In this paper the author will outline a backdrop for further research on Ricardian Contracts[1] which is a contract where a blockchain smart-contract is forged in a one-to-one relationship with a legal contract. For this backdrop I the author will focus on issues in trade and contracting practices in Brazil and South America.
In Brazil the financial contracting environment appears harmful to financial contracting. Indicators of country risk has consistently rated Brazil as moderate to high risk. Also the Brazilian economy is relevant to financial contracting in four ways: Weak institutions, interventionist state, high inflation and volatile real-sector activity. These factors worsen the risks of financial contracting and increases the cost of addressing such problems.[2]
“Operations Car Wash”, the largest corruption scandal in the history of Latin America and the Caribbean is often understood to have shattered public trust in government and non-governmental institutions and enterprises, as more than 9.5 billion dollars were laundered through numerous government institutions and private enterprises. The 2017 Edelman Trust Barometer revealed that trust in institutions, including Non Governmental Organizations (NGOs) and corporations declined globally to trust levels similar to those of the 2008 financial crisis. 85% of respondents indicated that they do not trust the system, with only 52% of the respondents indicating that they trust businesses (Edelman 2017).[3]
These developments in mistrust pose a great economic, as well as social and political risks, as is evident since trust levels between firms has been shown to be a central part of trade relationships (Kannan & Tan 2006).[4] When a party in a transaction has been paid to provide a goods or service, the paying customer expects the goods or service provider to perform a particular action. The social and political dimensions of this mistrust is also evident in the emerging anti-establishment movements that are sweeping the region and challenging what they believe to be an untrustworthy system.
January 29. 2014 Brazil implemented an anti-bribery and corruption act (Law n.12.846/2013) known as the “Clean Company Act”. This law provides severe administrative and civil responsibilities for companies who commit or are involved in fraud or corruption involving a domestic or foreign public official. The law also includes a successor liability clause where acquiring companies are responsible for the misdeeds of acquired companies.[5]
Institutions reduce the costs of enforcing contracts, defining property rights and measuring attributes of exchange.[6] These institutions include:
* Juridical enforcement such as a law court or judge and quasi-judicial enforcement such as an arbitrator.
* Practices for accounting and disclosure.
* Credit rating agencies, appraisers and auditors
* Regulatory bodies to promote market integrity
“there is an immense difference in the degree to which we can rely upon contract enforcement between developed countries and Third World countries” (North, 1990, p. 59).
Having weakness in institutions harm trust in contractual relationships. All through the institutions in Brazil are far from primitive they seem insufficient to develop substantial assistance to parties in financial contracts. In particular using the principle of stare decisis where previous judicial decisions are used as examples and principles is unfeasible because the judiciary is often regarded as inefficient and corrupt.[7]
The quality of disclosure in Brazil is also perceived as low. Accounting practices over South America are dominated by legal and administration systems inherited from Spanish and Portuguese colonizers. Such systems has been shown to result in a highly political environment (Ball, 1995, p. 23).[8] Most firms in Brazil has a financial statement which does not correspond to the reality of their operations and both the records small and large firms are subjects to manipulation (Pereira da Silva, 1990, pp. 30–31).[9] This faulty information combined with a regulatory framework which does not guarantee financial-system soundness compared to developed countries are of little prominence to the relationship between a firm, and its shareholders (Teixeira da Costa, 1993, p. 31).[10]
