1 s2.0 S1042444X20300499 Main

J. of Multi. Fin. Manag.
57–58 (2020) 100660
Contents lists available at ScienceDirect
Journal of Multinational Financial

Management
journal homepage: www.elsevier.com/locate/econbase
Corruption and financial fragility of small and medium

enterprises: International evidence
Anh-Tuan Le a , Anh-Tuan Doan b,∗
a
Department of Finance, National Central University, 300 Zhongda Road, Zhongli District, Taoyuan City 32001, Taiwan
b
International School of Business, University of Economics Ho Chi Minh City, 17 Pham Ngoc Thach Street, District 3, Ho Chi Minh City,
Vietnam
a r t i c l e i n f o a b s t r a c t
Article history: This paper examines the effect of corruption on the financial fragility of small and medium
Received 1 May 2020 enterprises (SMEs) across 62 countries over the period from 2012 to 2018. We also evaluate
Received in revised form 14 October 2020 how economic freedom and press freedom affect the association between corruption and
Accepted 22 October 2020
corporate financial fragility. We find evidence that an increase in the degree of corruption is
Available online 5 November 2020
positively correlated with the financial fragility of SMEs in developing countries. In contrast,
we show no evidence that corruption is significantly associated with the financial fragility
JEL classification:
of firms in developed countries. Furthermore, we find that the adverse impact of corruption
D73
on firm financial fragility is more pronounced in countries with less economic freedom. Our
G32
O16 results also reveal that firms in countries with greater press freedom can better mitigate the
negative impact of corruption on their risks than firms in countries with lower levels of inde-
Keywords: pendent press. Econometrically, our findings still hold even after controlling for dynamic
Corruption endogeneity, simultaneity, and unobserved time-invariant heterogeneity, inherent in the
Financial fragility
corruption–corporate fragility relationship.
Economic freedom
© 2020 Elsevier B.V. All rights reserved.
Press freedom
1. Introduction
Corruption is a global concern because it is considered to be a significant constraint on firm growth and development.1
Corruption can take many forms such as bribery, embezzlement, money laundering, tax evasion, cronyism, and among
others. It hurts and harms the growth of firms in both rich and poor countries, especially in developing countries. A large
body of research indicates the role or consequences of corruption in corporate operations.2 However, few empirical studies
have examined the association between corruption and corporate financial fragility. We fill this gap in the literature by
studying how political corruption affects small and medium-sized firms’ financial fragility around the world.
Existing studies consider two views of the economic effect of corruption. On the one hand, the “grease in the wheels”
view highlights the positive effect of corruption (Kaufmann and Wei, 1999). Firms may benefit from this view via their close
relationships with the government, which helps firms overcome bureaucratic obstacles. Those firms also obtain special
∗ Corresponding author at: International School of Business, University of Economics Ho Chi Minh City, 17 Pham Ngoc Thach Street, District 3, Ho Chi
Minh City, Vietnam.
E-mail addresses: tuanlechris@g.ncu.edu.tw (A.-T. Le), tuandoan@isb.edu.vn (A.-T. Doan).
1
An article on the World Economic Forum in 2019 argues that “corruption is costing the global economy $3.6 trillion dollars
every year” and “it contributes to instability, poverty and is a dominant factor driving fragile countries towards state failure”. See
https://www.weforum.org/agenda/2018/12/the-global-economy-loses-3-6-trillion-to-corruption-each-year-says-u-n.
2
See Butler et al. (2009); Liu (2016); Ellis et al. (2019); Thakur and Kannadhasan (2019); Nguyen and van Dijk (2012); Tran (2019a); Zakharov (2019).
https://doi.org/10.1016/j.mulfin.2020.100660
1042-444X/© 2020 Elsevier B.V. All rights reserved.
A.-T. Le and A.-T. Doan J. of Multi. Fin. Manag. 57–58 (2020) 100660
treatment such as government contracts and favourable loan terms (Méon and Weill, 2010; Duchin and Sosyura, 2012;
Bologna and Ross, 2015). Faccio et al. (2006) find that politically connected firms have higher leverage, lower tax rates, and
stronger market power than non-politically connected firms. They also easily overcome periods of financial distress thanks
to government bailouts. Chaney et al. (2011) indicate that politically connected firms have a lower cost of debt although they
exhibit lower earnings quality, suggesting that the magnitude of managerial risk aversion may differ between politically
connected firms and non-connected peers.
On the other hand, the “sand in the wheels” view treats corruption as a threat for firm operations because it increases
financing constraints (Qi and Ongena, 2019), reduces investments and innovations (Ellis et al., 2019; Zakharov, 2019), and
weakens corporate governance (Porta et al., 1998). Boubakri et al. (2013) document that corruption makes firms more likely
to engage in risky projects, resulting in an increase in the probability of experiencing a stock price crash risk (Chen et al.,
2018; Cao et al., 2019). Thus, firms that involve in corruption practices would create more financial fragility under the sand in
the wheels views. This diverse prior literature leads to conflicting predictions regarding the effect of corruption on financial
fragility. Given that the ‘grease the wheels’ hypothesis predicts that firms can engage in corruption to reduce risks, while
the ‘sand in the wheels’ suggests that corruption discourages good investments and strong corporate governance, existing
empirical evidence is mixed, and hence, no consensus has been reached.
We use the global sector of small and medium-sized enterprises (SMEs) because it is a more appropriate sample for our
examination. Theoretically, the corruption effect could be more severe in SMEs than in large firms for three reasons. First,
SMEs account for approximately 99 % of all firms around the world and generate approximately 55 % of the value added
on average (OECD, 2017). Second, SMEs often face with many obstacles in their business operations, such as difficulties
accessing external financing (Ayyagari et al., 2016) and adapting to uncertainties in new policies or an institutional envi-
ronment (e.g., the control of corruption) that would affect their businesses (Wang et al., 2014). Third, small businesses are
more sensitive to the uncertainties in economic policies compared to large firms since both macroeconomic and firm-level
changes significantly affect the financial fragility of SMEs (Rashid and Saeed, 2017). To empirically investigate the effect
of corruption on corporate financial fragility, we follow prior studies associated with corruption (Chen et al., 2015; Thakur
and Kannadhasan, 2019; Tran, 2019a) and employ the data on corruption from Transparency International’s “Corruption
Perceptions Index”. We use a rich sample of 98,890 firm-year observations from 25,754 SMEs across 62 countries during the
period from 2012 to 2018, which allows us to split our sample into two subsamples, including firms in developing countries
and developed countries.
The study contributes to the literature in a number of ways. First, our paper is in the vein of recent studies that provide
international evidence on the impact of country-specific corruption on corporate financial fragility (Chatjuthamard et al.,
2019; Tran, 2019b; Vural-Yavaş, 2020). Since some related studies mainly focus on single-country financial data such as
that of China (Pan and Tian, 2017; Zhang et al., 2019), Vietnam (Nguyen and van Dijk, 2012), and Russia (Zakharov, 2019),
our knowledge with regards to a broader range of countries, particularly developing and developed countries, remains
limited. In addition, while recent papers mainly find the consequences of corruption on other aspects of corporate activities,
such as innovation (Sena et al., 2018; Ellis et al., 2019; Huang and Yuan, 2019), investments (Pan and Tian, 2017), financial
policy (Qi and Ongena, 2019; Tran, 2019a), and cash trading (Thakur and Kannadhasan, 2019), we explicitly analyse the
effect of corruption on the SMEs’ financial fragility, for which the empirical evidence of different influences of the corruption
environment across countries is relatively scarce. Our paper is close to Boubakri et al. (2013) who use a sample of 45 countries
to document international evidence that politically connected firms tend to make less conservative investment choices and
engage in risky projects, resulting in higher earnings volatility. Different from this study in which general political objectives
are used to test corporate risk-taking, we mainly compare the effect of corruption on firm financial fragility in developed
countries with that of their developing counterparts.
Second, we further explore whether the relationship between corruption and corporate financial fragility may vary
according to cross-sectional country characteristics. In particular, we introduce the interaction terms between corruption
and both national economic freedom and press freedom. In this way, we explicitly analyse the mediating effect of country-
level factors on the relationship between corruption and firm financial fragility. Although few past studies suggest that
country-level antecedents play a pivotal role as determinants of corruption in host and home countries (Alfaro et al., 2019;
Bahoo et al., 2019), our findings are important for policy makers who need to consider corruption levels since they can have
adverse corporate financial risk and macroeconomic consequences. Despite the extensive literature on corporate financial
fragility using samples from the banking industry (Chen et al., 2015; Doan et al., 2018), a comprehensive study on whether
the changes in the press freedom and economic freedom mitigate or exacerbate the risk exposure of SMEs in non-financial
sectors does not yet exist.
Finally, unlike most prior studies examining the corruption–corporate fragility relationship in a static perspective (e.g.,
Chen et al., 2015; Cao et al., 2019), our study re-investigates the relationship between country-specific corruption and finan-
cial fragility in a dynamic framework within which the possible impact of historical corporate fragility on current corruption
is fully controlled. The fact that the corruption may increase the misreporting of income by firm managers, for example, to
improve the evaluation of their performance, measuring financial fragility could be challenged in a corrupt environment
where more corrupt managers involve in more income diversion activities (Mironov, 2015). Given that both corruption and
financial fragility are simultaneously determined in a system in which fragility goal is a component, variations in corruption
levels should not be systematically related to variations in firm financial fragility. In other words, corruption should be unre-
2
lated to performance in the presence of endogeneity sourced from simultaneity and unobserved heterogeneity. We use a
well-developed dynamic panel generalized method of moments (GMM) estimator to alleviate endogeneity concerns which
incorporates the dynamic nature of national governance choices to provide valid and powerful instruments that address
unobserved heterogeneity and simultaneity. By taking into account this dynamic endogeneity and other potential sources
of endogeneity (including simultaneity, and time-invariant unobserved heterogeneity), we expect to achieve more reliable
inferences about the causal link between corruption and financial fragility.
We obtain the following main findings. First, we show that increases in corruption are positively correlated with corporate
financial fragility only for SMEs in developing countries and not those in the developed countries. Second, our results also
reveal that increased corruption is associated with higher financial fragility for firms in countries with less economic freedom.
In contrast, firms in countries with high press freedom can better mitigate the negative impact of corruption on their risk
exposure than firms in countries with lower levels of the independent press.
The remaining paper is structured as follows. Section 2 reviews the literature on corruption and firm financial fragility.
We represent our methodology, including the measures of corruption, firm financial fragility, and the analysis strategy in
Section 3. Section 4 describes the data selection and statistics. The empirical results are discussed in Section 5. Finally, Section
6 gives a conclusion.
2. Literature review and hypothesis building
2.1. Corruption and firm-financial fragility
Corruption, which is normally defined as the “misuse of entrusted power for private gain” (UNDP, 2008, p.7), is a social,
political and economic phenomenon that is prevalent globally but is more pervasive in less developed economies. In the lit-
erature on the corruption-development nexus, corruption is widely believed to be pernicious to entrepreneurs’ investment
incentives, the composition of government expenditures, the effectiveness of public governance, product market competi-
tion, and the inflow of foreign direct investment, among others, and thus is detrimental to economic growth (Shleifer and
Vishny, 1993; Nguyen and van Dijk, 2012; Alexeev and Song, 2013; Hamilton and Hammer, 2018; Bui et al., 2020).
Given that previous work has generated various predictions about the direction of the effect of corruption on firms’
financial fragility, most recent work has focused on resolving this question empirically. Although the most common forms
of corruption include bribery, extortion, influence peddling, nepotism, fraud, and the embezzlement of funds, corruption
is difficult to define as it can be classified into various types and is even more difficult to measure due to its inherent
secrecy (Wang and You, 2012). A “first wave” of empirical research into this question generally adhered to the survey-based
indicators, which posits that formal measures of subjective corruption perceptions are strong predictors of states that are
perceived as legally or illegally corrupt (Boylan and Long, 2003). Many such studies relied on subjective measures such as the
Corruption Perceptions Index (CPI), Corruption Index (CI), World Governance Indicators (WGI), or International Country Risk
Guide (ICRG) in which an opinion survey was conducted with experts (e.g., Kaufmann et al., 2011; Dincer and Johnston, 2015;
Doan et al., 2020b). Several studies use the conviction-based ranking of each state in their empirical analyses, which focus on
“crimes involving abuses of the public trust by government officials” (Public Integrity Section, 2007). Unlike the survey-based
data or data on peoples’/firms’ perception of corruption, the conviction-based data provide an objective measure of public
corruption (Dass et al., 2020). However, one concern with this objective measure is that the number of convictions might
reflect variation in the level of law enforcement across states. If higher number of convictions indicate stronger enforcement
and, hence, lower levels of corruption, then it should bias the estimates against proposed hypotheses (Acemoglu and Jackson,
2017).
The research on the financial outcomes of corruption only provides mixed findings, in which agency costs are important
in interpreting two contrasting hypotheses of the relation. The central premise of arguments regarding the corruption –
fragility relationship is the potential trade-off between “grease the wheel” effect and “sanding the wheel” effect of corruption
(Kaufmann and Wei, 1999). Accordingly, predictions of the positive performance effect of corruption are based on view of
“grease the wheel”. Under the view of “grease the wheel”, corruption can help managers have strong incentives to actively
monitor and real power to discipline and/or influence management (Duchin and Sosyura, 2012). This helps to mitigate the
agency problems which, in turn, may benefit politically connected firms thanks to special treatment from the governments
(i.e., jumbo loans) (Méon and Weill, 2010; Bologna and Ross, 2015). In this point of view, in economies with governmental
organizations and high tariffs for customs and trade, corruption can expedite trade by eliminating governmental barriers
(Lui, 1985; Beck and Maher, 1986; Rose-Ackerman, 1997), and in countries where strict regulation is imposed, paying bribes
helps firms avoid such limitations. Furthermore, firms can take advantage of lobbying via political connections, especially
in the context of pervasive and cumbersome regulations in developing countries. Faccio et al. (2006) and Chaney et al.
(2011) show that politically connected firms are more likely to be bailed out by banks relative to non-connected firms
during distress, which helps them obtain timely actions to overcome governmental impediments. In a seminal work in this
perspective, Zhang et al. (2019) also argue that local corruption plays a crucial role in firms’ survival because officials give
favoured firms access to special interests, privileges, and favourable treatment. Consequently, firms can overcome policy
constraints and acquire protection from corrupt authorities, resulting in a lower default probability.
In contrast, the second perspective considers corruption as “sanding the wheel”, in which firms in regions with higher
degrees of corruption may potentially bear adverse effects during business operations. As argued by La Porta et al. (2002)
3
and Sapienza (2004), agency problems are more likely to thrive in firms operating in a weak legal institutional environment,
where managers tend to engage in maximizing social welfare rather than returns. In the presence of high corruption, the
agency problem is likely to shift from traditional principal–agent conflict to principal–principal conflicts (Young et al., 2008).
In other words, managers in firms with serious agency problem seem to act in their own interests and in the interests of
government officials, resulting in high risks and harming the growth of enterprises (Wu, 2005). Anecdotal evidence shows
that corruption would decrease firm value (Borisov et al., 2015; Zeume, 2017), firm growth (Nguyen and van Dijk, 2012;
Qi and Ongena, 2019), and innovations (Ellis et al., 2019; Huang and Yuan, 2019). Indeed, Cao et al. (2019) document
that firms located in high corruption regions face higher future stock price crash risk because corruption makes managers
undertake value-destroying projects and keep lousy news, which will lead to accumulation of bad news. As the bad news
or bad performance accumulates and reaches tipping point, a large amount of negative firm-specific information comes
out, resulting in a crash. Furthermore, managers engaged in corruption tend to change from business motives to political
motives. In particular, Ellis et al. (2019) and Huang and Yuan (2019) show that the motivations for investment in research and
development (R&D) and innovation activities are lower than for those firm managers. Therefore, the efficiency of corporate
investment tends to be worse in terms of the long-term sustainability of productivity.
Regarding the capital structure, corruption induces greater uncertainty in the bank activity in corrupt regions, and banks
tend to reduce the loan sizes to bribing firms. As a result, firms in the corrupt regions face difficulties accessing credit, and
they face higher financial distress and impeded future firm growth (Chen et al., 2015). Qi and Ongena (2019) also report
that bribery practices are negatively associated with financing access, as demonstrated by higher losses in those firms.
Additionally, Faccio (2010) stressed that although firms with close political connections may pay lower taxes and have
stronger market power, it is not necessary that they have good accounting performance, such as good ROA for example. Bliss
and Gul (2012) use a large sample of Malaysian listed firms to test the effect of political connection on the cost of debt. They
find that politically connected firms are perceived as being higher financial fragility by the financial markets. Those firms
tend to have higher leverage, a higher probability of reporting a loss or negative equity, and a higher likelihood of being
audited by a big auditing firm. Notably, lenders (e.g., commercial banks) will charge a higher interest rate to those firms
to compensate for the higher risk in politically connected firms than in non-politically connected firms. This implies that
engaging in corruption practices would lead to more financial fragility for a given firm.
Based on the conflicted predictions of agency theory and the above-mentioned arguments, we propose a significant
link between corruption and corporate financial fragility but do not establish any direction for this relationship. The first
hypothesis is formulated as follows:
Hypothesis 1. Corruption is significantly associated with financial fragility of SMEs.
2.2. Moderating impacts of economic freedom and press freedom
Despite a rich body of research on the corruption-financial fragility nexus, there is a limited number of works on the
roles that market openness and institutional development play in the financial risk management of SMEs. Regarding eco-
nomic freedom, empirical studies document that an increase in a country’s level of economic freedom reduces corruption
levels. Saha et al. (2009) indicate that an increase in economic freedom leads to reduced corruption in any political envi-
ronment when it is regressed over the entire distribution of corruption. By expanding business transactions and promoting
entrepreneurship, an open and transparent environment encourages competition and facilitates access to providing effi-
cient financial intermediation between investors and entrepreneurs. In addition, a government with strong intervention in
financial markets may go beyond the assurance of transparency and may increase the costs of financing entrepreneurial
activity, which impedes firm performance (Lin et al., 2016). Thus, firms operating in a high corruption environment with less
openness to foreign competition tend to have lower financial performance and higher financial fragility. In addition, Chen
et al. (2015) show the importance of the interaction between corruption and economic freedom on bank stability using a
sample of 35 emerging countries, and the results document that the effect of corruption on bank risk-taking in high eco-
nomic freedom countries is higher than that in low economic freedom countries. As a result, different economic openness
conditions may be correlated, on average, with more adverse effects of low economic freedom on firm financial fragility.
In addition to various effects of corruption, past studies also provide evidence that press freedom is very crucial for
reducing corruption levels of nations (Dutta and Roy, 2016). It is rational to expect that a nation should be institutionally
strengthened to combat the same. The importance of free speech in enhancing economic development of a nation is being
increasingly stressed in the recent development and other interdisciplinary social science studies (e.g., Ross, 1999; Sen, 2001;
Stiglitz, 2002). Key in this regard is reducing paucity of information flows and keeping citizens rightfully informed about every
event going on around them. A free and independent press (devoid of government or private democratization stronghold)
plays important role in bringing about the desired accountability within a system which in turn increases transparency,
reduces information asymmetry and generates greater monitoring power (Dutta and Roy, 2016). This role enables a free
press to be a powerful tool against combating corruption, as has been reiterated by extant research (Brunetti and Weder,
2003; Chowdhury, 2004; Freille et al., 2007). More information does not necessarily translate to the ‘right’ decisions if the
populace does not have the desired human capital. But, having said that, it can be reasonably assumed that free flow of
information still adds to the transparency and monitoring capabilities of the society.
4
Interestingly, the use of voice and accountability indicator (i.e., freedom of expression, freedom of association, and a
free media)3 as a proxy for the role of the national governance quality in determining the firm financial performance has
become the subject of an important and ongoing debate in the literature on financial fragility (Nguyen et al., 2015; Doan
et al., 2020a). In particular, the integral role of press freedom has been explored in the context of several development out-
comes in solving principal-agent problems (Besley and Burgess, 2002; Stiglitz, 2002). Since corporate decisions or resource
allocations are affected by government extraction, where firms run their businesses, firms in countries that have better free
and independent press experience lower corporate financial fragility (Alfaro et al., 2019). Indeed, firm managers in countries
having anticorruption regulations with greater press freedom are aware that anticorruption investigations cost them both
time and energy, and there may even be penalties due to corruption (Thakur and Kannadhasan, 2019; Tran, 2019a). They
become more risk-averse in the form of lower corporate financial fragility to prevent anticorruption investigations by gov-
ernments. Thus, it is assumed that, compared with firms in countries with worse press freedom, firms in countries having
freer environment are expected to mitigate the negative effect of corruption on corporate financial fragility. Based on the
predictions of the arguments mentioned above, we propose our next hypothesis as follows:
Hypothesis 2a. The relationship between corruption and financial fragility of firms is significantly influenced by economic
freedom, and
Hypothesis 2b. The relationship between corruption and financial fragility of firms is significantly influenced by press
freedom.
3. Methodology
3.1. Measuring corruption
The main indicator of corruption that we employ is Transparency International’s Corruption Perceptions Index (the
TRANSPARENCY index, hereafter). The use of the TRANSPARENCY index is also appropriate in the context of this paper since
it takes into account financial corruption. This index has been widely used in recent studies on corruption.4 The aim of
the index is to provide a measure of the extent to which public sector bureaucrats and politicians engage in corruption
(Transparency International, 2011). The TRANSPARENCY index is scaled from 0 to 100 since 2012. A higher TRANSPARENCY
index indicates less perceived corruption in the host country. In line with Tran (2019a) and Chen et al. (2015), we rescale the
data to allow our panel data to consistently range from 0 to 10, and then reverse this index as 10 minus the TRANSPARENCY
index. We obtain a new index, named CORRUPT, ranging from 0 to 10. A higher value of CORRUPT denotes more rampant
corruption. The final outcome is calculated by the following:
CORRUPTj,t = 10 − TRANSPERANCEYj,t /10 (1)
In addition, to reduce the variations in the measurements among countries, we follow Chen et al. (2015) to construct
the adjusted corruption index (ADJ CORRUPT). We divide the CORRUPT index in country j in year t by the mean of CORRUPT
indices across all countries each year as follows:
CORRUPTj,t
ADJ CORRUPTj,t = N (2)

