Corruption is a global issue that affects investment, economic growth and social development. It can also result in stock market crashes and undermine investor confidence. Government corruption often warps policy and public funds go to the wealthy, leaving behind underdeveloped public services and a growing burden on ordinary citizens who must contend with overcrowded housing, unsafe streets, poor education, and inadequate health care. The United States is no stranger to such corruption: Gilded Age tycoons bought politicians and bypassed regulation to monopolize the industry while workers struggled with long hours, low wages and dangerous work conditions (Rock, 2009).

Previous research has focused on firm-level factors, particularly ownership structure, as a driver of stock market crashes but little attention has been paid to institutional factors. We explore the interaction between corruption and institutions using disaggregated data for BRIC economies. We find that the quality of government institutions has a positive impact on stock market returns. Good bureaucratic practices and law and order increase SR by improving transparency and reducing uncertainty. However, when these institutions are corrupted, SR decreases because investors receive distorted signals.

We use Arellano-Bover and Blundell-Bond linear dynamic panel data estimation to analyze the impact of corruption and institution quality on SR. We find that a higher level of corruption significantly lowers SR and the interaction of corruption and institutions is complex. In general, the quality of government institutions seems to compensate for the negative effect of high corruption on SR but an individual variable such as democracy increases or decreases the effects of a high degree of corruption.