Despite contributing significantly to world trade and investment, BRIC countries rank poorly on Transparency International’s Corruption Perception Index. Corruption is a serious obstacle to investment because it impedes economic and financial governance by distorting the market by allowing cronyism; introduces instability into politics; and weakens property rights. The stock market’s reaction to corruption scandals is well documented but less research examines the effect of disclosure of a country’s level of corruption risk on the stock market. Using panel two-way fixed-effect model with monthly data from 1995 to 2014 and the BRIC economies, we find that corruption is a negative and significant driver of stock returns (SR). In particular, corruption negatively impacts SR by increasing the cost of doing business. We also find that a high level of corruption can reduce the quality of institutions, such as law and order and bureaucratic quality. This reduces SR by increasing the risk of investment and by making it more difficult to enforce property rights.
The interaction of corruption with institutions appears complex, providing mixed empirical evidence on whether corruption “greases the wheel” or “adds sand to it.” In addition, the effect of corruption and institutional quality is complementary and competitive. This finding suggests that companies can overcome corruption by instituting strict anti-corruption policies, which are likely to be beneficial for the company’s reputation and stock market performance. However, it is important to understand that corruption may have different effects on foreign and domestic firms as it is more challenging for domestic firms to control corrupt behavior in a culture where it is prevalent.