CORRUPTj,t /N
1
In robustness checks, we refer to the International Country Risk Guide (ICRG) produced by Political Risk Services and
define it as an alternative measure of corruption (ICRG).
3.2. Measuring firm financial fragility
We compute ZSCORE to measure firm financial fragility, which is frequently employed in prior works related to financial
fragility such as Fu et al. (2014); Alfaro et al. (2019), and Leung et al. (2019). Conceptually, ZSCORE measures the number
of standard deviations that a firm’s profit can decrease before it goes into bankruptcy. ZSCORE has a dominant ranking over
other accounting-based measures of risk since it includes the net income of firms. The computation method of ZSCORE is as
follows:
(ROAi,j,t + EAi,j,t )
ZSCOREi,j,t = (3)
(ROA)i,j,t
3
See Kaufmann et al. (2011) for a review.
4
Bahoo et al. (2019) review 137 research articles on corruption and find that most studies employed data on country-level corruption indexes using
TRANSPARENCY and ICRG.
5
where ROAi,j,t is the ratio of net income to total assets for firm i in country j in year t. EAi,j,t denotes the ratio of equity to
total assets. ROAi,j,t is the standard deviation of the return on assets for firm i in country j in year t. We employ a four-year
rolling time window period instead of the full sample period to estimate the standard deviation of the ROA because it allows
us to capture the time variation in the denominator of ZSCORE. In this way, ZSCORE is exclusively affected by the differences
in the firm level firm capital and profitability. Since ZSCORE is often highly skewed, as stated in the existing literature (e.g.,
Bhagat et al., 2015; Chen et al., 2015), we use the natural logarithm of (1+ ZSCORE) in the model specifications to reduce the
potentially high skewness. This approach is also similar to that of Houston et al. (2010) and Ashraf (2018). Therefore, a firm
with a higher ZSCORE has lower financial fragility. In contrast, a lower ZSCORE denotes a firm’s higher exposure to insolvency
risks.
3.3. Basic model
The basic model is as follows:

