Corruption, digital economy and profitability of foreign subsidiaries

Abstract

Drawing on more than 14,000 multinational enterprises and their foreign subsidiaries (over 18,000) operating in 14 emerging markets over the period of 2008-2016, we find that there is a reversed J-shaped relationship between profitability of a foreign subsidiary and host country corruption: when the host country corruption is in a middle range, foreign subsidiary profitability is strongly and negatively affected, which we argue is consistent with prospect theory. Yet, when corruption is widespread and becomes a norm, reducing uncertainty, the financial performance becomes relatively stronger, albeit still at a lower level compared to corruption-free environment. Furthermore, business restrictions decrease foreign subsidiary profitability, yet corruption attenuates this negative relationship, which is in line with the (narrowly defined) greasing-the-wheel theory. Foreign companies operating in digital sectors are less affected both by the host country corruption and by the business restrictions, compared to those in non-digital sectors.