Corruption by government officials distorts policy and hurts the public, as demonstrated by the “robber barons” of the late-19th century Gilded Age. They bribed tax inspectors and officials to gain unfair advantage, while workers struggled with overcrowded and unhealthy living conditions.

In modern societies, corruption can take a different form, such as politicians accepting bribes from business leaders to make their businesses thrive or allowing corrupt officials to extort large sums of money. Nonetheless, it distorts markets by creating inefficient signals and leads to poor economic outcomes.

While it is known that corruption has negative effects on stock market returns, the question of whether it also affects institutional components like democratic accountability, bureaucratic quality and law and order remains unexplored. This article investigates these relationships using a dynamic panel estimation.

The results show that higher corruption reduces a country’s stock market return but does not have any impact on DA, LO or BQ. This result is consistent with the sand in wheel hypothesis of corruption wherein the country’s institutions are able to moderate the damaging effect.

Moreover, the positive and moderate interaction effect between corruption and the institutional components reveals that investors are likely to adjust their expectations of future revenues and profits according to the level of corruption in a country. Consequently, they would not invest in the country with high corruption even though other factors are positive. This finding could explain the complementarity of BRIC economies as global investors have sought opportunities in these countries as developed economies faced financial crisis and slow growth.