FinancialFragilityi,j,t = ˛ + ˇ1 Corruptionj,t + FirmControlsi,j,t
(4)
+ MacroControlsj,t + CountryDummiesj + YearDummiest + εi,j,t
where the dependent variable, Financial Fragilityi,j,t , is the ZSCORE that indicates the inverse probability of insolvency for
firm i country j in year t. Corruptionj,t captures the corruption level in a given country j in year t, and is defined by CORRUPT
and ADJ CORRUPT in the baseline results and ICRG in the robustness check.
Firm controlsi,j,t is the set of firm-level control variables, including SIZE, FIRM AGE, LEVERAGE, FIXED, TANGIBLE, CASH,
and SALES GROWTH. The usual control variables are SIZE, which is the natural logarithm of total assets; and FIRM AGE,
which is calculated as the natural logarithm of the number of years since incorporation. Because firms’ risk manage-
ment activities are affected by firm size and the firm operating process through their product line diversification, these
variables are popular in existing papers on firm risk-taking and performance (Nguyen, 2011; Doan et al., 2020c). Fur-
thermore, given that the leverage proportion plays a crucial role in firm-level risk (Huang and Wang, 2015; Gande and
Kalpathy, 2017), we add the LEVERAGE variable, which is measured by the sum of total debt in current liabilities and
total long-term debts, scaled by the total assets. In addition, since firms with higher fixed and tangible assets tend to
bear higher relative idiosyncratic risk (Nguyen, 2011), we include the FIXED variable, which is the sum of fixed assets
scaled by total assets; and the TANGIBLE variable, which is the ratio of tangible assets to total assets. Since the sales growth
and cash holdings behaviour of firms are likely to have direct impacts on risk performance, we also follow Faccio et al.
(2011) and Coles et al. (2006) and control for the effects of sales growth (SALES GROWTH, the percentage growth of sales
over a two year period) and cash holdings (CASH, the sum of cash and equivalents, scaled by total assets) on firm risk
taking.
Additionally, Macro controlsj,t includes two variables to control for the effects of macroeconomic development
on firm financial fragility, including INFLATION, which is gauged by the annual inflation rate (GDP deflator); and
GDP GROWTH, which is the growth rate of GDP. Finally, Country Dummies is a set of country dummy variables,
and Year Dummies is a set of time dummy variables, which are included to control for country- and time-fixed
effects.
Note that ˇ1 in Eq. (4) is used to gauge the effect of the degree of corruption on firm financial fragility. If higher corruption
leads to higher fragility (i.e., a lower ZSCORE), one would expect ˇ1 to be negative.
3.4. The influences of economic freedom and press freedom
To assess how economic freedom (Eq. 5) and press freedom (Eq. 6) affect the relationship between corruption and
firm-level financial fragility (Hypothesis 2), we consider the following model specifications:
FinancialFragilityi,j,t = ˛ + ˇ1 Corruptionj,t
+LESS ECOFREEj,t × (ϕ1 + ϕ2 × Corruptionj,t )

(5)
+ FirmControlsi,j,t + MacroControlsj,t
+CountryDummiesj + YearDummiest + εi,j,t

where subindexes i, j, and t refer to the firm, the country and the time, respectively. We include the interaction term of
LESS ECOFREE and Corruption as in Eq. (5). LESS ECOFREE is a dummy variable, which equals one for a country that has a
degree of economic freedom in year t that is lower than the median of the Economic Freedom index (Heritage Foundation,
2019) of the sample in that year. The distribution of the economic freedom index for each country is based on a value range
from 0 to 100, with 0 indicating the least free business environment.5 We also use a rich set of firm-level control variables
5
The Heritage Foundation’s Index annually evaluates the economic freedom of different countries based on four main policy categories: rule of law,
government size, regulation and efficiency, and open markets. In addition, business freedom is a dimension of the efficiency of regulations.
6
as in the baseline regression. All other variables are as defined in Eq. (4), and we continue to impose the sample restrictions
of country and year dummies used in the model specifications.
In Eq. (6), we also include the interaction terms of press freedom and corruption. We employ country-level data on
“Freedom of the Press” index, which are sourced from the Freedom House database.6 Each country is classified as the status
of Free, Partially Free, or Not Free.7 For each year, we define the dummy variable PRESS FREEDOM, which takes one for a
country if its status is Free. The regression model is as follows:
FinancialFragilityi,j,t = ˛ + ˇ1 Corruptionj,t
+PRESS FREEDOMj,t × (ϕ1 + ϕ2 × Corruptionj,t )

(6)
+ FirmControlsi,j,t + MacroControlsj,t
Notably, the coefficients of the interaction terms will explain whether LESS ECOFREE or PRESS FREEDOM along with
the level of corruption enhance or impede financial fragility. In other words, ϕ2 in Eq. (5) indicates the difference in the
corruption effects between countries with high and low economic freedom, while ϕ2 in Eq. (6) demonstrates the difference
in the corruption effects between countries with press freedom and without press freedom. If less economic freedom can
exacerbate the drawback effect of corruption on firm financial fragility and a better press freedom can counteract the
adverse effects of corruption, we expect the interaction terms of LESS ECOFREE*Corruption and PRESS FREEDOM*Corruption
to be negative and positive, respectively.
To control for the possible endogeneity bias, we estimate all specifications using the two-step system generalized method
of moments (GMM) estimator. Blundell and Bond (1998) developed this estimation method from the original difference GMM
model of Arellano and Bover (1995) using lagged dependent variables. As suggested by Wintoki et al. (2012), we use a lagged
dependent variable as an explanatory variable, which allows corporate finance empiricists to control for potential dynamic
panel bias. In addition, we use the two-step GMM with error correction, which provides more asymptotically efficient
estimates than the one-step ones. Following the literature on this kind of model by Arellano and Bover (1995), there are two
specification tests to ensure the model requirements. First, we test the overall validity of the instruments (over-identifying
restrictions) using the Hansen J test. If we cannot reject the null hypothesis, it indicates that the instrument set is valid –
as in our cases. In addition, we ensure that there is no second-order autocorrelation in the residuals from the equations
according to the p-value of the AR (2) test.
4. Data
4.1. Data sources
We start collecting SMEs’ accounting data for the period from 2012 to 2018 in 80 countries using the Orbis database
developed by Bureau van Dijk. Unconsolidated data were selected, but we chose consolidated data in case these were not
available. By starting with the year 2012, we can exclude the effect of the financial crisis on firm financial fragility as well
as for consistence in using TRANSPARENCY index. We adopt the definition of small and medium-sized firms from the World
Bank, which classifies SMEs as firms that have either less than 300 employees or maximum total assets (annual sales) of 15
million dollars in a given year.
The initial sample includes 502,456 firm-year observations of SMEs in 80 countries. We then proceed to form the final
data set as follows: (1) we start by excluding firms in financial and utility industries (firm level SIC codes 6000–6999 and
4900–4999), (2) we drop firms that have available data for fewer than four years, and (3) we exclude firms that have negative
assets or sales. We then drop the firm-year observations with missing values. To minimize the effects of measurement error,
we also delete outliers by winsorizing all continuous financial variables at a 1 % level for both sides.8 Following these steps,
our final sample for the baseline regression is an unbalanced panel that includes 98,890 firm-year observations (25,754
SMEs) in 62 countries from 2012 to 2018.9
In addition, we combine various sources to measure corruption variables. We employ the data from Transparency Inter-
national’s Corruption Perception Index for the main regression and the corruption index from The International Country
Risk Guide (ICRG) database for the robustness checks. In the conditional tests, we employ the Economic Freedom score from
the Heritage Foundation and Press Freedom index from the Freedom House.
6
Freedom House has developed the index to rank media freedom country by country. Its survey has 23 methodology questions that are divided into
three subcategories, i.e., legal, political, and economic environments.
7
The internet source of Freedom of the Press index is https://freedomhouse.org/reports/publication-archives.
8
The result is quantitatively similar when we winsorize our data at the 97.5% or 95% levels.
9
Since the data are not available for all the countries for the entire sample period, we therefore construct unbalanced panel data sets for both the
developing and developed countries.
7
Table 1
Corruption and firm financial fragility for the years 2012 –2018. Panels A and B show the summary statistics of the corruption variable, firm-level financial
fragility by country for developing and developed countries, respectively. Panel C shows the results of the tests of the difference in means between the
subsamples of developed countries and developing countries. The economic development classification is in the line with the IMF’s World Economic Outlook
Reports (International Monetary Fund, 2020). The definitions of the variables are provided in Appendix A.
Panel A – Developing Countries Panel B – Developed Countries
Countries N ZSCORE CORRUPT ADJ CORRUPT ICRG Countries N ZSCORE CORRUPT ADJ CORRUPT ICRG
China 24,440 3.019 6.061 1.050 4.000 Japan 13,263 4.097 2.617 0.450 1.500
Thailand 6,125 3.424 4.529 0.780 3.000 Italy 6,824 4.028 5.418 0.931 3.430
Vietnam 5,946 3.355 5.278 0.911 3.256 France 5,953 3.782 2.991 0.514 1.688
Romania 623 3.478 5.374 0.926 3.619 Germany 4,970 3.634 2.005 0.344 1.000
India 586 3.336 6.123 1.054 3.500 Spain 3,540 3.789 4.094 0.704 2.304
Indonesia 566 3.207 6.431 1.110 3.000 Sweden 2,728 3.183 1.301 0.225 0.517
Israel 509 3.055 3.860 0.665 2.500 Belgium 2,589 3.862 2.420 0.417 1.309
Malaysia 495 3.338 5.090 0.877 3.500 United States 2,121 2.503 2.630 0.454 1.760
Turkey 479 2.887 5.665 0.976 3.560 Poland 2,112 3.429 3.923 0.677 2.706
Serbia 372 3.598 5.957 1.033 4.000 Netherlands 1,677 3.546 1.696 0.292 1.000
Pakistan 304 2.991 6.912 1.194 4.000 United Kingdom 1,391 2.785 2.064 0.356 1.179
Ukraine 290 2.850 7.092 1.227 4.274 Norway 994 3.313 1.441 0.248 0.518
Russia 246 2.765 1.523 0.263 1.417 Austria 920 3.459 2.661 0.458 1.500
Jordan 244 3.300 5.123 0.883 3.145 Finland 916 3.336 1.203 0.208 0.484
Philippines 227 3.217 6.459 1.116 3.597 Czech Republic 858 3.777 4.641 0.798 3.196
Brazil 188 3.357 6.190 1.078 3.995 Portugal 803 3.854 3.702 0.637 2.165
Bangladesh 159 3.597 7.382 1.274 3.086 Greece 701 3.493 5.667 0.974 3.703
Nigeria 155 3.011 7.317 1.264 4.500 Denmark 612 3.458 1.111 0.194 0.536
Estonia 130 3.866 3.048 0.524 2.199 Hungary 553 3.545 5.006 0.862 3.000
Myanmar 128 2.989 2.398 0.413 1.858 Slovakia 467 3.686 5.027 0.866 3.149
Oman 125 3.245 5.346 0.921 3.166 Bulgaria 362 3.467 5.821 1.002 3.477
Saudi Arabia 107 3.310 5.202 0.896 3.191 Australia 317 2.626 1.995 0.344 1.462
Kuwait 96 3.704 5.684 0.978 3.248 Slovenia 216 4.068 4.031 0.692 2.518
Nepal 87 3.063 4.014 0.692 2.077 Lithuania 182 3.514 4.192 0.722 2.899
South Africa 72 2.933 5.658 0.975 3.500 Luxembourg 166 3.658 1.823 0.314 1.000
Colombia 66 3.385 6.326 1.087 3.490 Croatia 155 3.375 5.139 0.887 3.267
Iraq 62 2.729 8.294 1.431 4.992 Latvia 132 3.649 4.405 0.760 3.065
Mexico 57 3.519 7.047 1.226 4.469 Switzerland 109 3.666 1.439 0.247 1.020
Chile 55 3.591 3.135 0.543 1.597 Iceland 79 3.380 2.210 0.382 1.004
Bahrain 46 2.865 4.417 0.766 2.500 New Zealand 70 3.124 1.024 0.177 0.500
Canada 46 2.254 1.811 0.313 1.000
Ireland 36 3.114 2.722 0.469 1.744
Mean 43,028 3.153 5.617 0.971 3.645 Mean 55,862 3.711 3.073 0.529 1.810
Median 43,028 3.101 6.000 1.036 4.000 Median 55,862 3.717 2.700 0.474 1.500
Panel C —Means by country characteristics (the t-statistics in italics are for the differences in means)
ZSCORE CORRUPT ADJ CORRUPT ICRG
Developing countries 3.153 5.617 0.971 3.645

