Drivers of Corruption Risk and Stock Market Effects: Evidence from the Defence Industry

Abstract

Since anecdotal evidence indicates that corruption is rampant in the defence sector globally, we examine the drivers of firm level corruption risk in the defence industry. Our empirical results indicate that visibility and shareholding are significant drivers affecting a firm’s corruption risk. Large firms and listed firms have lower corruption risk, other things being equal. Further, higher managerial shareholding is associated with higher level of corruption risk. These results hold even after controlling for country level drivers such as institutional quality, cultural and economic factors. Interestingly, stock markets in developed countries react more negatively around the announcement to firms achieving low corruption risk scores. Firms with low corruption risk experience lower stock price volatility after the disclosure of corruption risk scores. Finally, we also find that the disclosure of corruption risk is associated with an increase in firm level market liquidity.

Keywords: Corruption Risk, Stock Market Reaction, Information Asymmetry, Market Liquidity

JEL Classification: G34, H83, D73