pwc's opacity index: a powerful new tool for global investors

Roger Lipsey

Since its initialrelease in January2001, the Pricewa-

terhouseCoopers (PwC)Opacity Index has cre-ated a stir in manyparts of the world andmany sectors, rangingfrom business leadersto government officialsand the media. Follow-up releases in April and May haveunderscored that a new and trulyuseful tool is now available, andthe tool kit is growing.

WHY IS IT VALUABLE?

The value of the OpacityIndex for business leaders, espe-cially those involved in overseasinvestment decisions or signifi-cant domestic investments, can besimply put: the Index estimatesthe effects of opacity on the costof capital in 35 countries world-wide. The more transparent acountry’s economy, the moreopen, clear, and well markedone’s path of progress is likely tobe in a business venture. Themore opaque a country’s econo-my, the more obstacles one islikely to encounter. The Indexalso breaks into five distinct cate-

gories the opacity—or transparen-cy—a business is likely to experi-ence in the countries studied.

This article offers anoverview of the Opacity Indexand Index-based studies to date.The opening pages put the basicfindings before you. Later pageslook at how these findings cancontribute to your investmentdecision process.

Opacity is the lack of clear,accurate, formal, easily dis-cernible, and widely acceptedpractices in the broad arenawhere business, finance, and gov-ernment meet. The Opacity Indexwas conceived to bring the coollight of quantitative measurementto a topic about which ethicaljudgments have often dominatedpublic and private discussion. TheIndex can be used to estimatehow much certain behaviors and

structures cost fordomestic and foreignbusinesses as well asgovernments.

The Index esti-mates the extent towhich five key factorscontribute to or dimin-ish the transparency ofcapital markets and theoverall economic envi-

ronments in the 35 countries sur-veyed (in future releases, thenext major one scheduled forSeptember/October 2001, thenumber of countries will steadilyincrease). These factors are thelevel of perceived Corruption;the Legal system; Economic pol-icy at the government level;Accounting and reporting stan-dards; and the Regulatoryregime. These five dimensionsof opacity (CLEAR) are meas-ured separately on the basis ofsurvey interviews with bankers,equity analysts, chief financialofficers, and PricewaterhouseC-oopers in-country practitioners,and then integrated into a com-posite score, the O-Factor. Youwill find the calculations thatgenerate the Index at www.opac-ityindex.com, where all OpacityIndex releases are available.

The PricewaterhouseCoopers Opacity Index has cre-ated a stir among global investors. For the first time,you can rate how “transparent” a country’s econo-my is—how easy it will be for a business venture tosucceed, and what each country’s problem areasare. The author explains the details of this powerfulnew tool, and how to use it. © 2001 John Wiley & Sons, Inc.

PwC’s Opacity Index: A Powerful NewTool for Global Investors

featu

reartic

le

35© 2001 John Wiley & Sons, Inc.

In countries where the Indexpoints to problems, how do thefive CLEAR factors take theirtoll on the robustness and, forinvestors, the attractiveness of anational economy? Corruption ingovernment bureaucracy mayallow bribery or favoritism. Thelaws governing contracts or prop-erty rights may be unclear, con-flicted, or unenforced. Economicpolicies—fiscal, monetary, andtax-related—may be vague orchange unpredictably. Account-ing and reporting standards maybe weak, inconsistent, or improp-erly applied, thus making it diffi-cult to obtain accurate financialdata. Business regulations maybe unclear, inconsistent, orinexpertly applied. A highdegree of opacity in any ofthese areas will raise thecost of doing business andcurtail the availability ofinvestment capital.

Although researchquantifying the effects ofopacity is still in its early stages,we now know that opacity detersinternational capital flows, levieswhat amounts to a hidden tax oninvestment, and raises the riskpremium on sovereign bonds.While no country is likely toearn a perfect score, the OpacityIndex has identified four coun-tries (United States, UnitedKingdom, Chile, Singapore) thatset a high standard and can real-istically serve as a compositebenchmark for Index-based stud-ies of important variables.

