finds strong evidence that the propensity to bribe as well as the variation in the amount of bribe is highly positively correlated with the interaction level with public officials, the firm‟s ability to pay and the burden of regulation that firms face In this paper, the interaction with public officials is looked at different types of interaction Besides, this study also points out that company without official business registration licenses are more likely to avoid paying the informal costs These results are robust when the lagged values

of profit are used as instruments for profit

Keywords: firms, bribery, Vietnam

Table of contents

Chapter 1: Introduction 1

1.1 Problem statement 1

1.2 Research objectives 3

1.3 Research questions 3

1.4 The scope of the study 3

1.5 The structure of the study 4

Chapter 2: Literature review 5

2.1 Corruption 5

2.1.1 The definition of corruption 5

2.1.2 The Forms of Corruption 6

2.1.3 Measuring corruption 7

2.2 Empirical studies 11

2.2.1 Factors influencing the propensity to bribe 11

2.2.2 How much must graft-paying firms pay? 16

2.3 Basic framework to estimate the incidence and level of bribe 16

2.4 Conceptual framework 18

2.5 Chapter summary 18

Chapter 3: Corruption in Vietnam 20

Chapter 4: Data and Econometric Model 26

4.1 Data 26

4.1.1 Data source 26

4.1.2 Data description 27

4.2 Descriptive statistical analyses 28

4.3 Econometric model 33

Chapter 5: Empirical results 37

5.1 Factors influencing the propensity to bribe 39

5.2 Factors influencing the size of bribe payment 42

5.3 Robustness 43

Chapter 6: Conclusion 47

6.1 Main findings 47

6.2 Policy implications 47

6.3 Limitations and further research 48

6.3.1 Limitations 48

6.3.2 Directions for further studies 49

References 49

Appendices 55

List of tables

Table 2 1: Definitions of corrupt activities 6

Table 2 2: Summary of features of measures of corruption 9

Table 3 1: Vietnam‟s annual CPI result 21

Table 3 2: Average cost of bribes paid, by sector 23

Table 4 1: Panel data structure 26

Table 4 2: Data definition 27

Table 4 3: The descriptive statistics of the size of bribe payment by location 28

Table 4 4: The descriptive statistics of the size of bribe payment by the legal ownership form and sector 29

Table 4 5: The purpose of bribe payment 30

Table 4 6: The summary statistics of key variables 30

Table 4 7: Pairwise Correlation 32

Table 4 8: The Expected Variables in Heckman two step 36

Table 5 1: Heckman two-step regression analyses the incidence of bribery and bribe amount 38

Table 5 2: Heckman two-step regression analyses the incidence of bribery and bribe amount, using instrument variable 44

List of figures Figure 3 1 The most serious Economic & Social Issues for Vietnam 20

Figure 3 2 Perceptions of the prevalence of corruption across sectors 21

Figure 3 3 Key Indicators of Informal Charges (2006 to 2014) 22

Figure 3 4 The purpose of bribe payment 23

Figure 3 5 Awareness about the government's anti-corruption efforts 24

Figure 3 6 Willingness to report an incident of corruption (Southeast Asia) 25

List of appendix

Appendix 1: Heckman two-step regression on the incidence of bribery and the size of bribe 55 Appendix 2: Heckman two-step regression on the incidence of bribery and the size of bribe (corrects errors for heteroscedasticity) 57 Appendix 3: Heckman two-step regression on the incidence of bribery and the size of bribe (using instrument variable) 59 Appendix 4: Heckman two-step regression on the incidence of bribery and the size of bribe (correct heteroscedasticity and using instrument variable) 61 Appendix 5: Heteroskedasticity test using Breusch-Pagan / Cook-Weisberg - the Heckman two-stage model 63 Appendix 6: Heteroskedasticity test using Breusch-Pagan / Cook-Weisberg - the Heckman two-stage model when using instrument variable 63

Chapter 1: Introduction

1.1 Problem statement

Corruption occurs in both developed and developing countries with various degrees and has impacted on almost all parts of society (Lawal, 2007; Rohwer, 2009) Amundsen (1999) described corruption as “a disease, a cancer that eats into the cultural, political and economic fabric of society, and destroys the functioning of vital organs” Besides, World Bank (2009) identified corruption as “among the greatest obstacles to economic and social development”

In Vietnam, this problem is seriously alarmed for the government‟s failure to reduce corruption over past years In particular, the Corruption Perceptions Index (CPI)

2014, conducted by Transparency International ranked Vietnam at 119 out of 175 in global and at 18 out of 28 in the Asia Pacific region It is worthy to note that Vietnam‟s CPI score is unchanged in three consecutive years from 2012 to 2014 whereas a positive change was recorded in neighboring countries Besides, according to a report of Provincial Competitiveness Index (PCI) 2014, Vietnam witnessed a significant decline in controlling informal cost that firms have to pay for running a business smoothly More specially, the proportion of companies paying bribe jumped from 41% in 2013 to 66% in 2014 10% of firms showed that more than 10% of their revenue spent on bribes These pieces of evidence reflect the seriousness of corruption in Vietnam despite the effort of reducing it over the past years

