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Corruption’s Impact on Liquidity, Investment Flows, and Cost of Capital

44 Pages Posted: 18 Mar 2011 Last revised: 20 Feb 2014

Pankaj K. Jain

University of Memphis - Fogelman College of Business and Economics

Emre Kuvvet

Nova Southeastern University

Michael S. Pagano

Villanova University - Villanova School of Business

Date Written: February 14, 2014

Abstract

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. Highly transparent nations, where a “level playing field” exists between foreign and local investors due to lack of information asymmetries related to corruption, attract the most investment flows. However, at the margin, very corrupt countries attract more flows than moderately corrupt countries because a “perverse level playing field” in the former countries may put 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: G19

Suggested Citation

Jain, Pankaj K. and Kuvvet, Emre and Pagano, Michael S., Corruption’s Impact on Liquidity, Investment Flows, and Cost of Capital (February 14, 2014). Available at SSRN: https://ssrn.com/abstract=1786559 or http://dx.doi.org/10.2139/ssrn.1786559

Pankaj K. Jain

University of Memphis - Fogelman College of Business and Economics ( email )

Memphis, TN 38152
United States

Emre Kuvvet (Contact Author)

Nova Southeastern University ( email )

Ft. Lauderdale, FL 33314
United States

Michael S. Pagano

Villanova University - Villanova School of Business ( email )

800 Lancaster Avenue
Villanova, PA 19085-1678
United States
(610) 519-4389 (Phone)

HOME PAGE: http://www90.homepage.villanova.edu/michael.pagano

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