Wherever there is opacity,there is greater risk and reducedopportunity for growth anddevelopment, both at the corpo-rate and at the national level.This intuitive truth has been con-firmed by Opacity Index studiesto date. The converse is alsotrue: wherever there is a reason-able level of transparency in allfive CLEAR dimensions, oppor-

tunities for economic develop-ment and national prosperity willbe more abundant over time, andeffective risk management willbe much more likely.

MAJOR OPACITY INDEXFINDINGS

Exhibit 1 arrays the fiveCLEAR factor scores and result-ing O-Factor for each of thecountries studied to date. Thescores are alphabetized ratherthan ranked, to avoid conveyingthe message that this initial groupof 35 countries can or should beranked from top to bottom. Whenthe number of indexed countries

reaches past 100, it may be timeto look at rankings within theentire group, but even then, therewill be no definitive “winners”and “losers.” There are nationswith greater problems—andtherefore greater opportunities forprogress—and nations wherelonger experience in buildingcapital markets and managing theeconomic environment has creat-ed relatively healthy, productiveconditions.

However, comparisonbetween countries and withinregional groupings is not justinevitable, it is fascinating andinstructive. For example, thescores for Latin American coun-tries include in the study areindicated in Exhibit 2. As notedearlier, Chile is the benchmarkfor the region and a member ofthe composite global benchmark.Only with respect to macroeco-nomic policy at the government

level (the E column) does theOpacity Index suggest thatChile, while relatively transpar-ent, must continue to strive toclarify its processes. By othermeasures—perceived prevalenceof corruption, legal opacity, cor-porate accounting and reportingpractices, quality of the regulato-ry regime—Chile is a strongregional leader, althoughapproached in one or anotherrespect by a few neighbors.Mexico, for example, comes rea-sonably close to the Chileanstandard with regard to macro-economic and fiscal policy.

A WIDE RANGE OFRESPONSES TO THEINDEX

This brief look at LatinAmerican countries includ-ed in the study is meantonly to exemplify how tonavigate the columns andderive insights from them.

Since the release of the datafrom Exhibit 1 in January, Opac-ity Index scores have provoked awide range of responses. A num-ber of government officials fromcountries not yet included in theIndex have approachedPricewaterhouseCoopers withthe request to be included in thenext round. They are confidentthat they have a good story totell, and they are willing toexpose their country’s perform-ance to the probing survey thatunderlies the Index. Similarly,some governments of emerging-market countries have askedOpacity Index researchers topresent the findings at nationallysponsored economic confer-ences. PricewaterhouseCoopershas been invited to present theOpacity Index to multinationals,trade associations, chambers ofcommerce, international finan-cial institutions, international

36 The Journal of Corporate Accounting & Finance

© 2001 John Wiley & Sons, Inc.

…the Opacity Index has identifiedfour countries (United States, UnitedKingdom, Chile, Singapore) that set ahigh standard…

organizations, and internationalconferences. All of theseresponses reflect the view thatstrong Opacity Index scores will

encourage foreign and domesticinvestment, while weaker scoresprovide guidance for remedialefforts over time.

The business media havetended to use Opacity Indexscores to explain bad economicnews or troubling incidents.

