Corruption and firms’ efficiency: international evidence using an instrumental variable approach

Abstract

Using a sample of firms over the 2002–2010 period relative to the US, Europe, and Japan, this paper investigates the effects of control of corruption on firms’ efficiency. Our econometric analysis is developed into two main steps. In the first step, we rely on the application of the Stochastic Frontier Analysis (SFA) to estimate firm-level efficiency. We then regress the derived efficiency scores against the International Country Risk Guide (ICRG) control of corruption indicator, through an Instrumental Variable approach, where the ICRG index is instrumented using a measure of ethnolinguistic fractionalization. The evidence reported in the paper indicates that improved control of corruption systematically enhances firms’ efficiency. We also rely on a direct approach, in which we assess the impact of corruption on R&D expenditures and the number of registered patents and show that improved control of corruption stimulates both of these dimensions of innovation, though the impact is higher, in magnitude and significance, for patents. The evidence reported in this paper, which is robust to alternative specifications of the production technology, to an alternative instrumentation strategy and to the aggregation of firm-level information, brings relevant implications in terms of policy.