As the world grapples with the implications of a global stock market crash, we might do well to recall that the 2008 Wall Street collapse was a direct result of government corruption—that is, officials in high places buying stocks and driving down prices.
Corruption can be met directly by businesses in the form of demands for special payments and bribes in exchange for import/export licenses, tax assessments, police protection, favourable treatment in investment/trade and loan evaluations, and even to obtain government contracts or grants (Acemoglu and Verdier, 2000). Indirectly it may influence stock market returns through distortions in the rule of law at the ground implementation level including corruption within police and judiciary which increases the cost of production and brings inefficiency in the economy thus lowering stock market returns. Interaction of corruption with the quality of institutions namely democratic accountability, law and order and bureaucratic quality generates positive or negative impacts on SR.
The literature explores the interaction between democracy and corruption and finds that while higher levels of DA increase corruption opportunities, it begins to mitigate corruption as democracy matures (Rock, 2009). However, other studies show that autocratic regimes initiate political linkages that have positive impacts on Chinese firms’ stock values (Wang et al., 2018).
In this article we seek to investigate the impact of corruption and its interaction with institutional factors on SR using Arellano-Bover/Blundell-Bond linear dynamic panel data estimations. We find that corruption has a negative effect on stock market returns in BRIC countries and its magnitude becomes smaller as DA or bureaucratic quality are increased.