Responsible Investment

Does Virtue Pay? How corruption impacts financial markets

February 2, 2008
Image “Cash Money” by Nathan Gibbs (CC BY-NC-SA 2.0)

In their study “Corruption and International Valuation: Does Virtue Pay?”, authors Charles Lee (Stanford University) and David Ng (Cornell University) argue “that the level of public corruption is broadly symptomatic of contracting and monitoring costs within a country.In more corrupt regimes, agents must expend higher costs and greater effort in all their contractual transactions — e.g., to reduce counter-party risk, to monitor performance, and to enforce property rights. These higher transaction costs are not easily diversified away.” In a simple model, Charles Lee and David Ng show that “even when global markets are reasonably integrated, increased contracting costs will lead to higher required rates of return on a country’s equity investments.”

Financial data for the study came from the Worldscope database and I/B/E/S. Estimates of the level of corruption by country were provided by the annual Transparency International CPI index for the years 1995-98. This index is a “poll of polls” summarizing information from 12 surveys and ratings of corruption (more info at 

In further analyzing their data, the authors found that “this result derives mainly from the effect of corruption on required rates of return, rather than on expected earnings growth or future profitability. Firms in more corrupt countries do not generally earn lower nominal returns-on-equity (ROE), or have lower expected rates of growth in earnings. However, investors seem to demand a higher rate of return when discounting the expected cash flows of firms from more corrupt countries.” This leads to lower corporate values.

This study by Charles Lee and David Ng adds to the growing literature on the effects of corruption. Other academic studies have shown corruption to be linked with a variety of other social and economic problems, including low economic growth and foreign investment, reduced shareholder protection, lower healthcare and education spending. However, direct evidence of the economic consequences of corruption as shown in this study, has been relatively scarce.

This study won the 2003 Moskowitz Prize (awarded by the Center for Responsible Business at the Haas School of Business, in cooperation with the Social Investment Forum, the Moskowitz Prize promotes the concept, practice, and growth of socially responsible investing).


This article is based on a previously published article on, February 2, 2008.

This article may be reproduced according to our terms of use with attribution (and link, if online) to To be cited as: “Does Virtue Pay? How corruption impacts financial markets”, Lloyd Kurtz, and Ingrid Ramaan,, February 2, 2008.

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Ingrid Ramaan
Administrative Editor FSinsight

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