A massive body of academic research on corruption in the past decade divided into two segments: the determinants of corruption and the effect of corruption on growth1 Regarding the determinants of corruption, some typical studies include Ades and Di Tella (1997, 1999), Svensson (2000), Persson, Tabellini, and Trebbi (2003) Related to the effect

of corruption, a list of study can be seen Mauro (1995), Wei (1997) and Johnson et al (1997) Except for few studies, most of preceding studies share three common features First, these studies have primarily based on cross-country analyses Second, they use perceptive data rather than quantitative data due to the higher cost of collecting the later

1 For a review and summary, refer to Bardhan (1997), Jain (2001), Reinikka, Svensson (2002) and Aidt (2003)

one Third, the interpretation of corruption was based on a function of macro-factors such

as countries‟ policy or institutional environment

This branch of the literature with above-mentioned characteristics such as Kaufmann and Wei (1998) and Hellman et al (2000) Kaufmann and Wei (1998) examined the nexus between informal cost in the form of time spent by managers with bureaucrats and cost of capital To do this, they employed the firm-level data from three different surveys covered around 48 - 73 countries In this study, information about corruption is based on perception indices constructed from questions related to country characteristics Also, Hellman et al (2000) used a sample of 3300 firms in 20 countries that were obtained jointly by the World Bank and the Office of the Chief Economist in

1999 They explained the validation of corruption based on the function of the institutional environment, including protection of property rights and civil liberties

political-These existing pieces of literature have provided important knowledge about the aggregate determinants of corruption However, the interpretation based on cross-country analyzes as well as using perceptive data caused some drawbacks Firstly, the exploiting perception data on corruption can suffer from bias In particular, certain studies suggest that small firms are more likely to perceive their environment to be more corrupt than their counterparts (Batra, Kaufmann, & Stone, 2003; Bennedsen et al., 2009) Similarly, more productive companies tend to complain about their business environment more than less productive companies do (Malomo, 2013) Secondly, macro- determinant of corruption constrains the interpretation of variation in corruption within the country In the other word, country-level research cannot explainthe variation of the level of corruption across firms within a country (Svensson, 2002)

To avoid these problems, Svensson (2003) exploited the quantitative data on corruption, derived from the Uganda enterprise survey in 1998 which was designed to represent the population of private enterprises, operating in manufacturing and processing sectors However, there are two striking features in such data set Firstly, not all firms in the sample reported that they need to pay the informal cost Secondly, there has a significant variation in the size of bribe payment across firms under a similar policy To explain such variance, this paper developed a simple bargaining model, in which firms can

choose to either pay the bribe or exit the market when facing a request for a bribe of a public official

In similarity to Svensson (2003), this paper investigates the corruption in Vietnam for the period from 2005 to 2013 Based on the quantitative information on corruption and the detailed financial information from Small Medium Enterprise (SMEs) surveys in this period, this study attempts to answer two questions: who must pay a bribe and how much they pay To answer these questions, this paper primarily uses control right hypothesis and bargaining hypothesis In which, control hypothesis suggests that the interaction level with public official will determine whether or not a firm has to pay a bribe The bargaining hypothesis indicates that firm‟s bargaining power which measure by sunk cost component and ability to pay will interpret how much a firm pays

1.2 Research objectives

This study is to find out the factors that influence the incidence of bribery and the size of bribe payment of firms in Vietnam In other words, this study has two following objectives:

(i) Specify the factors that affect the propensity to pay a bribe of formal and informal firms in Vietnam

(ii) Specify the factors that influence the variation in bribe amount across bribe-reporting firms in Vietnam

(iii) Give some policy implications in order to reduce corruption in Vietnam

1.3 Research questions

This thesis aims to answer the following questions:

(i) Do the factors related to firm characteristics such as firm size, informal status, profit, firm‟s choice of technology, etc have influence the incidence of bribery?

(ii) Why do some firms have to pay more bribes than others?

(iii) What should be done to reduce corruption in Vietnam?