September/October 2001 37


Scores for O-Factor and CLEAR Components Country C L E A R O-FactorArgentina 56 63 68 49 67 61Brazil 53 59 68 63 62 61Chile 30 32 52 28 36 36China 62 100 87 86 100 87Colombia 48 66 77 55 55 60Czech 57 97 62 77 62 71Ecuador 60 72 78 68 62 68Egypt 33 52 73 68 64 58Greece 49 51 76 49 62 57Guatemala 59 49 80 71 66 65Hong Kong 25 55 49 53 42 45Hungary 37 48 53 65 47 50India 55 68 59 79 58 64Indonesia 70 86 82 68 69 75Israel 18 61 70 62 51 53Italy 28 57 73 26 56 48Japan 22 72 72 81 53 60Kenya 60 72 78 72 63 69Lithuania 46 50 71 59 66 58Mexico 42 58 57 29 52 48Pakistan 48 66 81 62 54 62Peru 46 58 65 61 57 58Poland 56 61 77 55 72 64Romania 61 68 77 78 73 71Russia 78 84 90 81 84 84Singapore 13 32 42 38 23 29South Africa 45 53 68 82 50 60South Korea 48 79 76 90 73 73Taiwan 45 70 71 56 61 61Thailand 55 65 70 78 66 67Turkey 51 72 87 80 81 74UK 15 40 53 45 38 38Uruguay 44 56 61 56 49 53USA 25 37 42 25 48 36Venezuela 53 68 80 50 67 63These data are based on average survey responses for the five types of opacity. Using the simple averages derived from aggregating the survey responses, the O-Factor is derived by adjusting the scores so that larger scores reflect more opacity, while smaller scores reflect more transparency. The CLEAR factors are weightedequally for purposes of global comparison, although in individual countries some factors are arguably more important than others.

Exhibit 1

Major newspapers have citedtheir country’s relatively weakscore as a “wake-up call” to thenation’s economic and fiscalleaders. Similarly, when a cor-ruption incident is reported incountry X or Y—and there havebeen reports of this kind inrecent months—the Index scorefor the country in question isoften cited. These are realisticuses of the Index, althoughPricewaterhouseCoopers hopesthat it will be used most fre-quently as a guide to progressiveefforts in specific, practicalareas of national economic life.It is a tool for building and bet-tering on the government side,and for wiser decision makingamong corporate investors.

There has also been resist-ance in some quarters: “Say itisn’t so,” or “No indexing here,thank you,” or “These numberscan’t be right.” To the last ofthese responses, the Pricewater-houseCoopers research teamreplies that the numbers are esti-mates, carefully prepared,intended to be directionally cor-rect and useful as such.Although it correlates with otherindices, the Opacity Index isnew and groundbreaking. Where

there is some degree of error,correction will emerge as futurecycles of the Index build a bodyof year-to-year evidence.

THE EFFECTS OF OPACITY: FDIDETERRED

Foreign direct investment(FDI) has been recognized asplaying an important role in eco-nomic growth, particularly fordeveloping nations (“host coun-tries”) and economies in transi-tion. It provides not just neededcapital for the host country, butalso essential technology transfersand managerial and marketingknow-how. From the perspectiveof a corporation headquartered ina source country, FDI represents acommitment to a host country—an expression of confidence inthat country’s economic futureand, more specifically, in its man-agement of the CLEAR factors.The Opacity Index is, of course,not the only information andanalysis that should be consultedby potential investors, but its use-fulness is evident.

In conjunction with otherpublicly reported economic data,the Opacity Index offers a basisfor estimating the percentage of

FDI deterred—that is, neverinvested or invested elsewhere—owing to the opacity of a coun-try’s overall economic environ-ment and capital markets. Esti-mates of deterred FDI require atwo-step procedure. First, a low-opacity benchmark is establishedbased on the average of the opac-ity scores for the four countrieswith the lowest scores in thesample (as noted earlier, theseare Singapore, U.S., Chile, andU.K.). Second, for every othercountry in the sample, variousmethods are used to estimatehow much more FDI the countrywould be likely to attract shouldit succeed in reducing its opacitylevel to the composite bench-mark. (For technical details, seethe appendix to the April releaseat www.opacityindex.com.)

The Opacity Index scoresand estimates of deterred FDIfor the countries studied are pre-sented in Exhibit 3, which arraystwo estimates of deterred FDI inpercentage terms, plus relatedestimates in U.S. dollars.1 Theneed for two estimates is easilyexplained: the first is an “aver-age estimate,” which assumesthat the relationship betweenopacity and FDI is very tight.