There are incentives for debtors to engage in bonding activities to lower the monitoring cost of creditors.[11] Bonding activities consists of hiring auditors and credit rating agencies to assess and interpret reports on the firm’s financial status and hiring a trustee to represent the interests of creditors. When expected costs for monitoring are borne by the debitor it benefits the debitor to contract the previously mentioned because the costs are greater when the creditors are left to their own devices.[12] All tough financial statements are required by law to be audited, reports are not generally relied upon.[13]
For investors to invest in Brazil there are currently challenges. Companies here are not always compliant with internationally recognised anti-bribery and corruption laws. A company could have secret off-record transactions and commitments. This can result in loose follow through of accounting laws. Financial records of companies in Brazil especially small and privately owned ones are generally of low quality and does not in adherence to accepted account practices.[14]
Business infrastructure in Brazil is still in a fragile emerging state. PWC reports relevant factors for business deal failure in the country:[15]
* Unexpected tax and labour problems
* Excessive legal formalities/bureaucracy
* Low quality of available information
* Market volatility
* Insufficient due diligence prior to investment
* Underestimation of time needed for deal execution
* Overestimated synergy/restructuring gains
* Low quality management
* Inefficient post-acquisition monitoring
Brazilian inflation is periodically extremely high and volatile. Especially in the the 90s inflation volatility spiked. When inflation is volatile contracting costs raises if the mechanisms for hedging against it are expensive. A hedge for this risk is using inflation indexation of debt obligations which if held to maturity guarantees a return higher than the rate of inflation.[16] All tough indexes can be subject to manipulation from gouvernement and using such a index introduces political risk into the contract.[17] Historically the Brazilian government has periodically fought inflation by tampering with indexes and enforcing price and wage controls.[18]
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[1] Grigg I. (1996) The Ricardian Contract. Systemics, Inc.http://iang.org/papers/ricardian_contract.html
[2] Anderson C. W. (1999) Financial contracting under extreme uncertainty: an analysis of Brazilian corporate debentures. Journal of Financial Economics issue 51 pp.45–84
[3] Edelman (2017) Edelman trust barometer 2017. Available at: https://www.edelman.com/trust2017/
[4] Kannan, V. & Tan, K. (2006) Buyer-supplier relationships: the impact of supplier selection and buyer-supplier engagement on relationship and firm performance. International Journal of Physical Distribution & Logistics
[5] GAN (2019) Compliance Guides. Available at: https://www.business-anti-corruption.com/compliance-quick-guides/brazil/
[6] North, D., 1990. Institutions, Institutional Change and Economic Performance. Cambridge University Press, Cambridge
[7] D’Almeida Pires Filho, I., 1991. Federative Republic of Brazil. In: Redden, K. (Ed.), Modern Legal Systems Cyclopedia: South America, vol. 10, William S. Hein & Co., Buffalo, NY, pp. 10.50.3–10.50.54.
[8] Ball, R., (1995). Making accounting more international: why, how, and how far will it go? Journal of Applied Corporate Finance 8, 19–29.
[9] Pereira da Silva, J., (1990). Ana ́ lise Financeira das Empresas. Editora Atlas, Sao Paulo.
[10] Teixeira da Costa, R., (1993). Preface. In: Tertuliano, F., Pessoa, I., Francisco de Aguiar, J., Ayoub, R., Trancanella, R., Rioli, V. (Eds.), Full Disclosure: como Aperfeic7 oar o Relacionamento das Empresas Abertas com o Mercado de Capitais. Editora Maltese, Sao Paulo, pp. 11–13.
[11] Smith, C., Warner, J., (1979). On financial contracting: an analysis of bond covenants. Journal of Financial Economics 7, 117–161.
[12] Anderson C. W. (1999) Financial contracting under extreme uncertainty: an analysis of Brazilian corporate debentures. Journal of Financial Economics issue 51 pp.45–84
[13] Teixeira da Costa, R., (1993). Preface. In: Tertuliano, F., Pessoa, I., Francisco de Aguiar, J., Ayoub, R., Trancanella, R., Rioli, V. (Eds.), Full Disclosure: como Aperfeic7 oar o Relacionamento das
[14]PWC (2017) Doing Deals in Brazil.
[15]PWC (2017) Doing Deals in Brazil.
[16] Anderson C. W. (1999) Financial contracting under extreme uncertainty: an analysis of Brazilian corporate debentures. Journal of Financial Economics issue 51 pp.45–84
[17] Roe, M., (1979). Finance, rules and the indexation of Brazilian government bonds. Vanderbilt Journal of Transnational Law 12, 1–65.
[18] Baer, W., (1995). The Brazilian Economy: Growth and Development. 4th ed., Praeger Publishers,
Westport, CT
