Combating Corruption and Other Organizational Pathologies

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Introduction

The effective use of human resources, tangible and intangible assets are key components of an organization’s success in the turbulent environment of the modern world. The effective use of resources requires the skillful application of the methods and procedures. In the application of these methods and procedures it is important to effectively reduce the occurrence of organizational pathologies, which are defined as situations that negatively affect the relations between and among stakeholders and may limit achieving organizational goals.

One can formulate the title this book as combating corruption and other wrongdoing. However, the author proposes the title of book related to organizational pathology, underlying that corruption, fraud, a shadow economy as well as money laundering should be considered as such pathology from the point of view of individuals, public organizations, society, states. In this book author focuses on analyzing of corruption and other irregularities from the point of macrostructure – the State and public organizations.

This book entitled: “Combating Corruption and Other Organizational Pathologies” was written in response to the demands of students, theoreticians and practitioners, from different countries. The objectives of this work are: 1) systematization of concepts related to the issues of corruption and other types of irregularities; 2) identification of the entities of public life, which should be involved in the fight against corruption and other types of irregularities, and the search for solutions to combat these irregularities, including the formulation of the methodology of diagnosis factors contributing to corruption and its symptoms. The book describes the results of author’s research studies that were designed to address the following research questions:

• What factors determine the occurrence of corruption and what problems are caused by corruption?

• How can corruption, fraud, money laundering and shadow economy be prevented?

• How can corruption, fraud, money laundering and shadow economy be detected?

The research work was conducted in the field of the discipline of management sciences. The applied research methods took into account the requirement of methodological triangulation. Recognizing organizational pathologies, as a subjective value, which affects a society, is acceptable to use in this study the strategy ← 7 | 8 → of a methodological pluralism. This means the usage of a variety of methods belonging to different paradigms of the discipline of management science.

The structure of this book takes into account the need to achieve the scientific goals and resolve of research problems. In Chapter I of the book entitled: “Organizational Pathologies”, the results of research literature on the concept of organizational pathology are presented, as well as, an author’s definition of pathology. The subsequent four kinds of pathology, which are extremely dangerous for any state, society and economy are: money laundering, corruption, fraud and a shadow economy, are presented. The book shows not only the causes and consequences of the occurrence of the above pathologies, but also data on the most vulnerable countries to money laundering, corruption or a shadow economy. The book also examines issues presented in the study of the European Research Centre for Anti-Corruption and State Building, which has not been fully explained and requires further in-depth research, due to fundamental issues concerning the European Union.

The second chapter: “Preventing Organizational Pathologies” starts by presenting the results of studies concerning the role of good governance in reducing organizational pathology. It then discusses the role of NGOs in preventing the occurrence of these pathologies resulting from a multifaceted anti-pathology strategy. Next, examples of organizations that have a significant impact on the reduction of a pathology are presented. Attention was, however, also noted, inter alia that the functioning of NGOs can catalyze an undesirable phenomenon. The remainder of this chapter presents an original model of combating corruption – bribe buyer behavior model. The advantages and limitations of this model is underlined. Then the role of management control system is presented in preventing organizational pathologies, which focuses among others on ethical issues, as well as the risk model. Author shows a variety of techniques to identify the risk of irregularities and its estimation and reduction. Next, the role of external auditors in building transparency, integrity and accountability is discussed. Finally, the identified corruption mechanism and public spheres exposed to corruption are shown. This part is complemented by numerous examples of revealed irregularities in the activities of European public organizations. Understanding these anomalies can improve their future identification and effectively prevent any future occurrence.

Chapter III, which is entitled: “Detecting Organizational Pathologies” begins by providing a methodology of diagnosing the susceptibility of an organization and its staff to corruption and other types of irregularities. Considerations are conducted from the perspective of the organization as a system consisting of the subsystem of the objectives and values, a psycho-social subsystem, an organizational ← 8 | 9 → subsystem, a management subsystem and technical subsystem. The detailed diagnostic questions are formulated and the matrix of the risk of irregularities is formulated. Next, examples of financial malpractices are presented. Such knowledge will help in preventing future occurrence of irregularities. Then the issue of obtaining witness testimony was discussed. Factors affecting the witness, as well as, the types of error in the testimony are presented. Next, the factors affecting the process of forming information given by a witness are identified. Finally the tactics used to obtain information from witnesses and interviewee are discussed. The issue of documentary evidence concludes this chapter. Among other documents forgery is presented, as well as, the approach to evaluating the reliability of documents. Finally the risk in the functioning of an IT system is discussed.

