“He’s a businessman … I’ll make him an offer he can’t refuse.” – The Godfather
Having spent the last 2 weeks on vacation in Russia, I was amazed by the beauty, the people, the art and also the amount of corruption which exists in this country. After talking with many people, I learned that it is almost impossible to do any legitimate business in Russia without bribes, kickbacks and payoffs. The next logical question that comes to mind is why would anybody do business there? Why would anyone invest in any publicly traded company in Russia, since fraud and corruption are so prevalent?
I thought it would be interesting to do some basic ‘back of the napkin calculations’ to see how corruption effects stock market performance. Transparency International publishes an annual Corruption Perception Index which ranks countries “by their perceived levels of corruption, as determined by expert assessments and opinion surveys.”
In the developed markets, the top 5 least corrupt countries year after year tend to be New Zealand, Finland, Denmark, Sweden and Singapore. The most corrupt are Italy, Israel, Spain and France and United States.
In emerging markets, the top 5 least corrupt countries are Chile, Taiwan, Poland, South Korea and Malaysia. The most corrupt are India, Mexico, Philippines, Indonesia and Russia (no surprise).
Having a rating for the counties over the last 10 years, I wanted to compare them to the average (arithmetic) stock market performance of those countries over the last decade to see if there were any correlations. Having full data for 10 years of Corruption Index and stock market performance for over 35 countries, I put together the chart below for developed markets.
As you can see, the least corrupt countries (those with highest Corruption Index Scores) tend to have better performances in the stock market over the last 10 years as the trend line shows. The picture changes once we look at emerging markets. If we look at 10 years of data in emerging markets, the countries which are more corrupt have had better market performances.
It seems for developed markets, corruption does not pay, but in emerging markets corruption does seem to pay, rewarding the most corrupt countries with higher market performances. This is rather puzzling. Why would a corrupt country have better market performance? My guess is that corruption cuts both ways.
For example, if you own a publicly traded company in Russia that makes widgets, you are probably skimming the profits from the top and short changing the shareholders. At the same time, you are also bribing politicians to get more lucrative deals and paying off the local officials to make it difficult for other widget manufacturers to do business and compete with you. Thus improving your profit margins in the process. In the long run, it’s a losing formula for the overall economy. In the short run, the markets do not seem to care how the profits are derived. It is also possible that shareholders are bidding up the price of stocks in corrupt countries in expectation that things will improve and that the upside will hold rewards. Just another way of saying “things can only get better”.
So in corrupt countries, corruption does seem to improve stock market performances at least in the short run. However, in developed countries, corruption seems to have a negative effect on markets.
A word of caution about my findings, it’s very possible the data sample of 10 years might be too small and if we looked at a much larger data set the conclusion might be different. Also there’s a chance that we are simply seeing a correlation and not a causation.