1.4 The scope of the study

The study uses the available data of SMEs surveys in Vietnam These surveys were conducted in the period of 2005 to 2013, covering around ten provinces and cities in Vietnam Except for foreign-owned enterprises, the surveyed samples include non-state

manufacturing enterprises with and without legal business registration licenses The former

is called formal firms while the latter is named informal firms Although the surveys cover more than twenty manufacturing industries, this thesis will focus on 14 largest sectors in terms of number of enterprises, including food products and beverages, fabricated metal products, wood and wood products, furniture manufacturing, tanning and dressing leather textiles, wearing apparel, paper and paper products, publishing - printing, chemical products, rubber and plastic products, non-metallic mineral products, other machinery and equipment, water treatment

1.5 The structure of the study

This paper consists of six chapters Following chapter 1 of introduction, chapter 2 describes a general picture about corruption, including definition, forms and the measurement of corruption This chapter also presents the empirical studies and theoretical models that examine the incidence and level of bribe Chapter 3 gives a brief overview of corruption in Vietnam Chapter 4 outlines the data and presents the descriptive statistical analyses In addition, the econometric models, as well as the variables, included in these models also presented in this chapter Then, the econometric results are discussed in chapter 5 Finally, the main findings, limitations, policy implications and suggestions for further researches are presented in chapter 6

Chapter 2: Literature review

2.1 Corruption

2.1.1 The definition of corruption

The term of “corruption” originates from the Latin word “corruption”, meaning

“moral decay, wicked behavior, putridity or rottenness” (Milic, 2001) However, it is difficult to give a globally accepted definition because corruption is a complex social, legal, economic and political phenomenon (Rohwer, 2009)

In reality, there are many different definitions of corruption The most popular and simplest definition is given by World Bank (1997), defining corruption as “the abuse of public power for private benefit” Corruption is also widely understood as „„the acts in which the power of public office is used for personal gain in a manner that contravenes the rules of the game‟‟ (Jain, 2001) Transparency International, 2009 defined that corruption

as „„misuse of entrusted power for private gain‟‟ This definition is similar with the World Bank‟s definition; however it can cover the corruption activities in both public and private sector Besides, the Oxford Advanced Learner's Dictionary (2000, p 281) suggested that corruption is the association of two important elements: authority and morality In particular, corruption is described as “the dishonest or illegal behavior, especially of people

in authority” and “the act or effect of making somebody change from moral to immoral standards of behavior” The Vietnamese Law on anti-corruption, 2005 defined corruption

as “the acts committed by persons with positions and/or powers of abusing such positions and/or powers for self-seeking interests”

In the aspect of economics field, (Klitgaard, 1988) explained corruption through an equation: Corruption = Monopoly Power + Discretion – Accountability Besides, United Nations Development Program (2004) uses another equation to define corruption, as follows: corruption= (Monopoly Power + Discretion) – (Accountability + Integrity + Transparency)

Awartani, H (2009) suggests that corruption activities are conducted by two parties consisting of demand-side supply-side Demand-side corruption involves corrupt public officials who asked individuals or companies to pay a bribe to receive public services or

implement regulations smoothly Supply-side corruption is individuals or firms who corrupt officials because of their benefit

In general, corruption in the public sector is now widely accepted as “an illegal act that involves the abuse of a public trust or office for some private benefit‟‟, or “the misuse

of public office for private gain.” (Fantaye, 2004)

2.1.2 The Forms of Corruption

As the broad definition suggests, corruption can occur in various forms In particular, Transparency International (TI, 2009) shows some popular forms of corruption such as bribery, embezzlement, fraud, extortion, cronyism, nepotism, patronage and graft The definitions of these most common forms are given in table 1 as follows:

Table 2 1: Definitions of corrupt activities

Bribery The payment (in money or kind) that is given or taken in a corrupt

relationship Equivalent terms to bribery include, for example, kickbacks, commercial arrangements or pay-offs These are all notions of corruption

in terms of the money or favours paid to employees in private enterprises, public officials and politicians.They are payments or returns needed or demanded to make things pass more swiftly, smoothly or more favourably through state or government bureaucracies

Collusion A secret agreement between parties, in the public and/or private sector, to

conspire to commit actions aimed to deceive or commit fraud with the objective of illicit financial gain The parties involved often are referred

Cronyism or

nepotism

A form of favouritism based on acquaintances and familiar relationships whereby someone in an official position exploits his or her power and authority to provide a job or favour to a family member or friend, even though he or she may not be qualified or deserving Nepotism may stretch to include other common grounds such as race, religion, common origin (e.g from the same village or nationality)

Fraud The act of intentionally deceiving someone in order to gain an unfair or

illegal advantage (financial, political or otherwise)

Gifts and

Hospitality

Gifts and hospitality (e.g vacations, luxury dinner, etc.) that could affect

or be perceived to affect the outcome of business transactions and are not reasonable and bona fide

Lobbying Any activity carried out to influence a government or institution„s

policies and decisions in favour of a specific cause or outcome Even when allowed by law, these acts can become distortive if disproportionate levels of influence exist – by companies, interest groups, associations, organisations and individuals

Revolving

Door

An individual who moves back and forth between public office and private companies, exploiting his/her period of government service for the benefit of the companies they used to regulate

Source: Transparency International (2009)