Developed countries 3.711 3.073 0.529 1.810
Difference −0.558*** 2.544*** 0.442*** 1.835***
P-value <0.000 <0.000 <0.000 <0.000
Notes: ***, **, and * indicate significance at the 1 %, 5 %, and 10 % levels, respectively.
4.2. Descriptive statistics
Regarding the financial fragility variable, Table 1 reports the values of ZSCORE by country, while Table 2 shows the
descriptive statistics of ZSCORE for the full sample. Specifically, the mean value of ZSCORE is 3.468 for the full sample
over the period from 2012 to 2018 with a standard deviation of 1.044. As reported in Panels A and B of Table 1, the
average ZSCORE in developed countries is higher than that in developing countries (3.711 and 3.153, respectively), which
implies that firms in developing countries tend to be risker than firms in developed countries. In addition, our descriptive
statistics show that Japanese firms have the highest financial stability on average, whereas firms in Iraq have the highest
fragility. Further analysis from Panel C of Table 1 also reports that the difference in ZSCORE between two country groups
is statistically significant, suggesting a reasonably high cross-sectional variation in ZSCORE among countries around the
world.
Table 1 also reports the country-by-country summary statistics for the key variables of the corruption measurement (i.e.,
CORRUPT, ADJ CORRUPT, and ICRG) across 62 countries, including developed and developing countries. It appears that, on
average, the corruption level in developing countries is more severe than that in developed countries. More specifically,
Panel B reports that the average CORRUPT in developed countries (3.073) is lower than that in developing countries (5.617)
and the difference is statistically significant at the 1 % level. We find that the top three countries with the most rampant
8
Table 2
Descriptive statistics of variables. This table shows a summary statistic of all variables. It includes 98,890 firm-year observations (25,754 SMEs) in 62
countries, covering the period from 2012 to 2018. The definitions of the variables are provided in Appendix A.
Panel A. Sample distribution by year
Year N Year N Year N
2012 9,786 2015 14,983 2018 16,419

2013 10,887 2016 16,827
2014 12,553 2017 17,435
Panel B. Sample distribution by industry
Industry 2-digit SIC N Industry 2-digit SIC N
Agriculture & Mineral industries 01-14 1,359 Wholesale trade 50-51 25,459
Construction 15-17 4,667 Retail trade 52-59 4,457
Manufacturing 20-39 42,680 Service >=70 15,001
Transportation 40-48 5,267
Panel C. Summary statistics
VARIABLE N MEAN SD P25 P50 P75
Corruption variables
CORRUPT 98,890 4.180 1.712 2.600 4.200 5.900
ADJ CORRUPT 98,890 0.721 0.297 0.448 0.724 1.034
ICRG 98,890 2.608 1.187 1.500 3.000 4.000
Financial fragility variable
ZSCORE 98,890 3.468 1.044 2.761 3.444 4.165
Firm controls
SIZE 98,890 3.935 1.192 3.256 4.007 4.703
FIRM AGE 98,890 3.804 0.933 3.045 3.951 4.718
LEVERAGE 98,890 0.151 0.172 0.000 0.088 0.257
FIXED 98,890 0.327 0.234 0.131 0.294 0.488
TANGIBLE 98,890 0.196 0.192 0.032 0.139 0.310
CASH 98,890 0.129 0.146 0.019 0.077 0.190
SALES GROWTH 98,890 0.088 0.337 −0.079 0.041 0.193
Country controls
INFLATION 98,890 0.034 0.045 0.005 0.027 0.078
GDP GROWTH 98,890 0.018 0.022 0.007 0.014 0.023
POLICY UNCERTAINTY 75,270 184.6 94.70 27.00 146.5 542.8
Other variables
TOBIN Q 70,150 1.885 2.457 1.039 1.538 2.311
CAPEX 70,150 0.061 0.047 0.012 0.035 0.082
ROA (%) 70,150 5.510 9.384 0 4.718 9.824
LESS ECOFREE 98,890 0.484 0.499 0 0 1
PRESS FREEDOM 98,890 0.511 0.491 0 0 1
corruption are Iraq, Bangladesh, and Nigeria. Meanwhile, New Zealand, Denmark and Sweden are countries with the lowest
corruption levels. These statistics are still similar to the mean values of ADJ CORRUPT and ICRG. The descriptive statistics
also exhibit that the national governance quality in developed countries is better than that in developing countries, which
is consistent with current empirical works in the economic and public administration literature (Chen et al., 2015; Debski
et al., 2018; Thakur and Kannadhasan, 2019; Tran, 2019a).
Panel A and B of Table 2 present the sample distribution by year and industry, respectively. Number of observations
increase year-by-year from 2012 to 2018. Most firms in our sample are in manufacturing sectors. The rest of Table 2
reports the descriptive statistics of the control variables used in all regressions. The mean SIZE for the whole sample is
approximately 3.935, while the mean and the standard deviation of FIRM AGE are 3.804 and 0.933, respectively. Firms
in our sample have a leverage ratio of approximately 15.1 % and they hold approximately 12.9 % in cash for business
activities. The growth rate of sales is approximately 9 % per year. Regarding the country-level variables, the mean annual
inflation rate is 3.4 %, which is calculated using the GDP deflator. In addition, the countries’ average GDP growth is 1.8
% per year.
Next, Table 3 reports the pairwise correlations among all variables in our main regression. The correlation between
corruption (CORRUPT) and financial fragility (ZSCORE) is negative and significant at the 1 % level, which is consistent with
existing studies such as Chen et al. (2015). This implies that corruption is negatively associated with the stability of firms.
More importantly, the correlations between independent variables are lower than 0.59, thus suggesting that the perfect
collinearity problem is not a significant concern in our study.
9
Table 3
Correlation coefficient matrix. This table provides the correlation coefficient matrix of the main independent variables. The sample includes 98,890 firm-year
observations (25,754 SMEs) over the period from 2012 - 2018. The definitions of the variables are provided in Appendix A.
Variables (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)
(1) ZSCORE 1.000

(2) CORRUPT −0.158*** 1.000
(3) SIZE 0.298*** −0.227*** 1.000
(4) FIRM AGE −0.177*** 0.161*** −0.286*** 1.000
(5) LEVERAGE 0.090*** 0.003 0.102*** 0.021*** 1.000
(6) FIXED −0.037*** −0.005 0.146*** 0.112*** 0.234*** 1.000
(7) TANGIBLE 0.035*** 0.069*** 0.062*** 0.073*** 0.275*** 0.588*** 1.000
(8) CASH −0.109*** −0.063*** −0.099*** 0.157*** −0.217*** −0.209*** −0.206*** 1.000
(9) SALES GROWTH −0.054*** 0.091*** −0.033*** −0.009*** −0.020*** −0.047*** −0.039*** 0.025*** 1.000
(10) INFLATION −0.243*** 0.546*** −0.197*** 0.207*** −0.077*** 0.010*** 0.033*** 0.066*** 0.084*** 1.000
(11) GDP GROWTH −0.153*** 0.247*** −0.138*** 0.210*** −0.009*** 0.047*** 0.049*** 0.020*** 0.050*** 0.316*** 1.000
Notes: ***, **, and * indicate significance at the 1 %, 5 %, and 10 % levels, respectively.
Table 4
Corruption and financial fragility. This table reports the results of the impact of corruption on firm financial fragility, as estimated by the GMM. Models
(1) through (6) report the basic regression results for each subsample (i.e., full sample, developing countries, and developed countries). ZSCORE is the
dependent variable for all specifications. The definitions of the variables are provided in Appendix A.
Dependent variable: ZSCORE

Independent
Variables Full Developing Developed
(1) (2) (3) (4) (5) (6)
ZSCOREt -1 0.953*** 0.959*** 0.631*** 0.631*** 0.890*** 0.890***

