Corruption’s Impact on Liquidity, Investment Flows, and Cost of Capital
Pankaj K. Jain
University of Memphis - Fogelman College of Business and Economics
Nova Southeastern University
Michael S. Pagano
Villanova University - Villanova School of Business
February 17, 2012
Corruption decreases liquidity available to institutional traders and discourages foreign portfolio investment inflows into a country. Corruption also increases corporations’ cost of equity capital. The effects of corruption on foreign investment and the cost of equity capital are nonlinear and reverse J-shaped, with intermediate levels of corruption yielding the most negative effects. Investors prefer highly transparent nations where a “level playing field” exists between foreign and local investors due to lack of information asymmetries related to corruption. Foreign investors also invest in very corrupt countries because a “perverse level playing field” puts foreigners and locals on an even footing in terms of resolving asymmetric information problems.
Keywords: Liquidity, Execution Risk, Equity Held by Foreigners, Corruption, Informational Asymmetry, Government Involvement, Institutional Trading Costs, Global Trading
JEL Classification: G19working papers series
Date posted: March 18, 2011 ; Last revised: July 10, 2013
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