O-Factors and CLEAR Scores: Latin AmericaCountry C L E A R O-FactorArgentina 56 63 68 49 67 61Brazil 53 59 68 63 62 61Chile 30 32 52 28 36 36Colombia 48 66 77 55 55 60Ecuador 60 72 78 68 62 68Mexico 42 58 57 29 52 48Peru 46 58 65 61 57 58Uruguay 44 56 61 56 49 53Venezuela 53 68 80 50 67 63

Exhibit 2



The Economic Cost of Opacity in Terms of Deterred FDI

Country Survey O-Factor Deterred FDI Deterred FDI Deterred FDI Deterred FDI (as percentage) (in millions of US$) (as percentage) (in millions of US$)

lower bound lower bound point estimate point estimate

BenchmarkSingapore 29 0 0 0 0United States 36 0 0 0 0Chile 36 0 0 0 0United Kingdom 38 0 0 0 0

Other CountriesArgentina 60 105 14,150 139 18,732Brazil 61 106 30,267 141 40,261Colombia 60 104 3,462 138 4,593Czech Republic 71 147 4,519 194 5,964Ecuador 68 135 977 179 1,295Egypt 58 95 978 125 1,287Greece 57 92 1,011 122 1,340Guatemala 65 123 381 162 502Hong Kong 45 41 7,824 54 10,305Hungary 50 63 1,319 83 1,738India 64 118 3,372 156 4,458Indonesia 75 164 954 218 1,268Israel 53 73 1,422 97 1,890Italy 48 53 2,352 71 3,151Japan 60 104 6,576 137 8,662Kenya 69 139 21 183 28Korea, Rep. 73 157 9,320 208 12,347Lithuania 58 97 582 128 768Mexico 48 53 6,477 70 8,554Pakistan 62 111 826 147 1,094Peru 58 93 1,787 123 2,363Poland 64 119 7,484 157 9,874Romania 71 149 2,174 197 2,874Russia 84 199 7,417 263 9,802South Africa 60 101 1,984 134 2,632Taiwan 61 105 1,920 140 2,560Thailand 67 131 7,742 173 10,224Turkey 74 160 1,375 212 1,822Uruguay 53 75 132 100 176Venezuela 63 117 5,275 155 6,988Notes:(1) The amounts of deterred FDI, in millions of U.S. dollars at the 1999 price, are computed in the following way. First, the average FDI inflows over a three year peri-od, 1997–99, are calculated based on country-specific balance of payments data from the IMF. Second, this average is multiplied by the estimated percentage lossof FDI to arrive at the estimated dollar amount of deterred FDI.(2) Since Taiwan is a not a member of the IMF, its data are downloaded from the Web site of its Ministry of Economic Affairs(www.stat.gov.tw/bs8/bulletin/se.asp?cc=J#content_j). Data for Pakistan come from the World Bank’s World Development Indicator database.(3) Due to missing data, the average FDI inflows over 1998–99, 1996–98, and 1995–97, are used, respectively, for Hong Kong, Pakistan, and Greece.(4) All pre-1999 FDI data (in U.S. dollars) are converted to the 1999 price, using the U.S. CPI inflation rates over the relevant time periods.

Exhibit 3

However, in reality the relation-ship is not airtight. For this rea-son, the second, or lower-bound,estimate is helpful. It recognizesthat the relationship betweenopacity and FDI may fall some-where within a range, the lower-bound estimate representing thelower end of this range.