(7.108) (7.190) (3.753) (3.767) (9.868) (9.708)
CORRUPT −0.095*** −0.078** −0.075
(-3.177) (-2.337) (-0.869)
ADJ CORRUPT −0.552*** −0.445** −0.444
(-3.198) (-2.326) (-0.870)
SIZE −0.063 −0.063 0.110 0.110 0.397 0.399
(-0.806) (-0.811) (1.518) (1.519) (0.881) (0.877)
FIRM AGE 0.199 0.198 0.034 0.032 0.336 0.334
(1.204) (1.203) (0.314) (0.297) (0.418) (0.412)
LEVERAGE 2.610* 2.643* −3.649*** −3.628*** 2.467 2.511
(1.861) (1.869) (-2.613) (-2.604) (0.815) (0.813)
FIXED −4.697*** −4.702*** −2.272** −2.250** 2.840 2.913
(-2.872) (-2.894) (-2.517) (-2.510) (0.706) (0.710)
TANGIBLE 6.664*** 6.685*** 2.464*** 2.443*** 2.186 2.193
(2.984) (3.003) (2.800) (2.792) (0.343) (0.339)
CASH 0.513 0.526 −1.386** −1.375** −6.454 −6.543
(1.210) (1.228) (-2.572) (-2.560) (-1.024) (-1.022)
SALES GROWTH 0.111*** 0.112*** 0.102*** 0.103*** 1.145 1.137
(3.741) (3.757) (3.732) (3.748) (1.201) (1.182)
INFLATION 0.152 0.196 −2.237** −2.216** 5.979** 6.031**
(0.228) (0.295) (-2.296) (-2.285) (2.465) (2.447)
GDP GROWTH −1.421* −1.367* 3.210* 3.209* −2.730 −2.741
(-1.755) (-1.716) (1.730) (1.737) (-0.632) (-0.627)
CONSTANT −0.309 −0.168 0.000 2.061** 0.000 −3.198
(-0.330) (-0.174) (0.767) (2.347) (0.987) (-1.116)
Country fixed effects YES YES YES YES YES YES
Year fixed effects YES YES YES YES YES YES
p-value for AR (2) test 0.440 0.447 0.404 0.409 0.161 0.161
p-value for Hansen Test 0.387 0.308 0.388 0.385 0.260 0.280
N 98,890 98,890 43,028 43,028 55,862 55,862
p-value (F-test of equal 0.02 0.00
coefficient estimates on
corruption between developing
and developed countries)
Notes: The values of the t-statistics are in parentheses. ***, **, and * indicate significance at the 1 %, 5 %, and 10 % levels, respectively.
5. Empirical results
5.1. Baseline results
Table 4 presents the results of our estimations to test Hypothesis 1. Models (1) and (2) show the results of Eq. (4) for the
full sample, while models (3) and (4) present the developing country subsample’s results. Two last columns (models 5 and 6)
10
report the results for developed countries. In each group, we regress two specifications separately for two corruption mea-
sures, namely, CORRUPT and ADJ CORRUPT, to avoid the potential problem of collinearity. We also include control variables
that may affect firm-level financial fragility. The coefficients of corruption, CORRUPT and ADJ CORRUPT, are negative and
significant in two first columns for the full sample, showing that a higher level of corruption leads to lower financial stability
for the SMEs around the world. When we look at the effects across countries, we find that there is a significant difference in
the effect of corruption on the financial fragility of SMEs for developing and developed countries (p-value of F test = 0.02).
Specifically, in developing countries, we find evidence that increased corruption in terms of CORRUPT and ADJ CORRUPT
tends to reduce ZSCORE (statistically significant at the 5 % level), while the relationship is insignificant for the subsample of
developed countries. In other words, firms in developing countries bear the higher risk from increased corruption from their
governments relative to developed countries. As shown in models (1) and (2), the coefficients on CORRUPT and ADJ CORRUPT
are -0.095 and -0.552, respectively. In terms of economic significance, an increase of one standard deviation in CORRUPT
(ADJ CORRUPT) leads to a decrease of 4.7 % in ZSCORE of its sample mean. Turning to developing subsample, as given in model
(3) of Table 4, the coefficients range from -0.078 to -0.445, which are equivalent to a decrease by 2.1 %–2.4 % of ZSCORE’s
sample mean in response to an increase o
Our results for developing countries support our first hypothesis: corruption is positively associated with the financial
fragility of SMEs. The finding is also consistent with the “sand the wheel” effect of corruption, which was confirmed in prior
studies (Borisov et al., 2015; Chen et al., 2015; Kong et al., 2017; Cao et al., 2019). It would be possible to apply the same line
of reasoning of both Chen et al. (2018) and Cao et al. (2019). They document that firms’ managers located in regions with high
local corruption (China, in particular) tend to hide bad news and undertake value-destroying projects for an extended period.
This would lead to accumulated bad performance, and when it reaches an upper point, the crash risk will result. In the same
vein, Borisov et al. (2015) indicate that when the amount of lobbying money for politicians increases, firms are more likely
to engage in unethical behaviours (i.e., accounting fraud and earnings management). As a result, these firms can experience
significant value losses in the long-run. Surprisingly, we find that the effect of corruption on financial fragility is insignificant
for developed countries, although it is still negative. This implies that the operational stability of SMEs in developed countries
is not affected by corruption shocks from the governance quality. Ramirez (2014) indicates that corruption is a “life-cycle”
concept in the development process. It appears to rise in the early stages of development and declines after modernization
has taken place. It is clear that during the sample period span from 2012 to 2018, developed countries is typically featured by
a higher institutional environment, high economic development. Hence, the effect of corruption on financial fragility should
differ between developed countries and developing countries.
We now briefly describe the set of control variables in Table 4. The LEVERAGE variable is significantly and negatively
correlated with ZSCORE in the subsample of developing countries. This finding is consistent with the view that highly levered
firms tend to expropriate their creditors, resulting in higher risk (Boubakri et al., 2013; Tran, 2019b). In contrast, the tangible
assets (TANGIBLE) of SMEs are negatively associated with firm risks, which is in line with the prior findings of Vural-Yavaş
(2020). Consistent with Faccio et al. (2011), our estimated coefficient for cash holdings (CASH) is negatively correlated with
ZSCORE only in the developing countries sample, indicating that firms that hold more cash tend to have higher financial
fragility (but this is not statistically significant for developed countries). Furthermore, we find evidence that sales growth
(SALES GROWTH) is negatively associated with the financial risks of firms, as confirmed by previous findings (Boubakri et al.,
2013; Gupta and Krishnamurti, 2018). Since other control variables exhibit insignificant effects (e.g., SIZE and FIRM AGE) or
mixed signs (e.g., FIXED, INFLATION, and GDP GROWRH), we thus have weak evidence corresponding to their effects on firm
financial fragility in this study.
5.2. Endogeneity concerns
5.2.1. Firm fixed-effects regression

Another estimation issue arises because our empirical results could be potentially biased if the presence of omitted
variables influences both corruption and financial fragility. While we address this issue above by using the GMM estimator,
in this section we further minimize potential endogeneity concerns by conducting a fixed-effects estimation for our model
specifications. This approach allows us to deal with time-invariant unobservable factors in which heteroskedasticity robust
standard errors are clustered at the firm level. The estimated results of the fixed-effects method are presented in Table 5.
The results are in line with our prior finding in which the corruption variables are still negatively associated with ZSCORE
in the full sample and the subsample of developing countries. As shown in models (1) and (2) of Table 5, the coefficients
on CORRUPT and ADJ CORRUPT for the developing sample are -0.002 (t-statistic = -4.111) and -0.354 (t-statistic = -2.789).
In contrast, these coefficients are both statistically insignificant for developed countries (models 5 and 6). The consistent
findings between GMM and firm fixed-effects models thus imply that endogeneity from omitted variables may not serve a
significant concern in our regression.
5.2.2. Two-stage least squares approach

We further consider the endogeneity issue for corruption. For example, the analysis of corruption in the previous section
ignores the fact that corrupt managers are not randomly governed by the firm’s accounting information. In other words,
using the standard deviation of the return on assets to measure ZSCORE, this could be endogenously problematic in a
corrupt environment where more corrupt managers engage in more income diversion activities (Mironov, 2015). To address
11
Table 5
Endogeneity addressing: Firm fixed-effects. This table reports the results of the impact of corruption on firm financial fragility, as estimated by the firm
fixed-effects model. Models (1) through (6) report the basic regression results for each subsample (i.e., full sample, developing countries, and developed
countries). ZSCORE is the dependent variable for all specifications. Standard errors are robust and clustered at the firm level. The definitions of the variables
are provided in Appendix A.

Independent
Variables Full Developing Developed
(1) (2) (3) (4) (5) (6)
CORRUPT −0.041*** −0.002*** −0.007

(-12.294) (-4.111) (-0.490)
ADJ CORRUPT −0.256*** −0.354*** 0.046
(-13.417) (-2.789) (0.612)
SIZE 0.229*** 0.229*** 0.120*** 0.120*** 0.196*** 0.195***
(55.255) (55.388) (9.587) (9.620) (16.309) (16.146)
FIRM AGE 0.073*** 0.071*** 0.326*** 0.335*** 0.150*** 0.153***
(12.513) (12.141) (6.973) (7.157) (4.768) (4.904)
LEVERAGE −0.001 −0.002 −0.459*** −0.455*** −0.182*** −0.181***
(-0.038) (-0.098) (-10.359) (-10.289) (-4.416) (-4.398)
FIXED −0.463*** −0.465*** −0.039 −0.042 0.154*** 0.155***
(-19.317) (-19.401) (-0.874) (-0.930) (3.023) (3.041)
TANGIBLE 0.443*** 0.444*** 0.105* 0.105* 0.219*** 0.220***
(14.589) (14.632) (1.725) (1.727) (3.122) (3.144)
CASH −0.240*** −0.243*** 0.187*** 0.181*** 0.050 0.051
(-9.454) (-9.584) (4.290) (4.129) (1.063) (1.082)
SALES GROWTH −0.000 0.001 0.068*** 0.067*** −0.038*** −0.038***
(-0.047) (0.173) (7.859) (7.778) (-3.556) (-3.596)
INFLATION 0.562*** 0.570*** 1.033*** 1.029*** 0.451*** 0.454***
(7.561) (7.745) (5.823) (5.906) (4.956) (4.979)
GDP GROWTH −1.624*** −1.552*** −1.020*** −0.945*** 0.086 0.099
(-12.714) (-12.113) (-6.509) (-5.964) (0.267) (0.308)
CONSTANT 3.121*** 3.127*** 1.388*** 1.681*** 2.384*** 2.332***
(92.595) (93.549) (6.194) (7.764) (19.110) (19.369)
Firm fixed effects YES YES YES YES YES YES
R-squared 0.025 0.025 0.014 0.014 0.009 0.009
N 98,890 98,890 43,028 43,028 55,862 55,862
corruption between
developing and developed
countries)
this concern, we conduct a Two-Stage-Least Squares (2SLS) regression approach, using instrumental variables (IVs) for
endogenous regressor of interest (CORRUPT or ADJ CORRUPT). Following Gründler and Potrafke (2019), we employ jack-knifed
regional averages of corruption index as instrumental variables for national corruption levels. We named it “COR NEIBOR”. We
also base on Gründler and Krieger (2016) to divide each country into four homogenous regions. The idea is that countries in
the region are more likely to follow their neighbours, indicating that corruption in an individual country positively correlated
with corruption in neighbouring countries. By this setting, an instrument should not directly affect the financial fragility of
a firm in the country, thereby do not violate the rule of choosing instrument variables.
Panel A of Table 6 reports the estimated results of the IV model regression for first-stage. Specifically, we regress each
corruption index (CORRUPT, ADJ CORRUPT) on the instrumental variable (COR NEIBOR) and all other control variables as in
the baseline equation.10 Standard error is clustered by country level. As shown in Table 6, the coefficient on COR NEIBOR is
positive and significant at the 1 %–5 % level, indicating that corruption in a country appears to be positively correlated with
corruption in neighbouring countries. In addition, the results of Cragg and Donald (1993)’s F-statistic of the regression range
from 21.02–92.29, which is much higher than the approximate cut-off of 10 as suggested by Wooldridge (2016), indicating
a strong instrument in this case.
Turning to the second stage, we regress ZSCORE against fitted values of the first stage and other control variables. We
observe consistent findings with the previous results in Table 4. Specifically, the coefficient on CORRUPT (as instrumented)
is negative and significant only for the full sample (beta = -0.082, t-statistic = -3.128) and the subsample of developing
countries (beta = -0.097, t-statistic = -2.123). Although we observe the negative association between corruption and firm
financial fragility in developed countries, this relationship is insignificant. The result is quantitatively similar when we
10
We thank the anonymous reviewers for this suggestion. For the brevity, we do not tabulate in the table, the estimated results are available upon request.
12
Table 6
Endogeneity addressing: 2SLS Approach. This table reports the first and second-stage regression results of the impact of corruption on firm financial
fragility, estimated by 2SLS regression. In the first stage (Panel A), we regress corruption index (CORRUPT, ADJ CORRUPT) on instrumental variable, which is
employed jack-knifed regional levels of corruption (COR NEIBOR) as suggested in Gründler and Potrafke (2019). We include a set of control variables as in
Table 4, but we do not show the estimated coefficient to save the space. Panel B shows the results of second-stage regression, where dependent variable is
ZSCORE for all specifications. In each panel, models (1) through (6) report the basic regression results for each subsample (e.g., full, developing, developed
countries). Standard errors are robust and clustered at the country level. The definitions of the variables are provided in Appendix A.
Panel A.– First stage regression results
Dependent variable
Independent
CORRUPT ADJ CORRUPT ADJ CORRUPT ADJ
variables
CORRUPT CORRUPT CORRUPT
Full Developing Developed
(1) (2) (3) (4) (5) (6)
COR NEIBOR 0.036*** 0.017*** 0.108*** 0.077*** 0.094** 0.027**