Besides, according to Rohwer (2009) and TI (2015) another popular criterion to classify corruption is based on scales of corruption In this way, corruption is classified as petty and grand corruption TI (2009) defined petty corruption as “everyday abuse of entrusted power by low- and mid-level public officials” when they interact with ordinary citizens who are trying to connect to public services such as hospitals, schools, police departments and other agencies with the small scale of monetary transaction On the other hand, “grand corruption consists of acts committed at a high level of government that distort policies or the central functioning of the state, enabling leaders to benefit at the expense of the public good” (TI, 2015)

2.1.3 Measuring corruption

Corruption is a complicated social, political and economic phenomenon that cannot

be measured directly However, the past decade witnessed a rise in public awareness of this problem along with an extension of corruption measurement (Rohwer, 2009) The key mode of measurement since the mid-1990s is perceptions - based Some indices at the aggregate level in this period can be listed such as the Corruption Perception Index (CPI),

the Bribe Payers Index (BPI), the Global Corruption Barometer (all produced by Transparency International), the Business Environment and Enterprise Performance Surveys (BEEPS) Another aggregate indicator may be mentioned is the Control of Corruption element in the World Bank Group‟s Worldwide Governance Indicators (WGI) (Heywood, 2014) Table 1 will summary some features of these measures

It is noted that due to the lack of global consensus on the definition of corruption, the multi-face of this issue and its nature, it is almost impossible to give an accurate and objective measure for corruption (Rohwer, 2009) However, it is necessary to distinguish three types of corruption indicators: perception – based indicators, experience-based indicators, and proxy indicators The perception-based indicators base on the opinions and perceptions of corruption of citizens and experts The experience-based indicators base on the actual experience of citizens or firms The proxy indicators measure corruption indirectly by trying to aggregate many opinions and signals of corruption or estimate though opposite aspects such as anti-corruption, good government, etc (UNDP 2008, 8 ff.)

Table 2 2: Summary of features of measures of corruption

Index/Survey

Source

Definition of corruption Measured

Information sources Coverage Interpretation

Corruption

Perceptions

Index (CPI)

Perceived corruption (composite) and some measures

of corruption control

Statistical summary of expert assessments (e.g expatriate business executives, senior business leaders, assessment by the US, regional, and in-country experts )

Almost global depending on having sufficient sources Annual (though not all data sources annual)

Cross-sectional ranking of perception of corruption focusing on business environment

Control of

Corruption

Index (CCI)

Perceived corruption (composite) and some business and public opinion survey evidence and corruption control assessment

Similar sources to CPI but with some survey evidence

Almost global depending on having sufficient sources

Biannual (though not all data sources annual or biannual)

Cross-sectional ranking of perception of corruption Sources may be somewhat wider than business environment focus of

CPI

Public Integrity

Index (PII)

Overall institutional the environment for controlling corruption

Absolute ranking (in principle allows assessment of change over

time)

Bribe Payers

Index (BPI)

Perceived willingness of companies from different countries to pay bribes, and sectors in which bribery most prevalent

Business experts

21 countries based on evidence from main emerging market economies Last carried out 2002

Ranking of perceived willingness to pay bribes in different countries The validity of perceptions and weighting

Public opinion surveys and partial household surveys

69 countries in 2005, though not nationally representative in

Comparative prevalence and amounts of bribe payments though the quality of survey data

Bribe payments by households Household surveys 16 countries Quantitative comparisons of

bribe prevalence and cost

Source: Oxford Policy Management (OPM), 2007

2.2 Empirical studies

2.2.1 Factors influencing the propensity to bribe

Previous firm-level studies have examined the drivers of bribery and the size of a bribe, indicating that these two things are affected by the interaction level with public officials and several firm characteristics2 Besides, Rand and Tarp (2012) also suggests that the informality status of firms is a good indicator to interpret the incidence of bribery

These studies examine the incidence of corruption in a situation where the firm with some probability faces a request for a bribe from the officials for running a business smoothly The corrupt officials who have discretionary power may take actions aim to either benefit or hurt the firm This section reviews the previous empirical studies investigating the factors influence the propensity to pay a bribe These factors are divided into three groups, including (i) control right of public officials over firms, (ii) bargaining power and (iii) visibility

(i) Control right: includes several indicator variable capturing the degree of interaction level

with public officials and the regulatory burden that the firm faces.

Regulations

Tanzi (1998) suggested that the bribery may derive from the burden of regulations There is no denying that the regulations such as licenses, permits, etc are of importance for governments to manage society and economy However, the existence of these regulations along with the monopoly power of the government officials in controlling these activities gives officials a good opportunity to extract a bribe from those who need the authorizations

or permits The author also showed that the emergence of these regulations requires a frequent and direct contact between government officials and citizens Citizens have to spend

a large amount of time to deal with these regulations This time amount can be reduced considerably through the payment informal cost

In line with Tanzi (1998), Svensson (2003) also demonstrates the influence of control right on the incidence of corruption, in which control right refers the interaction between firms and government In this study, the extensive interaction with public officials is measured by two variables, including regulations which reflect the percentage of