There are at least four reveal-ing ways to look at this table:

• Comparing any country tothe benchmark group

• Grouping countries by regionand comparing their scores

• Examining the CLEAR datafor each country in relation todeterred FDI (see Exhibit 1)

• Probing the economic andother circumstancessurrounding any par-ticular set of scores

Space limitations donot allow us to explore indepth these approaches,but readers of this journalshould not hesitate toexamine countries of inter-est to them. Here are just twosample observations. In view ofboth estimates for Mexico, thatcountry could increase its inwardFDI by 53 to 70 percent if itcould manage to reduce its opac-ity to the benchmark. In U.S.dollar terms, this would repre-sent a gain in the range of $6.5billion to $8.6 billion. Russia hasan even greater opportunity: itcould increase its FDI by 199 to263 percent were it able toreduce opacity to the bench-mark—in U.S. dollars, thiswould be a gain in the range of$7.4 billion to $9.8 billion.

THE EFFECTS OF OPACITY: THETAX-EQUIVALENT AND RISKPREMIUM “VIEWS”

Two additional “views” havethus far been developed, one of

which—the tax-equivalentview—relates directly to theconcerns of corporate execu-tives, while the other is moreremote from their interests butstill indicative of host-countryeconomic conditions. Both viewsare presented in Exhibit 4.

The tax-equivalent view esti-mates the adverse effects ofopacity as if it imposes a hiddensurtax on foreign direct invest-ment—a tax payable not to agovernment but, more obscurely,levied by and lost in the weave ofopaque business practices. Singa-pore serves as the benchmark forthese calculations. Reading thenumbers, you will see, for exam-ple, that an increase in opacity

from the level of Singapore tothe level of Colombia has thesame negative effect on invest-ment (domestic and internation-al) as a 25 percent increase incorporate income tax.

The opacity-driven risk pre-mium, estimated in the adjoiningcolumn of Exhibit 4, refers to theadditional premium that countriesmust pay investors to float sover-eign bond issuances, particularlythose denominated in the nationalcurrency. While the price of anasset already reflects a marketassessment of risk, in this study, Iam interested in decomposingthat price to understand the por-tion resulting from opacity fac-tors. The exhibit shows that coun-tries with more opaque practicesgenerally must reward investorsby paying a premium—aspread—over what the bench-

mark United States pays. (The“risk-free” rate in this columncorresponds to the United States,the nation with the lowest proba-bility of default on its bonds.)

I found that a one-pointincrease in the O-Factor scoreleads to a 25.5 basis pointincrease in the interest rate thatinvestors demand in order to pur-chase new-issue bonds originatedin that country. Were Poland, forexample, to issue 4 billion zloty(approximately U.S.$1 billion) ingovernment bonds, the opacityrisk premium implies an interestexpense of approximately 280million zloty (or approximatelyU.S.$70 million) per year, whichcould be avoided through the

reduction of opacity to thelevel of Singapore.2

To summarize the mes-sage of the three viewsoffered in Exhibits 3 and 4:opacity decreases the quan-tity and increases the costsof international capitalflows such as FDI and sov-ereign bond issuances, and

it exacts a hidden tax on corpo-rate investments and ongoingoperations in countries burdenedwith a high O-Factor.

THE CORPORATE INVESTORTHINKS IT THROUGH

In light of the Opacity Indexand the studies it has so far gen-erated, how should the corporateinvestor evaluate FDI opportuni-ties? In brief, we believe that thecomposite Index scores shouldbe consulted, and that each ofthe CLEAR factor scores shouldbe kept in mind.

C: Corruption

It hardly needs to be saidthat entrenched corruption at theinterface between business andgovernment, and in business-to-



…a one-point increase in the O-Factorscore leads to a 25.5 basis point in-crease in the interest rate that invest-ors demand in order to purchase new-issue bonds originated in that country.