The author notes that it is impossible to answer all questions related to the effective fight against corruption, fraud, money laundering, a shadow economy, and other organizational pathologies. If this were a case, the world would be a safer place to live in. Unfortunately, researchers of pathological phenomena often remain one step behind the new forms of these phenomena, tools, as well as mechanisms. The intention of the author is an indication of the possibility of predicting how these phenomena occur and getting acquainted with the experience of the past in order to better deal with their current and future occurrence. The author in many places indicates areas for conducting further in-depth research and hopes that the book will inspire readers to conduct their own further research in this area. ← 9 | 10 →

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Chapter I:    Concept of Organizational Pathologies

1.    Overview of Organizational Pathology

The term “pathology” is used in sciences and was introduced to sociology in the nineteenth century, mainly by E. Durkheim and other sociologists, representing the evolutionary position. J. Kopka notes that in contemporary sociology, pathology is identified, when the following conditions are met: the challenged behavior, attitudes, social facts are contrary to commonly accepted values and rules of behavior, a multiplicity of such behaviors and their intensity are considered as a threat to the established social order, this situation causes strong social demand to repair such situation¹.

From the perspective of management science, the pathology of the organization can be considered as a relatively permanent failure of an organization, which results in the waste of resources, exceeding the limits of social tolerance². Narrowly, to the sphere of human resource management, the pathology is the organization malfunction in a recognized pattern, representing the brake on the development of competence³. This is a situation where there is disharmony between structural elements, sociological and psychological⁴. Its consequence could be a deprivation, leading to the destructive actions of both individuals and social groups. Z. Dobrowolski argues that the theoretical generalization, ← 11 | 12 → formulated by W. Kieżun, is characterized by a certain relativism, and the analysis of this definition raises both ontological and epistemological questions. What are the limits of social tolerance pathology of any organization? Furthermore, are these limits immutable? An organizational pathology is a kind of reality, which is associated with the collection or disbursement of funds, flow of information and human resource management. All these issues are perceived differently, by different people acting in a different organizational environment. Classifications of pathological phenomena are different. For example, J. Zamecka in the sociology of law, states that pathological phenomena include disturbing violations of community standards. These events can be seen both from an etiological or interpretative point of view⁵.

An analysis of the concept of organizational pathology allows us to formulate a theoretical generalizations that an organizational pathology can be defined as a situation that negatively affects relations between stakeholders and it does not allow an organization as well as most of the stakeholders to achieve their goals. A coherent definition to the presented above idea is that an organizational pathology is defined as a maladjusted way of organizing and results in the operation to human needs in a specific period of time. The dysfunction of this organization includes the following designates: excessive informal network, inappropriate flow of information, which creates gaps in this flow, as well as alienation, which result in the isolation of organizations from the environment. The consequence of alienating an organization can lead to an atrophy or aberration of public discourse. The dysfunctional organization is represented by ritualism, formalism, incompetence and antipathy⁶. The above-mentioned incompetence may indeed be a consequence of legalism. Legality is the requirement of democracy. Legalism, however, can lead to conformity and routine. It may happen, when compliance with the law and/or regulation becomes a dominant value over other objectives of the activity. The consequence of this situation is the difficulty to adapt rapidly to the specific conditions, unforeseen by the legislature⁷.

Another reason which catalyzes any potential organizational pathologies, is the decision-making process, adopted within the organization. In today’s, within a turbulent environment, a decision-making process requires some discretionary powers. This in turn may lead to discrepancies between goals and actual ← 12 | 13 → achievements, and can lead to the inflation of the decision through the creation of further decisions and formalization of a management control system. Certainly an instrument of counteracting this situation is a multi-stage, in-depth analysis of the draft decisions, which focuses on the “cause – effect” relation. A pathology of the organization can be catalyzed by the deformation of the flow of information. A defect in the flow of information can result from deliberately incorrectly encoded information, incorrect organization of a communication channel, as well as the incorrect decoding of information by the recipient. The asymmetry of information can lead to deformities in cash transactions economic entities, and from the perspective of macro-organization to inefficient allocation of resources. Basic cause of pathology can be an uncritical application of the solutions in terms of organization and management. For example, excessive reduction of employment and the pursuit of efficiency can contribute to a perdition of the organization resources, as well as, to the improper realization of the tasks. The consequence or the cause of the pathology of an organization can be an anomy and therefore, as noted by E. Durkheim, such a situation in which individuals in a mass scale lose their ability to distinguish good from evil or the situation of an organization, in which the violation of norms goes unpunished. An effective option of a preventive nature is the inevitability of punishment and the speed of actions taken in case of any breach of standards. Such an approach fosters an institutional balance between formal and informal institutions⁸. While E. Durkheim notes that an anomie is primarily uncertainty associated most often with systemic changes, for R. Merton this refers rather to the sphere of social activities and means a situation where an individual can not realize the socially-imposed targets with socially acceptable rules. The result of an anomie is the powerlessness in the absence of opportunities to gain internalized values or as noted by L. Coser in the case of the disintegration of the group due to the fragmentation of the system of values⁹. Z. Dobrowolski agrees with J. Kopka that pathologies can appear not only in the case of important unmet human needs, but also by social processes, as pragmatic attitudes, ethnocentrism and concentration on consumption as pathological processes can be fueled by social policy. For example the distribution of social benefits can create a “culture of rent seeking,” where it does not pay to go to work. ← 13 | 14 →

