Corrupt government practices are a major threat to the stability of stock markets and economy at large. They distort the rule of law, raise transaction costs for businesses and sacrifice efficiency and increase the risks of economic collapse and national emergencies. Such malpractices also reduce the efficiency of financial institutions, especially central banks, which is why a stock market crash can cause a government shutdown and place critical public spending programs in jeopardy.
The purpose of this article is to analyze the impact of corruption on returns in BRIC stock indices (SR) and its interaction with institutional factors such as democratic accountability, law and order and bureaucratic quality. We use Arellano-Bover and Blundell-Bond linear dynamic panel data estimation with lagged dependent variables and a set of control variables.
Despite their enviable growth records, BRIC countries suffer from high levels of corruption according to Transparency International’s Corruption Perceptions Index. As a result, they are increasingly reliant on foreign investment to finance their rapid economic development and are characterized by imperfect and unstable institutions. This study shows that the negative effects of corruption on SR are moderated by the presence of institutional factors. In fact, as the level of democracy increases, corruption’s marginal effect on SR decreases while its interaction with bureaucratic quality and law and order increases. Such a result suggests that corruption interacts with other institutional factors to generate mixed empirical results, either greasing the wheel or adding sand in it, which can have both positive and negative consequences for stock market returns.