Government corruption—the misuse of public authority for private gain—harms society in many ways. It distorts policy, making it harder for governments to deliver public goods like education, infrastructure, and healthcare. It leads to a deterioration in the quality of financial markets and can even cause stock market crashes (Wang and You, 2012). It also drives away investment and growth by deterring foreign investors. Investors may be less willing to put their money in countries where local bureaucrats expect bribes and the national government preys on businesses. But corruption can have different effects depending on how it interacts with other institutions. Some institutions, such as a quality bureaucracy and law and order, have the potential to reduce the negative effect of corruption by lubricating the wheel of economic development.
We use dynamic panel data estimation in line with Arellano and Bover, 1995 and Blundell and Bond, 1998 to explore the heterogeneous impact of corruption and quality of institutions on stock returns (SR) across Brazil, Russia, India, and China (BRIC). We estimate a two-way fixed effect model using monthly data for the period from 1995 to 2014. Our free variables include CORR as corruption, democratic accountability, bureaucratic quality, and law and order. We find that a rise in corruption lowers SR but the effect is mitigated by democratic accountability and bureaucratic quality. The interaction between CORR and law and order is also significant. This is probably because corruption reduces SR by causing uncertainty and risk for investors.