Among the causes of pathologies improper relationships in organizations usually stand out, including those caused by a neurotic desire for power. The causes of pathology may therefore not only be of interest to management science, but also, for example cognitive science, based on explaining the thought processes. W. M. Orłowski notes that the financial world is particularly vulnerable to dishonesty, which is the result of the specific features of financial intermediation. Financial assets, which rotate in the financial market are written on paper as the promise to return the borrowed money. This means that such a promise generates the risk. So, there is no financial transactions without a risk, as well as, the size of the risk being difficult to determine. In addition to existing forms of banks, investment banks have appeared, and these have changed in listed companies, little interested in a customer’s profit, and mainly interested in maximizing their profits. This approach of listed companies has prompted them to increase the investment risk, and to cheat customers, by for example through creative accounting¹⁰. The main theories that are associated with pathologies of public management are the following: agency theory, transaction cost economics, the stakeholder theory, as well as the stewardship theory.

M. Jensen, W. Meckling, E. F. Fama identifies the agency relationship where one party, the principal, delegates work to another party, the agent. Such relationship can have a number of disadvantages coming from the opportunism or self-interest of the agent. The agent may not act in the best interests of the principal. Taking into account public sector, there can be a number of dimensions to this including, the agent is underpaid in his/her opinion in relation to the social profit of his/her work, or the risk is differently perceived. There is also the problem of information asymmetry whereby the principal and the agent have access to different levels of information. In practice, the agent creates information, and will have more information. No doubt, the problem is fueled by the separation of ownership and control. It is presented in further part of this book. This problem was noticed first by A.A. Berle and G.C. Means. Theoretically, the state’s properties belong to the society. They delegate the decision-making to politicians and public officials. However being the public managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance¹¹. In such circumstances Z. Dobrowolski ← 14 | 15 → argues that accountability, transparency and public assurance – the state audit must exist.

Transaction cost is often viewed as closely related to agency theory. It assumes that there is a connected group or series of contracts amongst the various players. There are certain economics benefits to the firm itself to undertake transactions internally rather than externally. In its turn, a firm becomes larger the more transactions it undertakes and will expand up to the point where it becomes cheaper or more efficient for the transaction to be undertaken externally. O. Williamson argues that the costs of any misaligned actions may be reduced by judicious choice of governance structure rather than merely aligning incentives and printing them out¹². What does it mean from the point of view of public sector? To build the answer, O. Hart argument can be used. One can state that there are a number of costs of a contract between principal and agent. The analysis of these costs lead to the assumption that contracts are incomplete rather than well prepared¹³. In such situation management control system does have a role. It can be seen as a useful tool in making decisions and in the process of realization and evaluation of contracts that have not been specified in the initial contract.

In this juxtaposition of agency theory is stakeholder theory. It takes account of a wider group of constituents rather than focusing on shareholders. Taking into account the public sector, one can argue that public organization should strive to maximize shareholder value, and also trying to take into account the interest of stakeholders. This multiple objectives may be different. Therefore, the public governance should help to make the best possible choice, taking into account the need to achieve these objectives. Finally, the stewardship theory is a theory that managers will indeed act as responsible stewards of the assets they control. This theory is an alternative view of agency theory, in which managers are assumed to act in their own self-interests at the expense of shareholders. It specifies certain mechanisms which reduces agency loss including the executive compensation, levels of benefits and also managers incentive schemes by rewarding them financially that aligns financial interest of executives to motivate them for better performance¹⁴. Such an assumption may lead to relativism ← 15 | 16 → in the public sector. One can ask, is the implementation of the public interest is not valid for public managers? Is it not a value in itself? Does public manager must have additional incentives? Preliminary studies (analysis of 30 public organizations, which was made in 2008–2015) demonstrated that the decision-makers actions were always driven by self-interest of public managers. In many cases, it was not about money, but about having the attribute of authority and social respectability.

