Government corruption is widely recognized as a major obstacle to international investment and economic growth. While the cost to society of bribing a bureaucrat for a business permit may be small, the harm caused by a powerful corporation bending the rules of the game in exchange for monopolistic rights is far greater. A well-known example is the “state capture” of Nigeria by a telecommunications company.
This article uses monthly panel data on Brazil, Russia, India, and China (BRIC) to explore the relationship between stock market indices and corruption and the interaction of corruption with institutional variables including democratic accountability, bureaucratic quality, law and order, and levels of risk in global and emerging markets. Our results suggest that, for BRIC countries, a high level of corruption significantly lowers stock returns. This is consistent with the sand in the wheel hypothesis, whereby corruption interferes with the functioning of markets. However, a country’s institution-level factors can mitigate the negative effects of corruption by improving the business environment and increasing stock returns.
Specifically, we find that democracy increases corruption opportunities and then starts to mitigate corruption in the later stages of its development; and law and order reduces corruption by making it more difficult for corrupt officials to prey on investors. In addition, we also find that the quality of bureaucracy can help to grease the wheels of stock markets by reducing red tape and improving the efficiency of doing business. However, the interaction of these variables is complex and provides mixed empirical support for the sand in the wheel and greasing the wheel hypotheses.