Corruption and Startups

A lot of people like to point out that startups don’t really care about taxes.  They don’t earn money, so they don’t pay them.  They do need to attract employees though and so indirectly high taxes and governmental costs affect startups.  They impact the daily standard of living and the cost to have a family.  We are seeing it in California where the cost of living is artificially high because of poorly designed public policy.  High tax states like New York and Illinois are losing to states like Colorado, Texas, North Carolina and even Florida. I hear Tampa has some startup activity percolating.

The stories have always been sort of anecdotal.  Poop and hypodermic needles on the streets in San Francisco.  Rats exploding in population in LA along with third world diseases like typhoid.  Massive homeless populations in LA, SF, NYC, and Chicago.  All due to poorly designed government policy at the state and local level.  You can see it come out in data on migration statistics a little bit.  But, there is always some talking head that will put some doubt or counterbalance into the equation.  Plus, in places like NYC and SF, there is alpha.  There is funding.  So enough people move into the startup community to chase the dream to keep it full.

Then I saw this study by  University of Illinois Gies College of Business professor of accountancy Nerissa Brown.  Wow.  Jaw dropping.  Especially given I live in one of the most corrupt cites/states in the world Chicago, Illinois.  Corruption should have an emoji on the state flag and they ought to put another red star on the Chicago flag for it.

A broader point of the study is this;

“We know that corruption has a negative effect on firm value. It’s a deadweight tax on firm value,” said Brown, who also is a PricewaterhouseCoopers Faculty Fellow. “One key factor that exacerbates this negative effect is when firms operate in highly competitive industries. In such industries, the profit margins or economic rents that a firm earns are much lower because competition drives those margins down. If low-profit firms face corruption on top of that, they already have a small piece of the profit pie – and that slice will surely be smaller if they have to grease the palms of rent-seeking public officials.

Further analysis in the paper suggests that corruption is particularly harmful to shareholder value when state governments are controlled by a single party, consistent with the notion that interparty competition deters corruption, Brown said.

Ask a small business person in Chicago or Illinois how many palms they grease directly or indirectly.  Speaker of the House Democrat Michael Madigan’s palms are so slick they could be ball bearings in an engine.  He’s made millions on commercial property tax appeals.  He has been Speaker for 41 years.  Democrats have fun Chicago since the 1930’s.

In a weird way it impacts taxpayers indirectly right in their pocketbook.  A corrupt government might have to give away more in tax subsidies in order to attract businesses to cover the cost of corruption.

But, this point was even more interesting;

If you’re a start-up and you’re thinking about where to locate, “then the corruption culture is something you ought to take into consideration,” Brown said. “This is no different from a multinational corporation that should assess a country’s corruption culture before entering the market.”

This is the first study that I have seen that corellates data about political corruption and translates it to how it decreases the value of businesses.  Would public firms that are headquartered in Chicago be worth more if they were headquartered in a place that had less or no corruption?  How about startups?  What are the opportunity costs to corruption that are impacting the ability of Chicago’s startup sector to grow?

It’s awfully hard to tease out of the data when a person is thinking about moving to Austin or Chicago and chooses Austin.  But from the data in this study we can assume that it probably is happening.