2 See, Svensson (2002), Lee, S H., Oh, K K., & Eden, L A., (2010); Rand, J., & Tarp, F (2012) and Malomo,

F (2013)

administrator‟s time spent dealing with a government regulations each month and the monthly cost for accountants, lawyers who deal with regulation and taxes Meanwhile, Rand and Tarp (2012) use the number of government inspectors which strongly correlate with the time use of management to deal with the government to measure the degree of interaction with public officials

Svensson (2003) finds that the probability of paying bribe positively related to the degree of interaction with public officials More specially, enterprises usually have to pay the informal cost when they deal with public officials who have the power to affect their business They are more likely to spend more time dealing with public regulation Besides, they also face an increase in payment for accountants and specialized service providers to deal with regulations and taxes

The burden of regulation that firm faces (Tax)

Svensson (2003) and Malomo (2013) suggested that the burden of regulation caused the firm to facing a higher risk to pay a bribe To measure the burden of regulation, Svensson (2003) use the type of taxes the firms have to pay while Malomo (2013) use the percentage of sales declared for tax purposes Svensson (2003) fail to demonstrate the effect of the type of taxes on the incidence of corruption due to the multicollinearity problem However, when overcoming this issue by using principal components analysis, the author points out the significant and positive relationship between two variables Similarly, Malomo (2013) also find evidence that companies that spent increasing percentages of sales for tax purpose are more likely to pay a bribe

Export dependence

Lecraw (1984) and Luo (2007) suggest that certain firms mainly sell their product to domestic customers while other firms primarily generate their income by exporting their output to global market The former are more likely to be required to interact more intensely with local supplier, customers, labor force and public official when they operate their business which caused their exposure to corrupt practices This can be explained by the fact that the intensification of exposing to the internal environment will make firms contact with

to a wider range of potential legal vulnerabilities related business' regulatory requirements

On the other hand, Kobrin (1987), suggest that exporting firms characterized by higher technical and managerial capabilities which are strengthened over time through the learning and innovation when they business in the global market Their profitability is less likely to

suffer from the vulnerability to government corruption than their counterparts This enables them to raise the firm‟s bargaining power vis-à-vis government

Another argument for the negative relationship between export and the drivers of corruption as follows In developing countries and especially in countries with balance of payments problem, export activities are highly appreciated because of their contributions to foreign exchange and employment (Grosse, 1996; Vernon, 1971; UNCTAD, 2006) This points out that export-oriented firms have high national salience and public officials are more likely to dampen their bribe demands in order to avoid punishment (Lee, Oh & Eden, 2010)

In addition, Lee, Oh, and Eden (2010) also suggest that the competition among national governments in attracting and supporting export-oriented firms will strengthen the firm‟s bargaining position With above arguments, Lee, Oh, and Eden (2010) give the hypothesis that the export-oriented firms are less likely to face a risk of to pay the informal cost as well

as the smaller the bribes have to pay to government officials

The dependence of firm’s profitability on government

Pfeffer and Salancik (1978) showed that there is the difference in firm-level profitability dependence on the government among firms The companies obtaining a large share of their revenue from government tend to more beholden to the whims of the public official Such dependence comes to be problematic when the corruption dominates the award

of state contracts (Dela Rama, 2012) Because the sales from such contracts might be important for companies‟ survival, the firms‟ strategies might aim to induce political decisions in favor of them This subsequently requests firms to develop more internal resources to quickly obtain information on their government characteristics (Hillman & Hitt, 1999; Hillman, 2005)

Hansen et al (2009) indicated that when state-owned enterprises have become firm‟s key client will have a positive and significant impact on firm performance It may be argued that there is an informal split benefit between the firm and the government official Rand and Tarp (2012) and Malomo (2013) also use a dummy variable that indicates whether the government is a firm‟s customer, to examine the bribe incidence They give hypothesis that when firm‟s business depends on government contracts or government is a firm‟s customer,

the firm is more likely to corrupt public official

The dependence of firm’s input on government

According to Tanzi (1998), in most countries, sate sector engages in providing of goods, services, and resources at a lower price than market prices The list of these public

goods and services can be listed as foreign exchange, credit, public housing, public land, electricity, water or some public services such as such as health care, education, and so on With access to a large amount of these public goods at a below-market price, some groups of people can considerably benefit from trading these goods Sometimes, the limited supply causes the shortages of these products; therefore, a solution like ration coupon becomes unavoidable Because the responsibility of allocating the limited supply is often of public employees, people who would like take advantages of access would be willing to pay the informal cost to the public official

Svensson (2003) and Malomo (2013) also examine the relationship between the degree of using public services such as electricity, water, telephones and waste disposal and the propensity to pay a bribe They point out that the companies receiving public services t have a higher risk of paying a bribe

In line with Svensson (2003) and Malomo (2013), Rand and Tarp (2012) prove that when the government as firms‟ main supplier, they face a higher probability of paying a bribe