(4.812) (3.183) (3.272) (4.954) (2.005) (2.251)
Control variables YES YES YES YES YES YES
Country Fixed effects YES YES YES YES YES YES
Year Fixed effects YES YES YES YES YES YES
R-squared 0.234 0.202 0.151 0.149 0.278 0.297
Cragg-Donald F statistic 21.02 89.12 39.51 63.11 45.72 92.29
LM statistic 18.17*** 88.87*** 34.05*** 56.78*** 37.03*** 90.57***
N 98,890 98,890 43,028 43,028 55,862 55,862
Panel B. Second stage regressions results

Independent
variables Full Developing Developed
(1) (2) (3) (4) (5) (6)
CORRUPT (IV) −0.082*** −0.097** −0.012

(-3.128) (-2.123) (-0.327)
ADJ CORRUPT (IV) −0.412** −0.507*** −0.119
(-2.181) (-2.675) (-0.928)
SIZE 0.188*** 0.189*** 0.170*** 0.200*** 0.177*** 0.176***
(10.834) (10.818) (8.242) (10.322) (9.962) (9.862)
FIRM AGE −0.102*** −0.105*** −0.169*** −0.104** −0.069*** −0.072***
(-3.993) (-3.697) (-4.155) (-2.637) (-2.794) (-2.951)
LEVERAGE 0.041 0.045 −0.481 −0.185 0.244 0.242
(0.327) (0.357) (-0.080) (-1.277) (1.333) (1.311)
FIXED −0.531*** −0.531*** −0.034 −0.066 −0.841*** −0.846***
(-3.897) (-3.898) (-0.036) (-0.279) (-10.933) (-10.874)
TANGIBLE 0.488*** 0.489*** 0.229*** 0.157** 0.671*** 0.676***
(4.793) (4.802) (3.182) (1.996) (7.107) (7.057)
CASH −0.544** −0.542** −0.373* −0.208** −0.793*** −0.802***
(-2.447) (-2.391) (-1.798) (-1.982) (-4.045) (-3.972)
SALES GROWTH −0.051 −0.056 0.013 −0.007* −0.154*** −0.149***
(-0.985) (-1.211) (0.262) (-1.756) (-3.137) (-3.440)
INFLATION 0.060 0.287 −28.401 0.856 −0.287 0.098
(0.113) (0.901) (-0.040) (0.826) (-1.144) (0.472)
GDP GROWTH −0.494 −0.808 −9.685 1.142 2.172** 2.053*
(-0.732) (-0.878) (-0.043) (0.204) (2.120) (1.825)
CONSTANT 1.583** 2.128*** 1.098*** 1.827*** 1.832*** 0.976***
(2.286) (10.102) (5.211) (7.823) (10.718) (8.548)
R-squared 0.234 0.236 0.112 0.075 0.214 0.213
N 98,890 98,890 43,028 43,028 55,862 55,862
corruption between
developing and developed
countries)
13
Table 7
Interaction of corruption and economic freedom. This table reports the effects of corruption and firm financial fragility conditional on the degree of economic
freedom, as estimated by the GMM. Models (1) through (6) report the basic regression results for each subsample (i.e., full sample, developing countries,
and developed countries) that include ZSCORE as the dependent variable. The definitions of the variables are provided in Appendix A.

Independent
(1) (2) (3) (4) (5) (6)
ZSCOREt -1 1.591*** 1.580*** 0.885*** 1.570*** 0.620*** 0.620***

(22.952) (22.756) (3.704) (30.889) (14.717) (14.868)
LESS ECOFREE 3.714*** 3.565*** 2.446 5.469** 1.165 1.124
(2.994) (2.924) (0.843) (1.978) (1.034) (1.114)
CORRUPT 0.865*** 0.922** 0.208
(3.609) (2.162) (1.329)
ADJ CORRUPT 4.550*** 2.618* 1.265
(3.559) (1.781) (1.365)
CORRUPT * LESS ECOFREE −1.056*** −0.863** −0.292***
(-3.369) (-2.429) (-2.854)
ADJ CORRUPT * LESS ECOFREE −5.798*** −5.903* −1.684***
(-3.335) (-1.935) (-2.916)
SIZE −0.081 −0.085 0.259** 0.148 0.349* 0.345*
(-0.512) (-0.543) (2.470) (0.996) (1.796) (1.790)
FIRM AGE −0.191 −0.117 0.580*** 0.320 0.082 0.078
(-0.808) (-0.491) (2.859) (1.194) (0.258) (0.252)
LEVERAGE −1.562 −0.857 −4.083*** 0.533 0.125 0.133
(-0.741) (-0.427) (-3.153) (0.540) (0.271) (0.296)
FIXED 6.815** 6.242** −3.697** 1.467 0.117 0.135
(2.444) (2.248) (-2.262) (1.034) (0.076) (0.090)
TANGIBLE −9.580** −8.914* 3.332** −0.234 −0.605 −0.654
(-2.083) (-1.953) (2.340) (-0.080) (-0.207) (-0.230)
CASH 1.246 0.832 −2.820*** 0.635 −0.191 −0.197
(0.871) (0.622) (-3.049) (0.410) (-0.356) (-0.368)
SALES GROWTH 0.154*** 0.160*** 0.085*** 0.220*** −0.043 −0.042
(5.099) (5.433) (2.671) (8.655) (-1.411) (-1.418)
INFLATION 1.389 2.241 6.624* 2.678 2.127 2.504
(0.686) (1.051) (1.698) (0.440) (1.216) (1.406)
GDP GROWTH −5.599 −5.347 −3.787*** −6.270 0.099 0.049
(-1.208) (-1.208) (-2.753) (-1.506) (0.022) (0.011)
CONSTANT −0.848*** −0.868** 0.000 0.000 −0.933 0.000
(-2.985) (-2.170) (0.718) (0.484) (-1.714) (1.060)
N 98,890 98,890 43,028 43,028 55,862 55,862
replicate our analysis using ADJ CORRUPT. In sum, after controlling for the endogeneity problem with firm fixed effects and
2SLS approaches, we document that corruption significantly increases the financial fragility of firms, especially in developing
countries.
5.3. The roles of economic freedom and press freedom
We further examine the influences of economic freedom (Hypothesis 2a) and press freedom (Hypothesis 2b) on the rela-
tionship between corruption and firm financial fragility. We add the interaction terms between corruption and less economic
freedom (CORRUPT*LESS ECOFREE or ADJ CORRUPT*LESS ECOFREE) and include the same set of control variables for all the
regressions, as in the baseline specification of Eq. (5). Consistent with our expectations, we find that all coefficients of the
interaction terms in Table 7 are negative and statistically significant at least at the 5 % level. This implies that, compared
with firms in high economic freedom countries, firms in less economic freedom countries bear a higher level of corporate
financial fragility. Our findings are consistent with Chen et al. (2015) who document that the corruption environment in less
free economies tends to be more detrimental for firms’ financial stability than those in high economic freedom countries.
As an alternative explanation, Pieroni and d’Agostino (2013) indicate that a lack of competition policies and government
regulations in less economic freedom environment may strengthen corruption. In other words, market competition may be
bad for corruption when institutions are weak, as they often are in developing countries although, in general, the aggregate
index confirms that competition reduces corruption. If economic freedom increases sufficiently, then the level of corruption
tends to fall, and continues to fall as the quality of institutions gradually improves. Thus, the estimated results support
Hypothesis 2a, suggesting that the adverse impact of corruption on firm financial stability is more pronounced for firms in
14
Fig. 1. The marginal effect of interaction terms. Panel A. Interaction term between corruption and economic freedom. Panel B. Interaction term between
corruption and press freedom. This figure summarizes the main findings of the interaction terms between corruption (CORRUPT) and Economic Freedom
(LESS ECOFREE) in Panel A and Press Freedom (PRESS FREEDOM) in Panel B. The y-axis represents firms’ financial fragility (ZSCORE), conditional on a wide
range of corruption (CORRUPT) and control variables (SIZE, FIRM AGE, LEVERAGE, FIXED, TANGIBLE, CASH, SALES GROWTH, INFLATION, GDP GROWTH) and
country, and year fixed effects. LESS ECOFREE = 1 includes firms in countries that have an economic freedom index in a given year that is lower than its
sample median. PRESS FREEDOM = 1 includes firms in countries that have the status of press freedom is Free in a given year. The definitions of the variables
are provided in Appendix A.
countries with less economic freedom. This result is consistent with the pattern from Panel A of Fig. 1, in which we draw
the marginal effect of interaction term between corruption (CORRUPT) and economic freedom. We observe that firms in
countries with less economic freedom (LESS ECOFREE = 1) appear to have lower ZSCORE, compared to firms in countries with
high economic freedom (LESS ECOFREE = 0).
Similarly, Panel B of Fig. 1 shows that firms in countries with high press freedom exhibit higher financial fragility (higher
ZSCORE). To test Hypothesis 2b, we run the regression in Eq. (6) including the interaction between the level of corruption
(CORRUPT or ADJ CORRUPT) and free press (PRESS FREEDOM). We report the regression results in Table 8. The coefficients
on the interaction CORRUPT*PRESS FREEDOM is positive and statistically significant in all specifications, implying that the
negative effect of corruption on corporate financial fragility is significantly lower for firms in countries with better free-
dom of the press. The results are similar when we use ADJ CORRUPT to measure corruption. Especially, the coefficients on
CORRUPT*PRESS FREEDOM and ADJ CORRUPT* PRESS FREEDOM are positive and significant in developed countries (Models 5
and 6 of Table 8). Taking all together, this indicates that the insignificant effect of corruption on firm financial fragility (as
previously shown in Table 4) can be attributed to the better press freedom in developed countries. It is not surprising that
the average corruption level in developed countries is lower than that in developing countries, which could result in the
opposite view of institutional influences across countries. Thus, our results support Hypothesis 2b, indicating that, compared
with SMEs in not freedom of the press, SMEs in press freedom countries experience lower financial fragility under increasing
corruption. The finding is also in line with Freille et al. (2007) and Dutta and Roy (2016), who document that press freedom,
by itself, restrain corruption, even for countries with lower media reach. One possible explanation is common to see a free
press supplies unbiased information to the society, leading to citizens in freedom press countries can rightfully use this
information to fight corruption.
15
Table 8
Interaction of corruption and press freedom. This table reports the effects of corruption and firm financial fragility conditional on the level of press freedom,
estimated by the GMM. Models (1) through (6) report the basic regression results for each subsample (i.e., full sample, developing countries, and developed
countries) that include ZSCORE as the dependent variable. The definitions of the variables are provided in Appendix A.
Independent Dependent variable: ZSCORE

variables
(1) (2) (3) (4) (5) (6)