The Effects of Opacity on the Cost of Capital: "Tax-Equivalent" And Risk Premium Views

Country O-Factor Tax-Equivalent (percentage) Opacity Risk Premium(Basis Points)Argentina 61 25 639Brazil 61 25 645Chile 36 5 3Colombia 60 25 632Czech Republic 71 33 899Ecuador 68 31 826Egypt 58 23 572Greece 57 22 557Guatemala 65 28 749Hong Kong 45 12 233Hungary 50 17 370India 64 28 719Indonesia 75 37 1,010Israel 53 19 438Italy 48 15 312Japan 60 25 629Kenya 69 32 848Lithuania 58 23 584Mexico 48 15 308Pakistan 62 26 674Peru 58 23 563Poland 64 28 724Romania 71 34 915Russia 84 43 1,225Singapore 29 0 0South Africa 60 24 612South Korea 73 35 967Taiwan 61 25 640Thailand 67 30 801Turkey 74 36 982UK 38 7 63Uruguay 53 19 452USA 36 5 0Venezuela 63 27 712

Note: Where zero is reported in the table, that country served as the benchmark level of opacity for the calculations.

Exhibit 4

business dealings, adds anunpredictable, burdensome, and,in many instances, illegal cost ofdoing business. A commercialculture of this type can beapproached, but it should beapproached knowingly. TheOpacity Index, in parallel withdata issued by TransparencyInternational on perceived cor-ruption, offers some of the bestinformation available today.

In just the past few years,over 60 countries have signedonto a host of new internationalanti-corruption treaties negotiatedunder the auspices of organiza-tions such as the OECD, theOrganization of American States,and the Council of Europe. Effec-tive compliance and risk manage-ment strategies are key to address-ing opacity. Such strategies wouldinclude an internal control frame-work, an effectively implementedcompliance program, aclear gift and entertainmentpolicy, and standard anti-corruption contract clausesin agreements with foreignbusiness partners.

Reputational due dili-gence concerning the integrity ofbusiness partners is key. “Redflags” include the following:

• The agent states that a par-ticular amount of money isneeded for him to “get thebusiness” or “make the nec-essary arrangements.” Anyexpression of this kind is awarning flag.

• The venture principalrequests that checks be madeout to “bearer” or “cash,” orseeks payment by unusualmeans, such as through shellcompanies created to receiverevenues and facilitate trans-actions.

• The venture principal wantsto work without a contract(or with a vague contract)

and hesitates to makeFCPA-styled compliancecertifications.

• The venture principal asksfor commissions that aresubstantially higher than thegoing rate in that countryamong comparable serviceproviders (especially wherethe amount or nature of thework does not justify unusu-ally large payments).

• The venture principalrequests an unusually largecredit line for a new cus-tomer, unusually largebonuses or similar payments,or substantial and unortho-dox up-front payments.

• A potential government cus-tomer or authorizing agencyrecommends a venture prin-cipal (the reasons for therecommendation should becarefully evaluated).

• A venture principal’s busi-ness appears to lack suffi-cient capability or staff qual-ifications to perform theservices offered, is new tothe business, or cannot pro-vide references to documenttheir claimed experience.

In addition to taking all thenecessary due diligence precau-tions before you form a businessrelationship with a partner orrepresentative, make sure thatyour own company has an effec-tive compliance program inplace, coordinated with a stronginternal control framework.Internal controls ensure the effi-ciency of operations, the reliabil-ity of financial reporting, andcompliance with laws and regu-

lations. These internal disci-plines should spill over to yournew foreign venture, where theywill be no less important.

L: Legal System Issues

An opaque legal system canalso reduce the benefits of FDI.If investors are uncertain thatproperty rights will be protected,they may be less willing to shareintellectual property or engage incertain kinds of technologytransfer. If contractual agree-ments and covenants are likely togo unenforced, the scope of sub-sidiary firm activities may wellbe more limited than in an envi-ronment with a sound legal sys-tem. Moreover, if investors lackconfidence in the host country’slegal system, FDI will be struc-tured to ensure that the proceedsof the venture are immediately

moved offshore, rather thaninvested in the local econo-my. This will inhibit theproductivity-enhancingpotential of FDI, and theeconomy within which yourinvestment is sited may not

generate the widening marketsyou legitimately expect.

