Corruption is an important determinant of stock market crashes as it raises firms’ cost of capital, reduces operating efficiency and undermines corporate governance (Athanasouli & Goujard, 2015; Meon & Weill, 2010). It also increases the risk of business failure and suppresses firm growth (Maloney, 1998; Wang & You, 2012). However, some authors claim that corruption can have beneficial consequences if it is “lubricant” instead of “sand in the wheel”, enabling businesses to operate efficiently and gain competitive advantage.
This article investigates the impact of government corruption and institutional factors such as democratic accountability, law and order and bureaucratic quality on stock market return volatility (SR). Using Arellano-Blundell-Bond linear dynamic panel data estimations and resolving endogeneity by means of lagged dependent variables we find that corruption has a strong negative effect on SR whereas democratic accountability and law and order have a positive influence. Furthermore, the interaction between DA and LO has a negative effect on SR while the interaction between CORR and BQ is positive, indicating that corrupt officials use law and order as a tool for extracting bribes from businesses and hence increase costs of doing business which lowers SR.
Our findings suggest that corruption negatively affects SR of the BRIC economies as it creates uncertainty and risks for investors. However, this is counterbalanced by their high growth records, large and unsaturated markets, cheap labour and young population which attracts global funds. Additionally, the co-movement between BRIC and global indices indicates that investors are compensated for the risk of investing in the BRIC countries by the complementary relationship with global markets.
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