Government assistance

According to Rand and Tarp (2012), over the past years, to promote the development

of SMEs, Vietnamese Government has implemented many supporting policies, divided into two groups: financial and technical assistance However, there has been a significant decline

in the proportion of firms receiving assistance from government authorities since the 1990s This trend is in line with the Vietnamese government‟s strategy of promoting private sector development However, this also caused of an increase in exposing to potentially corrupt activities This hypothesis was proved when these authors find that the firms receiving government assistance face a higher probability of paying the informal cost

In line with Rand and Tarp (2012), Stensson (2002) also suggests that tax exemption

is one of the firms‟ incentives to pay a bribe However, this study fails to prove this relationship

(ii) Bargaining hypothesis

Svensson (2003) constructs a bargaining hypothesis suggesting that firms‟ ability to pay and firms‟ refusal power influence the probability of having to pay a bribe In which firms‟ ability to pay is measured by firm‟s profitability and firms‟ refusal power is measured

by firm‟s choice of technology The author expects that companies with high profit are more

cost existing current industry will strengthen firms‟ refusal power However, the result of this study shows that there is no link between firms‟ ability to pay and firms‟ refusal power and the incidence of corruption

In line with Svensson (2002), Rand and Tarp (2012) and Malomo (2013) also test the relationship between these variables Malomo (2013) points that profit and sunk cost don‟t influence on whether or not companies have to pay informal cost whereas Rand and Tarp (2012) find a significant and positive relationship among them These results prove that the test of bargaining hypothesis is still ambiguous

(iii) Visibility

Stensson (2002) hypothesizes that firm visibility will affect the propensity to pay a bribe Rand and Tarp (2012) give two visibility proxies: firm size and the informal status of firms

With regard to firm size which is usually measured by the total number of firm‟s employees or the logarithm of the total number of firm‟s employees at the end of the most recent fiscal year3 There is not consensus about the effect of firm size on the propensity to bribe More specially, Beck et al (2005) point that smaller firms are less likely affected by rent-seeking bureaucrats and other institutional problems compared to their larger counterparts However, Hellman and Schankerman (2003) show that relative to their larger peers, smaller firms pay a higher proportion of their income as bribes and the frequency is asked to pay informal cost also more permanent In addition, weak political resources of smaller firms make them be not able to shape regulation in their favor This caused them become more vulnerable to government predation (Bennedsen et al., 2009; Harstad & Svensson, 2011) Besides, Rand and Tarp (2012) find a positive and statically significant relationship between firm sign and the incidence of bribe whereas Svensson (2003) failure to prove this relationship

Related to firm‟s informal status, Rand and Tarp (2012) suggests that smaller and informal firms seem to hide more easily from government regulation and easily avoid bribe Sharing the similar view with these authors, Dabla-Norris and Koeda (2008) argued that the-the main drivers of the increase in the number of such firms are to reduce or eliminate tax burden as well as avoid complex administrative procedures and bribe incidence

However, Rand and Tarp (2012) also points out an opposite effect of informality on bribe incidence In particular, if the firms may seek the benefits of informality, they are

3

Svensson, 2002; Rand, J., & Tarp, F., 2012, Galang, R M N., 2013

willing to offer an informal cost to maintain or achieve the informal status Therefore, the specification of the net effect of informality is also an empirical question

2.2.2 How much must graft-paying firms pay?

Svensson (2003) construct a simple bargaining model to explain the variation in the size of bribe across firms This model supposes that a large number of private firms operate under control of public official in a territory These firms must choose between paying bribes

to run their business smoothly and rejecting paying bribe and exit current market If the yield from relocating their capital to another industry is greater than net profit from bribery, the choice of exiting market is optimal In an opposite direction, firms must bargain about the size of bribe Their bargaining power depends on firm‟s ability to pay a bribe (profitability) and firm‟s ability to refuse to pay a bribe (choice of technology) Svensson (2003) and Rand and Tarp (2012) show that a firm using technology with lower sunk cost (lower K/L ratio) will strengthen the firm‟s bargaining power

Svensson (2003) empirically find a significant and positive relationship between current and expected future profit and bribe amount Additionally, the author points out an opposite direction between sunk costs which measure firm‟s capital mobility and firm‟s refusal power This means that the firms with higher profit, the more it has to pay and the firms with lower cost exiting the current industry will strengthen their refusal power and pay less bribe These results are robust when industry-location averages of the profit rate are used

as an instrument variable for profit

In line with Svensson (2003), Malomo (2013) provides strong evidence of a positive relationship between profit and sunk cost with bribe payment

