Clarity of Risk is Essential for Success in International Business Development: Opacity Index & Corruption Perceptions Index (CPI)…

“We realized that a lot of information about countries or companies is lost or intentionally hidden. If you can’t get good information, risks can be overvalued or undervalued.” ~Joel Kurtzman

Opacity (defined as ‘lacking transparency or translucence; opaqueness’) is not only a deterrent to global economic development, but it also decreases the ability to access capital. According to the ‘World Bank Doing Business Database’, regulatory and legal transparency is an important indicator of the cost of starting or expanding a business, and, it can enhance or constrain business investment, productivity, and growth…

The Opacity Index is a measure of a country’s regulatory and legal transparency, and consists of five factors: corruption, legal system efficiency, economic and enforcement policies, accounting standards and regulatory effectiveness. Together, these factors form the acronym ‘CLEAR’. ‘Higher level rankings’ of opacity in the ‘CLEAR’ factors indicate poorly functioning governments, which increases the cost of doing business, as well as the risk.

The Opacity Index measures high-frequency, low-impact risks, which include; corruption and un-enforced laws and policies. It also measures the rights of debt- and equity-holders around the world, the adequacy of corporate governance and the quality of accounting standards. Whereas, most traditional measures of risk look at low-frequency, high-impact events, such as coups-d’état, nationalization of industries and earthquakes…

In the blog Overseas Investors Get Guidance from PwC’s Opacity Index by AccountingWEB writes:  The analytical model for the Opacity Index was developed by ‘PricewaterhouseCoopers (PwC) Endowment for the Study of Transparency and Sustainability’ to provide guidance for policy makers and business leaders who are considering the economic impact of international business development.  The objective was to create a country-by-country ‘ranking of opacity’, which represented degrees of ‘lack-of-clear, accurate, easily discernible and widely accepted practices governing the relationships among businesses, investors, and governments’.

The Opacity Index draws upon 65 objective variables from 41 sources compared across 48 countries. Each component of opacity; corruption (C), efficacy of the legal system (L), deleterious economic policy (E), inadequate accounting and governance practices (A) and detrimental regulatory structures (R) — is rated separately, and the component ratings contribute to an overall opacity rating…

In the article “The True Cost of Going Global” by Judy Warner writes: The Opacity Index helps to make known, that which is hard to know: True cost of doing business globally. What does it really cost to tap China’s massive market? Is that a better value than setting up shop in India or Brazil? Why is Finland considered a safe place to do business?

These type questions are the basis of the book, Global Edge: Using the Opacity Index to Manage the Risks of Cross-Border Business” by Joel Kurtzman and Glenn Yago. While working at PwC, Kurtzman and Yago developed the initial research that led to the creation of the Opacity Index. “What we were interested in were the capital markets and how they reacted to information,” Kurtzman recalls. “We realized that a lot of information about countries or companies is lost or intentionally hidden”.

If you can’t get good information, risks can be overvalued or undervalued. Our yardstick was how the capital markets looked at companies and whole countries and how that related to currencies…Then we looked at governance nationally and at a corporate level, and were able to determine that there’s a lot more globalization of processes than information. We know how to manufacture around the world but, for example, executives in Germany don’t necessarily know how business is conducted in France, or other countries. The index provides a snapshot”…

In the article The Global Costs of Opacity by Joel Kurtzman, Glenn Yago, and Triphon Phumiwasana write:  A careful review of the individual ‘CLEAR’ factors can provide highly useful information in decision-making, since even in countries with the same overall Opacity Index rating the causes of opacity might be quite different. For example, if managers have a choice of where to locate a regional headquarters, they might choose a country with scores higher on the legal and economic sub-indices. If they are looking for a place to build a plant, they may care more about the corruption sub-index.

If they are looking at a joint venture with another company, the legal sub-index will indicate those locales in which the provisions of a joint-venture contract will be best enforced. This is not to suggest that businesses should avoid high-opacity countries. Indeed, in some areas of commerce such as mineral extraction and oil production, that would be difficult, since many of the largest producers of raw materials and oil have high opacity scores. Instead, businesses can use the Index to prudently measure their risks and to create mechanisms to protect themselves against those risks.