ZSCOREt -1 0.859*** 0.890*** 1.123*** 1.202*** 0.578*** 0.591***
(9.623) (17.056) (5.233) (5.712) (41.476) (45.282)
PRESS FREEDOM −0.765 −0.832 −17.327* −10.260* −1.935*** −0.101
(-1.361) (-1.535) (-1.933) (-1.948) (-3.314) (-0.189)
CORRUPT −0.032 −0.092 −0.252**
(-0.369) (-1.112) (-2.014)
ADJ CORRUPT −0.231 −0.446 0.671
(-0.507) (-1.039) (0.979)
CORRUPT * PRESS FREEDOM 0.338** 0.655** 0.454***
(2.298) (1.978) (4.940)
ADJ CORRUPT * PRESS FREEDOM 1.955*** 1.025** 0.930**
(2.595) (2.024) (1.964)
SIZE 0.032*** 0.027** −0.015 0.035 0.541*** 0.266**
(2.617) (2.530) (-0.166) (0.441) (4.599) (2.392)
FIRM AGE −0.024*** −0.021** 0.123 0.170 −0.059 0.308*
(-3.119) (-2.446) (0.680) (1.003) (-0.328) (1.869)
LEVERAGE −0.083* −0.095*** −2.101** −2.173*** 0.210 0.665**
(-1.767) (-3.676) (-2.393) (-2.584) (0.738) (2.455)
FIXED −0.126 −0.101*** −3.877** −3.184** −0.516 −1.930**
(-1.442) (-2.584) (-2.515) (-2.302) (-0.608) (-2.396)
TANGIBLE 0.099 0.072* 3.406** 2.829** −0.278 −1.012
(1.164) (1.929) (2.534) (2.320) (-0.306) (-1.161)
CASH −0.083 −0.058 −1.884*** −1.707*** −0.137 −1.041**
(-0.918) (-1.425) (-2.743) (-2.657) (-0.295) (-2.394)
SALES GROWTH 0.086*** 0.089*** 0.120*** 0.132*** −0.073*** −0.065***
(8.172) (8.665) (4.536) (5.129) (-4.048) (-3.790)
INFLATION 0.212 0.134 −3.906* −2.913 3.847*** 3.399***
(0.335) (0.419) (-1.790) (-1.321) (6.791) (6.190)
GDP GROWTH −0.722*** −0.508** −0.921* −0.321 −7.043*** −1.745
(-2.817) (-1.987) (-1.770) (-0.626) (-2.769) (-0.815)
CONSTANT 0.848*** 0.515*** 0.487*** 0.686*** 0.889 0.753*
(3.205) (9.127) (8.109) (2.610) (1.315) (1.748)
N 98,890 98,890 43,028 43,028 55,862 55,862
5.4. Robustness check
5.4.1. Alternative measure of corruption

To check the robustness of our findings, we use the corruption proxy from the ICRG. The original ICRG score captures
the extent of corruption, and its values are in the range of zero to six, with a higher score suggesting a lower corruption
level. To simplify the interpretation of the results, we use six minus the original value to transform the ICRG into a new
index whereby a higher score indicates more rampant corruption. This index is also widely used in corruption studies (e.g.,
Jha, 2019). We then re-estimate Eq. (4) to Eq. (6) and reported the results in Table 9. Overall, although our key variable of
corruption changes, the main results reported in Table 9 are basically unchanged. We document the positive correlation
between corruption and firm financial fragility, in line with the results reported in Table 4. In addition, we also show that
the coefficients on ICRG*LESS ECOFREE and ICRG*PRESS FREEDOM are negative and positive, respectively, indicating that our
previous findings are unlikely to change with the alternative measure of corruption. The evidence from the robustness check
again confirms that the negative influence of corruption on firm financial fragility is more pronounced for firms in countries
with less economic freedom. In contrast, high press freedom appears to mitigate this adverse effect of corruption.
5.4.2. The effect of economic policy uncertainty

So far, we show that corruption negatively affects the financial stability of firms. However, it is worth noting that corrup-
tion is also highly correlated to other institutional characteristics. For example, a high level of corruption may lead to high
volatile economic policies. To address this issue, we now deepen the analysis by including the economic policy uncertainty
index (POLICY UNCERTAINTY) from Baker et al. (2016) as additional control and re-examine the effect. Since the index is
16
Table 9
Robustness check: alternative measure of corruption. This table reports the effect of corruption on firm financial fragility as well as this effect conditional
on press freedom or economic freedom, as estimated by the GMM. Models (1) through (9) report the basic regression results for each subsample (i.e., full
sample, developing countries, and developed countries) that include ZSCORE as the dependent variable. The definitions of the variables are provided in
Appendix A.
Dependent variables: ZSCORE

Independent
(1) (2) (3) (4) (5) (6) (7) (8) (9)
ZSCOREt -1 0.958*** 0.802*** 0.796*** 0.644*** 1.535*** 1.148*** 1.070*** 1.514*** 0.597***
(7.113) (8.325) (11.348) (4.030) (23.926) (0.130) (12.411) (8.902) (40.055)
ICRG −0.150*** 0.136 0.103 −0.165** 0.183 0.542* −0.254** −0.603** −0.155
(-3.321) (0.787) (0.621) (-2.162) (0.521) (0.297) (-2.018) (-2.617) (-1.333)
LESS ECOFREE 2.166** 7.837** 1.005***
(2.461) (2.313) (2.943)
ICRG*LESS ECOFREE −0.812* −0.943** −0.795***
(-1.692) (-2.284) (-2.699)
PRESS FREEDOM −0.352 −1.825 −1.012***
(-0.649) (1.475) (-2.680)
ICRG* PRESS FREEDOM 0.537*** 0.718** 0.463***
(3.208) (2.508) (4.398)
SIZE −0.057 −0.030 0.040*** 0.094 0.279 −0.000 −0.255 0.001 0.486***
(-0.723) (-0.314) (3.408) (1.417) (1.424) (-0.002) (-1.191) (0.008) (4.619)
FIRM AGE 0.205 0.373 −0.042*** 0.013 0.289 −0.077** 1.982*** 0.304 0.210
(1.211) (1.561) (-4.118) (0.136) (0.969) (-2.409) (3.293) (0.743) (1.330)
LEVERAGE 2.674* 4.241* −0.076** −3.060** −0.414 −0.099 0.044 −1.232 0.623*
(1.876) (1.725) (-2.412) (-2.432) (-0.356) (-1.598) (0.012) (-0.437) (1.924)
FIXED −4.801*** −5.544*** −0.172*** −2.111** 3.252* 0.029 −3.708 2.152 −0.451
(-3.008) (-2.969) (-3.213) (-2.421) (1.742) (0.621) (-1.059) (1.010) (-0.525)
TANGIBLE 6.906*** 8.129*** 0.129*** 2.224*** 0.904 0.007 17.403*** 2.735 −2.452**
(3.135) (3.151) (2.659) (2.669) (0.233) (0.142) (2.696) (1.009) (-2.047)
CASH 0.565 1.709 −0.187*** −1.174** 3.673 0.124* −13.642** 0.354 −0.882*
(1.285) (1.350) (-2.671) (-2.378) (1.435) (1.815) (-2.053) (0.751) (-1.866)
SALES GROWTH 0.113*** 0.033 0.085*** 0.107*** 0.245*** 0.158*** 0.512*** 0.073** −0.070***
(3.715) (1.144) (8.177) (4.021) (8.193) (8.543) (3.181) (2.452) (-3.511)
INFLATION 0.459 −1.399 −0.804 −1.309 −2.609 −4.952** 9.956*** 1.640 3.104***
(0.667) (-0.892) (-1.638) (-1.544) (-0.422) (-1.988) (2.963) (0.495) (5.497)
GDP GROWTH −1.244 −0.260 −2.296*** 2.547 −0.339 −1.395 −13.781* −8.007 −6.901***
(-1.598) (-0.081) (-3.622) (1.468) (-0.074) (-1.067) (-1.755) (-1.008) (-3.296)
CONSTANT −0.002* −1.697 −1.911*** −0.001 −6.417* 0.125** −0.000 −3.187*** −5.629***
(-1.764) (-0.643) (-17.278) (-0.506) (2.557) (2.102) (-0.140) (-0.904) (-3.533)
Country fixed effects YES YES YES YES YES YES YES YES YES
Year fixed effects YES YES YES YES YES YES YES YES YES
p-value for AR (2) test 0.433 0.412 0.839 0.590 0.141 0.531 0.169 0.245 0.111
p-value for Hansen Test 0.456 0.215 0.182 0.195 0.758 0.116 0.538 0.968 0.985
N 98,890 98,890 98,890 43,028 43,028 43,028 55,862 55,862 55,862
only available for 22 countries around the world, this left our sample, which consists of 75,270 firm-year observation, rep-
resenting 31,703 and 43,567 firms in developing and developed, respectively. As reported in models (1) to (3) of Table 10,
the coefficients on POLICY UNCERTAINTY are negative but insignificant at the conventional level. Interestingly, the effect of
corruption on financial fragility remains unchanged in both terms of sign and statistical significance. The economic magni-
tude is also quite similar results from Table 4, suggesting that our main results for the relationship between corruption and
financial fragility are basically unchanged after controlling for the effect of economic policy uncertainty.
5.4.3. Further analysis

The fact that China and Japan are the largest contributors to our sample. In contrast, some countries account for a minority
of total observations (e.g., Ireland, Canada, Bahrain, Chile). This line of argument sheds a concern on whether our estimation
may have biased due to overrepresentation. We address this problem by (1) excluding firms in China and Japan; (2) excluding
countries with lower 200 firms. These actions leave our sample consisting of 61,187 and 83,679 firm-year observations,
respectively. We then re-run our baseline model and report the results in models (4) to (9) of Table 10. Specifically, models
(4) through (6) shows that the coefficients on CORRUPT are negative and significant at 1 % level only for the full sample
and subsample of developing countries. There is no evidence for the impact of corruption on financial fragility in developed
countries. We find this difference is significant (p-value of F-test = 0.06). As the same vein suggested in the three last columns
17
Table 10
Robustness check: further analysis. This table reports the effect of corruption on firm financial fragility on subsamples, estimated by GMM. Models (1)
through (3) are included by additional control variable of economic policy uncertainty. We exclude firms in Japan and China for Model (4) to (6). Model
(7) to (6), we regress on the sample excluding firms in countries that have lower 200 firms. ZSCORE is the dependent variable for all specifications. The
definitions of the variables are provided in Appendix A.
Dependent variables: ZSCORE

Independent
variables Controlling for Policy Uncertainty Excluding Japan and China Excluding countries with lower 200 firms
Full Developing Developed Full Developing Developed Full Developing Developed