To encourage FDI, the legalsystem of the host countryshould address opacity risks. Asthe representative of the investingfirm, you should assure yourselfthat the following issues areclearly and specifically covered:

• After the investment is made,the investing firm can expectthat the investment will bepermitted to operate on thesame basis as its domesticcompetitors.

• In other words, the investorwill be granted “nationaltreatment.” There will be ade-quate assurance of investmentprotection, addressing suchmatters as expropriation,



Effective compliance and risk man-agement strategies are key toaddressing opacity.

repatriation of profits androyalties, currency restric-tions, and fair and equitabletreatment.

• Even greater assurance foryou as the investor can beprovided if the legal systemof the host country supportsthe country’s internationalcommitments with an effec-tive dispute resolutionmechanism.

Again, a country thatcompares poorly with othersin its legal system may haveoffsetting strengths that jus-tify investment—but theissue needs to be facedbefore taking the plunge.When a firm undertakes aforeign investment, it iscommitting its capital, intel-lectual property, and skillsto a project. It is likely toachieve more both for itself andfor the host country if the rule oflaw is wisely and comprehensive-ly structured and enforced.

E: Economic Policy andEnvironment

Opacity with respect tomacroeconomic policy and deci-sion processes may also persuadecorporate investors to go slowlyin countries with a high score inthis CLEAR category. Unpre-dictable fiscal and monetarypolicies harm the general eco-nomic and social environment.The resulting instability can havemany adverse effects, some ofthem unexpected—for example,it may reduce your ability toattract the best expatriate man-agers to a new venture. TheOpacity Index and studies basedon it offer empirical evidence—in terms of sovereign borrowingcosts and lost FDI—that shouldpersuade governments to under-take economic policy reforms.

The fiscal and economicmanagement of an entire nation,of whatever size, is a difficultexercise at best. Even AlanGreenspan, thought by many tobe as close to a genius in thisfield as any nation is likely tosee, receives his share of badpress. Because even certifiedsages run into difficulty, the cor-porate investor does well to get

to know the economic policy andpolicy makers of a host country.

A: Accounting and Reporting

The presence or absence ofrigorous accounting and report-ing standards in a host countryshould also be considered in anyinvestment strategy. Expatriatemanagers who are accustomed toworld-class standards ofaccounting and reporting will beunable to bring the full benefitsof their training and experienceto an environment where high-quality accounting rules and pro-cedures are unfamiliar or under-valued. Further, if corporateaccounting and reporting are rel-atively opaque, you would hesi-tate to trust the reported prof-itability of an FDI venture. Otherfeatures of the opportunity mayjustify the investment, but it isimportant to know as much aspossible in advance.

Transparency has much to dowith adherence to established

accounting norms and annualaudits that permit investors toevaluate corporate performance.These norms include fair disclo-sure of financial and operatingresults, related-party transactions,ownership structure, voting rights,and material foreseeable risks.Equitable treatment of sharehold-ers includes the principle of “oneshare/one vote” and fair treatment

of minority shareholders inchallenges for corporatecontrol. Accountability bestpractices generally call foreffective oversight throughcorporate boards of direc-tors that ensure sound plan-ning processes, monitorconflicts of interest, ensureeffective risk management,assess the tone at the top,measure performance, andoversee reliable, relevant,and timely external commu-

nications.All of these values are prob-

ably in place and strong in yourown enterprise. Can you migratethem to your foreign investment?It is better yet if these values arealready part of the texture ofbusiness life in the host country.

R: Regulation

The last of the CLEAR ele-ments, regulatory opacity, cannotbe ignored. If policies concern-ing the required form of FDI areinconsistently applied, arbitrarilychanged, or impose excessivelytime-consuming procedures, thescope and nature of the activitiesof your foreign venture may wellbe constrained. Accordingly, thepurpose of a sound FDI regula-tory policy is to establish aframework of fair, firm, and pre-dictable foreign investment stan-dards of protection, administeredin an open and transparent fash-ion and providing for effectivedispute settlement.