2.3 Basic framework to estimate the supply of bribes

This study aims to examine the factors influence the bribe incidence and the factors contribute to the bribe amount For this purpose, this study follows the model constructed by Svensson (2003), considering an economy consist of a large number of firms and public officials, in which each firm comes within one bureaucrat‟s jurisdiction The Official is assumed to maximize his profit However, he faces two constraints Firstly, he does not collect any bribes in the event that the firm exits the market Secondly, he may get caught with a bribe and be punished The size of bribe depends on the officials‟ control rights over the firms‟ business activities Therefore, bribery tends to occur in the public sector

characterized by high control right Assume that there are two-sector in an economy, including a relatively clean sector (s1) and a fairly corrupt sector (s2)

The probability of randomly picking a firm i who has to pay bribe is:

p(i) = σ(i∈s2) * ρ (1) where σ(i∈s2) is the probability of firm i operate in sector s2

ρ: is the probability of randomly drawing an official in sector s2 that tend to take a bribe

Assume that the firms manufacture two goods: x1 and x2 that are traded on the world market The world market price of x1 and x2 is respectively θ and 1 and the host country is as

Π(k, θt, |s2): is current net profit

Etβ[Π(k, θt+1, |s2) – pb(θt+1)]: is expected future profits, in which p: is the probability of firm face a request for a bribe

Firms cannot borrow to pay bribes so firm‟s net profit in each period must be non-negative: Π(k, θt, |s2) – b(θt) ≥0, ∀ t (3)

The level of equilibrium bribe is determined by:

gained if firm exit industry and reallocate its capital in another industry It means that higher ability to pay lead to a decrease the firm‟s bargain power while lower sunk cost of capital will increase its bargain power

2.4 Conceptual framework

As mentioned in literature review, Svensson (2002), Hansen et al (2009), Rand and Tarp (2012) and Malomo (2013) show that the degree of interaction between company with public official, the regulation burden, the visibility proxies, the refusal power and ability to pay will influence the bribe incidence and the bribe amount This relationship can be summarized through the following diagram:

2.5 Chapter summary

This chapter includes three main parts The first one provides a general view of corruption, including definition, forms and the measurement of corruption This part points out that corruption is a complicated social, political and economic phenomenon that cannot

be measured directly The measurement of corruption is primarily based on three types of corruption indicators: perception - based indicators, experience-based indicators, and proxy indicators.The second part reviews several academic studies examining the factors that drive bribery and bribery amount This part indicates that the literature on corruption at the firm-level within individual country contexts is very limited These studies almost use control right

1 Visibility

- Firm size (The log of total employment)

- Informal (Not registered officially)

- Regulations – real time

- Received government assistance

results of these studies reveal that the interaction level with a government official and the regulatory burden are positively correlated with the propensity to pay a bribe Besides, the visibility which is captured by firm size and firm‟s informal status is a good indicator to interpret the incidence of bribery The previous studies also prove that the variation in the bribe amount can be explained by the firm‟s ability to pay and their refusal power The third part introduces the basic framework to estimate the incidence and the level of bribe.

Chapter 3: Corruption in Vietnam

The war against corruption in Vietnam has been implemented over the past years, marked by the Law on Anticorruption in 2005 However, after a decade, corruption has become a threat to the sustainable development of the country

A Sociological survey by World Bank (2012) showed that corruption is one of three most serious issues drawing the attention of population This survey was conducted in ten provinces and cities, focusing on three groups of respondents: citizens, firms, and officials It indicated their perceptions of corruption in the list of ten serious problems which attract concern from social In particular, officials suggest that corruption is a most serious issue on the list A group of enterprises admit that corruption became only the second cause of concern, behind the cost of living Citizens rank corruption at the third place after the cost of living and traffic accidents Indeed, figure 1 depicts clearly about the serious issues that Vietnam faces

Figure 3 1: The most serious Economic & Social Issues for Vietnam4

Source: World Bank (2013)

Additionally, this survey proves that corruption in Vietnam occurs in various forms with different levels in many sectors More specifically, three surveyed groups including public officials, enterprises and citizens reach the high consensus of corruption prevalence among sectors More than 75% of the total respondents agree that four most corrupt sectors in

Vietnam comprise traffic police, land administration, customs, and construction Meanwhile, post and telecommunication, media, treasury, and the ward/commune police were recorded

as the four least corrupt sectors (Figure 3.2)

Figure 3 2: Perceptions of the prevalence of corruption across sectors5

Source: World Bank (2013)

Corruption in Vietnam has become more and more serious when Corruption Perceptions Index 2014 (CPI 2014) reports a low rank for Vietnam In particular, on a scale from 0 to 100, where 0 is highly corrupt, and 100 is very clean, Vietnam score 31, ranking

119 out of 175 countries worldwide and 18 out of 28 countries in the Asia-Pacific region It is noticeable that despite the effort to reduce corruption, there has no change in the population‟s perceptions about corruption in three consecutive years (2012 – 2014) This reflects the lack of citizens‟ trust in the effectiveness of public administration

