Corruption is an unfortunate reality in many developing countries. It distorts policy and hurts the public as it diverts money from vital social services to private gain. For example, the lack of regulation bought by robber barons in America’s Gilded Age allowed them to profit from speculation and shrewd investments that ultimately led to financial and stock market crashes that cost people their life savings.
In a similar vein, corruption in Brazil, Russia, India, and China has been shown to lower investor confidence, which makes it more difficult for those countries to attract the foreign investment necessary for growth. Corruption is also a tax on business as it erodes the efficiency of government processes that impact the economy. For example, corrupt officials might demand bribes in return for licenses to export or import, or slow down the process by dragging their feet on bureaucratic tasks such as tax assessments or police protection.
While previous work has examined the effect of corruption on a country’s overall economic performance, little attention has been paid to its impact on stock markets specifically. This paper examines the impact of corruption on stock market returns by estimating a panel two-way fixed-effect model using the Arellano–Bover/Blundell–Bond linear dynamic panel data estimation technique for BRIC countries in 1995–2014 with monthly frequency. We find that the interaction between corruption and institutional quality (i.e., democratic accountability, bureaucratic quality and law and order) has a negative effect on stock market returns. The individual coefficient for corruption is negative as well, but its impact diminishes as the democratic maturity of a country increases within our sample.