Stock markets play a crucial role in the global economy as they provide a means for transferring wealth. However, the functioning of stock markets is jeopardized by corruption. Corrupt practices such as bribing tax inspectors, paying off powerful officials and spending on entertainment to build networks initiate political linkages that have a direct impact on the value of firms and bank loans (Wang and You, 2018). The fact that most countries are corrupt makes it difficult for investors to rely on market signals, which may negatively influence investor perceptions about the economic future and thus reduce stock returns.
This study investigates the effect of government corruption on stock market performance in BRIC nations using monthly data from 1995 to 2014. We examine the interaction between corruption and institutional components such as democratic accountability, bureaucratic quality and law and order.
Our results show that a higher level of corruption greases the wheel of stock market growth, while a lower level of corruption dampens stock market growth. The interaction effects also show that DA, LO and BQ moderate the negative effect of corruption on SR. In particular, a high level of DA can mitigate the ill effects of corruption by improving business practices and reducing red tape, while a low level of LO distorts law and order to lower stock market returns.
The findings of this study are consistent with previous research indicating that higher levels of corruption have a negative impact on the economy and stock market returns. Nevertheless, this research provides novel evidence that institutional factors such as democratic accountability, bureaucratic quality, and law and order can mitigate the effect of corruption on SR by improving business practices and minimizing red tape.