Local corruption and local stock returns
| Date | 07 October 2019 |
| DOI | https://doi.org/10.1108/JFC-01-2018-0011 |
| Published date | 07 October 2019 |
| Pages | 1065-1077 |
| Author | Serkan Karadas,William McAndrew,Minh Tam Tammy Schlosky |
Local corruption and local
stock returns
Serkan Karadas
Department of Economics, The University of the South, Sewanee, Tennessee, USA
William McAndrew
Dahlkemper School of Business, Gannon University, Erie, Pennsylvania, USA, and
Minh Tam Tammy Schlosky
Department of Economics, The University of the South, Sewanee, Tennessee, USA
Abstract
Purpose –The purposeof this study is to investigate the effect of corruptionon stock returns in the USA. In
particular, this studyexamines the relationship between corruption in a state(i.e. local corruption) and stock
returns of firmsheadquartered in that state (i.e. local returns).
Design/methodology/approach –This paper uses the Fama–MacBethtwo-step regressions. In the first
step, the authors estimate the coefficients on the market, size, value and momentum factors for individual
stocks. In the second step,they use those coefficients along with the corruption score of the state where stocks
are headquarteredto explain stock returns.
Findings –This paper finds that corruption in a state adversely affects stock returns of firms
headquartered in that state. It further documentsthat the effect of corruption on stock returns is limited to
geographicallyconcentrated firms.
Originality/value –To the best of the authors’knowledge, this paperis the first to document the effect of
state-level corruption on individual stock returns in the USA using the Fama–MacBeth regressions. This
study contributesto the literature by documenting the effect of local corruptionon local stock returns in a low
corruptioncountry.
Keywords Local corruption, Local stock returns, Institutions, Justice, Political corruption
Paper type Research paper
1. Introduction
Political corruption is a lack of political integrity where significant agency problems occur,
incentivizing government officials toward rent-seeking behavior. This paper examines the
effect of corruption on stock returns in the USA. We use corruption data provided by the
Department of Justice and investigate the relationship between the level of corruption in a
state (i.e. local corruption) and stock returns of firms headquartered in that state (i.e. local
stock returns) for the 1988-2014 period. According to Transparency International, the USA
is often in the top 10 per cent of the most transparent(the least corrupt) countries, hence, it is
not considered a corrupt country[1]. However,our analysis reveals a variation across states
in terms of their corruption scores.For example, we find that Illinois, the most corrupt state,
is eight times more corruptthan Oregon, the least corrupt state.
Although corruption in its colloquial meaning is a negative term, it will not necessarily
have a negative effect on an economy or a firm. Two competing hypotheses explain this
JEL classification –G10, G12, G18, D72, D73, K42
Local
corruption
1065
Journalof Financial Crime
Vol.26 No. 4, 2019
pp. 1065-1077
© Emerald Publishing Limited
1359-0790
DOI 10.1108/JFC-01-2018-0011
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