We have seen several instances of government corruption in the US, from bribes paid by defense contractors to win contracts, to revolving doors where former officials move into private sector employment and then back into government. We also see evidence of corruption in Britain in the way that the Serious Fraud Office has been scuttled by government ministers citing national interests, and also in the fact that defence companies are among the most corrupt industries.
These issues erode public confidence in government which has been a key driver of stock market returns for many decades. When people believe that the system is rigged, they disengage from voting and other forms of political participation which makes their representatives less accountable and responsive to their needs.
Corrupt practices can also have severe consequences for business. Companies that engage in bribery risk being punished by regulators, and they may lose business to competitors that have clean hands. Moreover, corrupt practices can lead to bad press which hurts corporate reputations and drives away investments.
In this paper, we study the impact of corruption on stock market development in Brazil, Russia, India and China (BRIC). We find that a high level of corruption reduces stock market development by lowering the quality of institutions such as bureaucratic practice, law and order and democratic accountability. This is a negative effect that is counteracted by the positive effects of the interaction variable between corruption and democracy. We also find that voluntary corruption control measures do not always have the expected impact.