Expatriate managers who are accus-tomed to world-class standards ofaccounting and reporting will beunable to bring the full benefits oftheir training and experience to anenvironment where high-qualityaccounting rules and procedures areunfamiliar or undervalued.


A GENERIC COMPARISON

A generic comparison mayclarify these points. If a foreigninvestor decides to open a plantin a relatively transparent coun-try, the influx of foreign capitalplus expatriate managers andtheir economic ties to their homecountry will have significantspillover effects. Investors andmanagers will be free of corruptand inefficient bureaucracy and,in all likelihood, will have reli-able relationships with suppliersand other business partners, whowill provide inputs to the venturethat help it prosper. The partners,in turn, will be generallystraightforward and honest intheir business dealings becausethey are confident in the eco-nomic benefit of the venture tothe host economy and know thatthey can rely on the structureand enforcement powers of thecountry’s legal system.

On the other hand, a foreigninvestor in a plant located in arelatively opaque country is like-ly to face significant obstacles.Corruption may impose a bur-den, not only in terms of legalrisks, cash payments, and otherperquisites, but also in terms ofunreliable relationships. In addi-

tion, legal contracts may not behonored or arbitrary policies andregulatory burdens may beimposed, thus infringing theability of the new facility tooperate and prosper. Lack ofconsistently applied accountingand reporting standards willhamper the ability of expatriatemanagers to define the truevalue-added of the new factoryand to justify long-range plansfor improvements to senior man-agement, investors, or the mar-ket. Economic and, to a lesserextent, regulatory uncertaintycan be alleviated if hedging andarbitrage are possible, but theabsence of sophisticated andwell-regulated financial marketswill mean that this and othersorts of risk management will beexpensive, even where available.

In short, the operating envi-ronment of a highly opaquecountry will block management’sability to take full advantage ofthe economic opportunities,which could, under more trans-parent skies, be expected from anew venture.

AN INVITATION

Television newscasters say,“Stay with us.” As the Opacity

Index and studies based on itcontinue to grow, Pricewater-houseCoopers invites you to staywith us. Its purpose is realismabout costs—costs in capitalmarkets and in ongoing opera-tions. Its further purpose is toprovide a map for corporateinvestors and governments.Investors can know somewhatbetter what to expect as theyglobalize. Governments canknow somewhat better where todirect their efforts to clarify and,where appropriate, fundamental-ly revise their policies andprocesses across the CLEARdimensions. None of us shouldexpect perfect transparencyacross the world’s capital mar-kets and varied economic envi-ronments. There will always befog. But radar can pierce it.

NOTES

1. Please note that in this and laterexhibits, the number of countries hasbeen reduced from 35 to 34, owing todata collection delays in Chna.

2. Some opacity premia in this tabulationare higher than the actual interest rateat which a country is able to borrow.This apparent anomaly is explained bycertain capital markets dynamics andby hidden subsidies. See the full Aprilrelease at www. opacityindex.com fordetails.



Roger Lipsey is global editorial director for PricewaterhouseCoopers, where he has served in various com-munications roles since 1990. Traveling widely for his company, he considers it a privilege to work withbusiness-thought leaders in all parts of the world.

A Note on the Developers of the Opacity Index: The Opacity Index is a project of the Pricewaterhouse-Coopers Endowment for the Study of Transparency and Sustainability. The Index was conceived by JoelKurtzman, a partner of PricewaterhouseCoopers, and developed in cooperation with a team of distin-guished economists: James R. Barth (Auburn University and Milken Institute), Thomas W. Hall (PepperdineUniversity and Milken Institute), Susanne Trimbath (Milken Institute), Shang-Jin Wei (Brookings Institutionand Harvard University Center for International Development), and Glenn Yago (Milken Institute). A Price-waterhouseCoopers team helped in many ways: Carlo di Florio, Max Henderson-Begg, and the author.

pwc's opacity index: a powerful new tool for global investors

Documents