All of these theories are helpful in understanding the organizational pathology. What are the types of pathology from the point of view of society, state and economy. The first pathology discussed in this book is money laundering. This phenomenon is extremely dangerous since catalyzes other phenomena as corruption or terrorism.

2.    Concept and Scale of Risk of Money Laundering

Money laundering is one of the essential types of pathology that can be perceived both through the prism of its impact on macrostructure – the State as well as individual organizations and individuals. Money laundering is dangerous for the stability of states and their economies for several reasons. First, it disrupts the banking system, which relies heavily on trust, and therefore a value that is not imitation. Second, it has the negative impact on monetary policy, and it can affect the budgetary balance. From the perspective of the proponents of the new institutional economics, the generalization can be formulated that money laundering disturbs the institutional order. Money laundering catalyzes other organizational pathologies. It can also be the result of existence of these pathologies. Therefore, money laundering should not be analyzed in isolation from corruption, fraud, gray or black market. What does it mean money laundering?

The definition of money laundering adopted by the United Nations Office on Drugs and Crime states that money-laundering is the method by which criminals disguise the illegal origins of their wealth and protect their asset bases, so as to avoid the suspicion of law enforcement agencies and prevent leaving a trail of incriminating evidence¹⁵. ← 16 | 17 →

The Financial Action Task Force (FATF), which is recognized as the international standard setter for anti-money laundering (AML) efforts, defines money laundering succinctly as “the processing of…criminal proceeds to disguise their illegal origin” in order to “legitimize” the ill-gotten gains of crime¹⁶. INTERPOL’s definition of money laundering is: “any act or attempted act to conceal or disguise the identity of illegally obtained proceeds so that they appear to have originated from legitimate sources”¹⁷. Money laundering usually consists of three steps: placement, layering, and integration. Placement is the depositing of funds in financial institutions or the conversion of cash into negotiable instruments. Furthermore, placement is the most difficult step. The easiest way to begin laundering large amounts of cash is to deposit them into a financial institution. However financial institution are required to report deposits in cash made by an individual in a single day. To disguise criminal activity, launderers route cash through a “front” operation; that is, a business such as a check-cashing service or a jewelry store. Another option is to convert the cash into negotiable instruments, such as cashier’s checks, money orders, or traveler’s checks. Layering involves the wire transfer of funds through a series of accounts in an attempt to hide the funds’ true origins. This often means transferring funds to different countries. Integration involves the movement of layered funds, which are no longer traceable to their criminal origin, into the financial world, where they are mixed with funds of a legitimate origin¹⁸.

The problem which arises in the case of money laundering is fueled by a methodology for estimating the scale of this phenomenon. The position of the Financial Intelligence Unit (FIU) in the macrostructure determines the possibility of obtaining data about the scale of this phenomenon. For example, in some countries, the FIU is created within the Ministry of Finance. In other countries, the FIU is part of the central bank or law enforcement authorities. Banking secrecy also does not help to obtain information about the sizes ← 17 | 18 → of money laundering. In this situation, the estimates of the scale of money laundering are based on street knowledge and / or disclosed cases of money laundering. Of course, such a way of estimating the scale of the problem is exposed to criticism. For example, it examines only the “tip of the iceberg”. Another problem is the fact that it is easier to focus on monitoring the implementation of international regulations in different countries, but it does not mean that a system created by the law will efficiently combat money laundering. For example, organizations using blending fulfil their tax obligations properly. This means that the Internal Revenue Service should analyze, from a point of view of money laundering, very good taxpayers through the prism of whether sales and income declared by the taxpayer are documented. Accounting system, as well as replacing cash transactions using non-cash transactions will help in combating money laundering.

The Committee of Experts on the Evaluation of Anti-Money Laundering Measures and the Financing of Terrorism – MONEYVAL is a permanent monitoring body of the Council of Europe entrusted with the task of assessing compliance with the principal international standards to counter money laundering and the financing of terrorism and the effectiveness of their implementation, as well as with the task of making recommendations to national authorities in respect of necessary improvements to their systems. Through a dynamic process of mutual evaluations, peer review and regular follow-up of its reports, MONEYVAL aims to improve the capacities of national authorities to fight money laundering and the financing of terrorism more effectively¹⁹. MONEYVAL’s system of peer review is based on the FATF model, however, the process of self-assessment and mutual evaluations are undertaken against a more extensive set of anti-money laundering and counter-terrorism financing standards. Apart from FATF Standards, MONEYVAL assesses the compliance of its jurisdictions with the international conventions included therein, as well as the EU legislation adopted in this respect²⁰.