Corruption and Firms: Evidence from Randomized Audits in Brazil

We exploit spatial variation in randomized anti-corruption audits related to government procurement contracts in Brazil to assess how corruption affects resource allocation, firm performance, and the local economy. After an anti-corruption crackdown, regions experience more entrepreneurship, improved access to finance, and higher levels of economic activity. This is inconsistent with corruption acting as “grease in the wheel.” We find that two channels explain these facts: allocation of resources to less efficient firms, and distortions in government dependent firms. Using firms involved in corrupt business with the municipality, i.e. “corrupt firms,” we find that the second channel is more important. Difference in difference estimation suggests that, after audits, the performance of corrupt firms improves relative to a similar set of unaffected firms. Corrupt firms invest more, increase borrowing and leverage, reallocate labor inside the firm, restructure the organizational design by increasing hierarchical layers, rely less on government contracts, and grow faster. Our findings provide novel micro-evidence on why corruption acts as an institutional failure that is detrimental to firm performance and economic growth. Date: November 14, 2017. We thank Shai Bernstein, Nick Bloom, Pascaline Dupas, Josh Rauh, and Amit Seru for their invaluable advice. We also thank Eliot Abrams, Arun Chandrasekhar, Marcel Fafchamps, Claudio Ferraz, Fred Finan, Elisa Maffioli, Davide Malacrino, Melanie Morten, Marcus Opp, Rohini Pande, Nicola Pierri, Luigi Pistaferri, Tomás Rau, Cian Ruane, Isaac Sorkin, Edoardo Teso, Austin Wright, and seminar participants at Stanford Economics, Stanford GSB Finance, NEUDC-MIT, DEVPEC, TADCLBS, USC Marshall PhD Conference in Finance, EEA-ESEM Lisbon, EMCON Chicago, SFSU, and USF for helpful comments and suggestions. Naoko Yatabe provided superb research assistance. Emanuele Colonnelli is extremely grateful to the CGU director Gustavo de Queiroz Chaves and many other CGU officials for insightful discussions and clarifications. We are grateful to the Stanford Institute for Innovation in Developing Economies (SEED), the Private Enterprise Development in Low-Income Countries (PEDL) Initiative by the Centre for Economic Policy Research (CEPR), the Department For International Development (DFID), the Stanford Center for International Development (SCID), the Stanford Institute for Research in the Social Sciences (IRiSS), the Abdul Latif Jameel Poverty Action Lab (J-PAL) Governance Initiative, and Universidad del Rosario for financial support. Department of Economics, Stanford University. email: [email protected]. ‡Department of Economics, Universidad del Rosario. email: [email protected]. 1 CORRUPTION AND FIRMS 1