In the article “Measuring Opacity” by Christos and Mary Papoutsy write: The Opacity Index measures ‘level of opacity’, defined as “the lack of clear, accurate, formal, easily discernible, and widely accepted practices.” The potential for opacity exists and no country is likely to earn a perfect score. For example, there may be corruption in government bureaucracy that allows bribery or favoritism. The laws governing contracts or property rights may be unclear, conflicting, or incomplete. Economic policies — fiscal, monetary, and tax-related — may be vague or change unpredictably.

Accounting standards may be weak, inconsistent, or irregularly applied. A high degree of opacity in any of these areas will raise the cost of doing business as well as curtail the availability of investment capital. As the world’s markets, in the era of “globalization,” become more interdependent, it becomes obvious that one country can differ from another in clarity and consistency of their approaches to managing their economies. Some national economies are relatively transparent, while many others are relatively opaque. The Opacity Index brings a degree of clarity to the subject of costs related to corruption…

Since 1995, ‘Transparency International (TI)’ has published an annual ‘Corruption Perceptions Index (CPI)’ ordering the countries of the world according to “the degree to which corruption is perceived to exist among public officials and politicians”. The organization defines corruption as “the abuse of entrusted power for private gain”. A higher score means less (perceived) corruption.

Since this index is based on polls, the results are fully subjective and based on a reputational model, and less reliable for countries with fewer sources. Also, what is legally defined (or perceived) to be corruption, differs between jurisdictions: a political donation that is legal in some jurisdiction may be illegal in another; a matter viewed as acceptable tipping in one country may be viewed as bribery in another.

In former Soviet states, the term “corruption” itself has become a proxy for the broader frustration with all changes since the breakup of the USSR. In the Arab world, terms for corruption had to be invented by advocates as recently as the 1990s… Critics point out that definitional problems with the term “corruption” makes the tool problematic for social science. Aside from precision issues, a more fundamental criticism is aimed at the uses of the Index. Critics are quick to concede that the CPI has been instrumental in creating awareness and stimulating debate about corruption.

However, as a source of quantitative data in a field hungry for international datasets, the CPI can take on a life of its own, appearing in cross-country and year-to-year comparisons that the CPI authors themselves admit are not justified by their methodology. The authors themselves state: “Year-to-year changes in a country’s score can either result from a changed perception of a country’s performance or from a change in the CPI’s sample and methodology. The only reliable way to compare a country’s score over time is to go back to individual survey sources, each of which can reflect a change in assessment.”

In the blogCorruption Realities Index 2010 by Anatoly Karlin writes: There are three corruption indices that aren’t as well known as the CPI, but far more useful. One of them is ‘Transparency International’s’ less well-known ‘Global Corruption Barometer’. Every year, they poll respondents on the following question: “In the past 12 months have you or anyone living in your household paid a bribe?” The answers hint at the prevalence of corruption in everyday life, as experienced by a sample of normal people…

Another key resource is the ‘Global Integrity Report’, which evaluates countries on their actually existing ‘Legal Frameworks and Actual Implementation’ on issues, such as, “the transparency of the public procurement process, media freedom, asset disclosure requirements, and conflicts of interest regulations.” This involves line-by-line examination of the laws in question, and the “de-facto realities of practical implementation”…

Finally, there is the ‘International Budget Partnership’, which – believe it or not – assesses budget transparency and accountability. It compiles an ‘Open Budget Index’ on the basis of factors such as budget documents availability, and the effectiveness of oversight by legislatures and supreme audit institutions… Data from all these three aforementioned corruption indices – to the extent available — is amalgamated to produce the ‘Corruption Realities Index’…

Having ‘clarity of risk’ is essential for success (or, for averting failure) in international business development. When assessing business risk, do your homework before investing in a country. Otherwise, problems such as corruption, weak legal systems, inefficient enforcement policies, deliberately confusing or illegal accounting procedures and dysfunctional regulations can increase your costs of doing business or even thwart your efforts.

Learn what to expect before you commit resources: The “Opacity Index” aggregates information on these complex factors to help individuals and companies formulate strategies to protect themselves against the risks of globalization. They also offer a useful, contrarian perspective on a range of issues; for example, they may question the vogue for investing in Brazil, Russia, India and China, which are highly opaque countries, according to their index…

“It’s the same whether it’s a company, a country or a region, if the risk picture is unclear, capital is less likely to go where it’s needed.” ~Matt Feshbach