Table 3 1: Vietnam‟s annual CPI result

Moreover, the PCI 2014 Survey points out a worrisome decline in the score of informal cost criteria Comparing this to PCI, 2006 shows an increase in surveyed firms‟ pessimism To be specific, in 2008, 66% of respondents have said that they usually pay the informal cost to run the business smoothly After many years of decline, the trend of firms paying the informal cost reverse and turned to be over a threshold in 2014 This report also indicated that 10% of businesses paying bribes spend more than 10% their revenue on bribes

In addition, increasing number of firms say that they usually suffer the harassment from public officers in administrative procedures (66% in 2014, up from 41% in 2013) The same result also was recorded in the PCI-FDI Survey

Figure 3 3: Key Indicators of Informal Charges (2006 to 2014)

Source: The Provincial Competitiveness Index (PCI), 2014

Figure 3.4 indicates the main purposes of informal payment As can be seen from this, the bribe payments are mainly for dealing with tax collectors and easily accessing public services In particular, there is about 20 percent of such payment for the former reason, and 30% of payment for latter one Comparing to previous years (2009 and 2011), tax services show improvement while public service access has poorer performance

Figure 3 4: The purpose of bribe payment

Table 3 2: Average cost of bribes paid, by sector

Source: Transparency International (TI), 2013

Several studies point out the cause of corruption in Vietnam CIEM (2005) indicates four major causes, include: (i) the abuse of public power; (ii) the arbitrary decisions involved

to policies and administration; (iii) the weaknesses in transparency and accountability of

To deal with taxes and tax collectors

To gain government contracts public procurement

To deal with customs

Other

2009 2011 2013

officials and government agencies, (iv) the weakness in implementation and monitoring of state Furthermore, the report of IT also emphasizes that the differences in corruption across countries can be explained by the effectiveness of the judicial system, the rule of law, and the public governance personnel (Nguyen & Van Dijk, 2012)

Despite government‟s efforts in combating corruption, communities still show a negative perception of the state of corruption in Vietnam The findings of TI survey, 2013 show that only one-fourth (24%) of total respondents agree that the government's anti-corruption efforts are efficient Meanwhile, 38% of replies assess the government's anti-corruption efforts is inefficient or very inefficient The remaining 38% of surveyed people thought that the efficiency of anti-corruption programs is not clear This report also reveals the increase in public mistrust of the government‟s anti-corruption efforts To be more specific, in 2013, 60 percent of questioned people give negative responses in comparison with 35% of those in 2010

Figure 3 5: Awareness about the government's anti-corruption efforts

Source: Transparency International (TI), 2013

About the public apprehension about corruption, TI (2013) shows Vietnamese unwillingness of denouncing corruption over time In 2013, up to 62% of respondents are unwilling to report corruptive incidents while this figure for urban citizens is even higher, 66% A contrasting result was recorded in 2010 when 65% of respondents were willing to report occurrences of corruption

Comparing such results among Southwest Asia shows that Vietnamese citizens appear

to be the least voluntary to reveal cases of corruption The TI (2013) points out that the

less than those of Malaysian responses Vietnamese figure is even lower than the average number of 63%

Figure 3 6: Willingness to report an incident of corruption (Southeast Asia)

Source: Transparency International (TI), 2013

In general, these countries - level data depicts a brief overview of corruption in Vietnam There is no doubt that such hazard in Vietnam is severe, especially in traffic police, land administration, customs and construction The abuse of power by public officials and the arbitrary decisions related to policies and administration are the major causes of corruption Vietnamese government‟s efforts against corruption over the past years seem to be inefficient These result public skepticisms of anti-corruption program

Chapter 4: Data and Econometric Model

This chapter consists of three main parts The first part outlines the data source and data description As mentioned above, this study uses the available data of SMEs in Vietnam from the period of 2005 to 2013 that provide quantitative data on bribe payment and detailed financial information of surveyed firms The second part presents the descriptive statistical analyzes This part aims toprovide a brief look over the key variables and initial relationships between the initial relationship between explanatory variables and response variables The final part specifies the econometric models as well as the variables included in these models

4.1 Data

4.1.1 Data source

This study uses the available data of SMEs Surveys in Vietnam from 2005 to 2013 that have been conducted by several parties Those are the Central Institute for Economic Management (CIEM), The Ministry of Planning and Investment (MPI), the Institute of Labour Science and Social Affairs (ILSSA) - the Ministry of Labour, Invalids and Social Affairs of Vietnam (MoLISA), Department of Economics - Copenhagen University, and Embassy of Demark in Vietnam These surveys covered around 2500 small and medium enterprises, including non-state manufacturing ones in ten cities and provinces in Vietnam The formal and informal private companies have different sizes of samples To answer the research questions, this study exploit information on firm‟s financial performance, the interaction between firms and public officials, as well as the information on bribe payment

Table 4 1: Panel data structure

Source: Author‟s calculation

Table 4.1 indicates the panel data structure All the firms in cleaned sampled are absolutely