(1) (2) (3) (4) (5) (6) (7) (8) (9)
ZSCOREt -1 0.888*** 1.044*** 0.688*** 0.953*** 1.009*** 0.885*** 0.876*** 0.925*** 0.892***
(7.532) (5.109) (5.853) (7.629) (4.749) (11.436) (7.089) (4.211) (11.845)
CORRUPT −0.079** −0.013** 0.032 −0.095*** −0.085*** 0.033 −0.098*** −0.091** 0.023
(-2.539) (-2.239) (1.096) (-3.381) (-2.637) (1.220) (-3.682) (-2.555) (1.013)
SIZE −0.030 0.133* 0.222 −0.063 0.099 0.137 −0.048 0.106 0.085
(-0.314) (1.884) (1.187) (-0.773) (1.202) (0.933) (-0.612) (1.214) (0.629)
FIRM AGE 0.125 0.281** −0.044 0.199 0.121 −0.127 0.172 0.110 −0.112
(1.129) (2.210) (-0.243) (1.267) (0.664) (-0.965) (1.094) (0.574) (-0.916)
LEVERAGE 2.260 −1.982* −1.576 2.610* −2.586 −0.980 2.510* −2.645 −0.521
(1.372) (-1.888) (-1.197) (1.791) (-1.643) (-0.863) (1.776) (-1.602) (-0.516)
FIXED −3.971** −3.110* −0.020 −4.697*** −3.103** 1.076 −5.205*** −3.645** 0.832
(-2.354) (-1.774) (-0.014) (-3.211) (-2.025) (0.794) (-3.417) (-2.124) (0.650)
TANGIBLE 4.979** 4.527** −0.259 6.664*** 3.922** −1.212 7.399*** 4.738*** −1.183
(2.414) (2.313) (-0.126) (3.436) (2.539) (-0.748) (3.750) (2.776) (-0.774)
CASH 0.302 −0.205 −0.420 0.513 −0.792 −0.045 0.482 −0.813 −0.054
(0.714) (-0.491) (-1.416) (1.179) (-1.045) (-0.165) (1.104) (-0.993) (-0.205)
SALES GROWTH 0.112*** 0.149*** −0.029 0.111*** 0.119*** −0.001 0.097*** 0.105*** 0.002
(3.378) (5.869) (-1.005) (3.689) (3.492) (-0.066) (3.139) (2.814) (0.139)
INFLATION −0.026 −2.058 0.523 0.152 −1.140 0.334 0.001 −1.060 0.394
(-0.034) (-0.979) (1.071) (0.221) (-1.153) (1.017) (0.001) (-0.929) (1.169)
GDP GROWTH −2.474 5.781 −1.554 −1.421* 0.250 −1.136 −1.878* 0.271 −1.287*
(-0.758) (0.919) (-0.980) (-1.918) (0.211) (-1.577) (-1.875) (0.138) (-1.777)
CONSTANT 0.002* −0.002 −0.002 −0.309 0.200 0.293** 0.062 0.000 0.003*
(1.905) (-0.844) (-1.043) (-0.336) (0.143) (2.451) (0.065) (1.256) (1.856.)
POLICY UNCERTAINTY 0.000 −0.002 −0.002
(0.295) (-0.844) (-1.043)
Country fixed effects YES YES YES YES YES YES YES YES YES
Year fixed effects YES YES YES YES YES YES YES YES YES
p-value for AR (2) test 0.987 0.620 0.100 0.433 0.797 0.125 0.172 0.979 0.184
p-value for Hansen Test 0.761 0.952 0.175 0.387 0.123 0.359 0.473 0.218 0.145
N 75,270 31,703 43,567 61,187 18,588 42,599 83,679 36,511 47,168
p-value (F-test of equal 0.00 0.06 0.00
corruption between
developing and
developed countries)
of Table 10, there is no association between corruption and financial fragility of firms in developed economies.11 Overall,
we reveal that our previous findings are unbiased by the overrepresentation concern of some countries in the sample.
5.4.4. Other robustness test: financial fragility, corruption and firm value
To determine the economic implications of corruption and firm financial fragility, we further test the impacts of financial
fragility on firm value conditional on the level of corruption. Following previous studies (Allayannis and Weston, 2015;
Kim et al., 2017), we employ Tobin’s Q as a proxy for firm value. Given the existing literature that suggests that financial
fragility may negatively influence firm value, we posit that this effect is more pronounced for firms located in high corruption
countries. To test this conjecture, we regress the following model:
TOBINQi,j,t = ˛ + ˇ1 Corruptionj,t + ˇ2 ZSCOREi,j,t + ˇ3 Corruptionj,t × ZSCOREi,j,t
+ FirmControlsi,j,t + MacroControlsj,t (7)
We include a set of control variables that may affect firm value, as suggested in the literature (Zou, 2010; Allayannis and
Weston, 2015; Kim et al., 2017). Specifically, we control for firm size (SIZE), firm age (FIRM AGE), leverage ratio (LEVERAGE),
11
We find the consistent results when using ADJ CORRUPT; but we do not tabulate in this table for brevity. The detail estimation is provided upon request.
18
Table 11
Financial fragility, and firm value. This table reports the effects of firm financial fragility on firm value conditional on the level of corruption, estimated by
the GMM. Models (1) through (6) report the basic regression results for each subsample (i.e., full sample, developing countries, and developed countries)
that include TOBIN Q as the dependent variable. The definitions of the variables are provided in Appendix A.
Independent Dependent variable: TOBIN Q

variables
(1) (2) (3) (4) (5) (6)
TOBIN Qt -1 0.536*** 0.669*** 0.468*** 0.603*** 0.987*** 0.984***

(57.196) (10.127) (3.950) (7.282) (14.515) (14.623)
ZSCORE 0.653** 0.162*** 0.547** 0.383** 0.131 0.104**
(1.960) (4.782) (2.262) (2.012) (0.729) (2.198)
CORRUPT −0.302* −0.293*** −0.106**
(-1.879) (-2.656) (-2.482)
ADJ CORRUPT −1.248** −1.432** −1.627**
(-2.026) (-2.208) (-2.527)
ZSCORE * CORRUPT −0.356* −0.422** −0.114*
(-1.815) (-2.060) (-1.750)
ZSCORE * ADJ CORRUPT −0.685*** −0.586* −0.483**
(-2.945) (-1.842) (-2.108)
SIZE 0.195*** 0.188*** 0.092* 0.111** 0.093 0.081
(3.946) (2.842) (1.809) (2.552) (0.678) (0.605)
FIRM AGE 0.169*** 0.104* −0.021 −0.028 0.165** 0.161**
(3.479) (1.768) (-0.400) (-0.553) (2.022) (1.990)
LEVERAGE 2.993 2.055* 2.810 2.853 −2.846 −2.721
(0.288) (1.932) (1.108) (1.282) (-0.841) (-0.811)
CAPEX 3.150 2.246*** 1.506* 0.921 1.682* 1.705*
(0.682) (3.278) (1.785) (1.570) (1.891) (1.924)
ROA 0.455 0.109** 1.061* 0.390*** 0.543* 0.565*
(1.389) (2.108) (1.811) (3.289) (1.787) (1.861)
INFLATION −1.193 1.393 1.034 1.078* 1.169 1.069
(-0.239) (1.502) (0.017) (1.886) (0.839) (0.774)
GDP GROWTH −6.488 −4.224*** −1.160 −2.846** 2.460 2.485
(-1.398) (-3.578) (-0.391) (-2.473) (0.972) (0.980)
CONSTANT −0.768** −1.155 0.434** 1.259 0.722** 0.276*
(-2.247) (-0.375) (2.279) (0.534) (1.980) (1.702)
N 70,150 70,150 29,242 29,242 40,908 40,908
growth opportunity (CAPEX, ROA). We also account for macroeconomic factors as in Eq. (4). Our main interest in Eq. (7)
is the coefficient (ˇ3 ) on the interaction term between CORRUPTION and ZSCORE. If corruption strengthens the negative
impact of financial fragility on firm value, we expect that ˇ3 should be negative and significant. The estimated results in
Table 11 confirm our prediction. In particular, we show that the coefficients on ZSCORE*CORRUPT and ZSCORE*ADJ CORRUPT
are negative and statistically significant in all specifications at the conventional level. These results are in line with Shahzad
et al. (2019), who show a negative linkage between firm financial fragility and both current and future performance. In
addition, the coefficients on CORRUPT and ADJ CORRUPT are negative and significant, documenting an adverse influence
of corruption on firm value. These findings are consistent with previous studies that show negative effects of corruption
on investment quality (Hanousek et al., 2019), innovation (Ellis et al., 2019), stock price crash risk (Cao et al., 2019), and
corporate governance (Nguyen and van Dijk, 2012). Overall, the findings of our additional tests reveal that financial fragility
negatively affects firm value and this effect should be severe for firms in countries with high corruption.
6. Conclusion
One of the main challenges for policymakers across the world is the design of effective policies that deal with the financial
risks of SMEs. These policies will be better informed if we can empirically disentangle the relative importance of national
corruption and institutional factors. This paper contributes to the debate by reassessing the relationship between corruption
and the financial fragility of SMEs. We also evaluate how economic freedom and press freedom affect the association between
corruption and firm financial fragility. We first discuss the theory behind the GMM estimator and explain why it is appropriate
for estimating the corruption/financial fragility relation in a dynamic framework. We specifically apply this technique to
estimate the effect of corruption on financial fragility in a panel of extensive international data set with 98,890 firm-year
observations of SMEs in 62 countries from 2012 to 2018. We first find that the degree of corruption is positively associated
with the financial fragility of SMEs in developing countries. However, this effect is insignificant in developed countries. More
19
importantly, the results of the interaction terms show that firms in countries having less economic freedom tend to bear a
higher level of financial fragility once corruption increases. In contrast, firms in countries with greater press freedom may
mitigate the negative effect of corruption on firm financial fragility. Our findings are robust to endogeneity caveats by firm-
fixed effects model, two-stage least square estimation, alternative measure of corruption, even controlling for economic
policy uncertainty and the over-representation of the sample. In addition, we also explore that the financial fragility of firms
is negatively related to firm value and this effect is more pronounced for firms in high corruption country.
The national governance quality is crucial for firm operations, especially for small- and medium-sized enterprises that
are more sensitive to the business environment and policy changes. Corruption is also one of the usual barriers that SMEs
may deal with during their businesses. The findings of this study may benefit governments in launching timely regulations
to improve the institutional frameworks in their countries. Additionally, the implications of our paper may help a firm’s
manager in building a business strategy to obtain the best long-run performance.
While our research concentrates on corruption and performance, others have applied dynamic panel GMM estimators in
other areas (e.g., institutional development and firm performance, determinants of corporate governance, etc.). However, it
is likely to be particularly important in corruption environment since much of this research seeks to determine the effect
of corruption on financial fragility, an aspect of research that is particularly susceptible to biases that may arise by ignoring
the effect of historical fragility on current corruption.
Appendix A. Regression variable definitions
Variables Definition Sources
ZSCORE Natural logarithm of [1 + (ROA + total equity/total asset) / ␴ROA ]. The ROA Authors’ calculation based on
represents the return on assets in year t for firm i, and ␴ROA is the standard Orbis
deviation of the return on assets over a 4-year rolling window. A higher score
suggests a lower probability of firm insolvency, indicating a higher degree of
financial stability.
CORRUPT The original score of Transparent International’s Corruption Perception Index Transparent International’s
(TRANSPARENCY index) indicates the perceived level of prevailing corruption Corruption Perception Index
on a scale of 0–10, with a higher score suggesting higher economic and
political integrity. We use 10 minus this TRANSPARENCY index to make higher
TRANSPARENCY indicate more rampant corruption.
ADJ CORRUPT Adjusted corruption index, which is interpreted as the corruption index of As above
country j in year t relative to the average index of all countries in that year. A
higher score implies the country is relatively more corrupt than a typical
country.
ICRG The original score of Transparent International’s Corruption Perception Index The International Country Risk
(TI index) indicates the perceived level of prevailing corruption on a scale of Guide (ICRG)
0–6, with a higher score suggesting a lower corruption level. We use 6 minus
this x to make a higher ICRG indicate more rampant corruption.
POLICY UNCERTAINTY The index of economic policy uncertainty from Baker et al. (2016). https://www.policyuncertainty.
com/
PRESS FREEDOM A dummy variable takes one for a country if its status of press freedom is Free Freedom House
in a given year.
LESS ECOFREE In each year, a dummy variable that is one for country that has an economic Heritage Foundation
freedom index in year t that is lower than its sample median.
SIZE Natural logarithm of total assets for firm i in year t As above
FIRM AGE Natural logarithm of the number of years since incorporation As above
LEVERAGE Leverage ratio, which is the sum of debt in current liabilities and total As above
long-term debt divided by total assets in year t for firm i.
FIXED The ratio of fixed assets to total assets in year t for firm i As above
TANGIBLE The ratio of tangible assets to total assets in year t for firm i As above
CASH The ratio of cash and equivalents to total assets in year t for firm i As above
SALES GROWTH The percentage change in sales in year t for firm i. As above
INFLATION The inflation rate based on the GDP deflator index for each country World Bank Indicator
GDP GROWTH The growth rate of real gross domestic product As above
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57–58 (2020) 100660

Contents lists available at ScienceDirect

Journal of Multinational Financial

Corruption and ﬁnancial fragility of small and medium

2. Literature review and hypothesis building

2.1. Corruption and ﬁrm-ﬁnancial fragility

Hypothesis 1. Corruption is signiﬁcantly associated with ﬁnancial fragility of SMEs.

2.2. Moderating impacts of economic freedom and press freedom

3.1. Measuring corruption

CORRUPTj,t = 10 − TRANSPERANCEYj,t /10 (1)

3.2. Measuring ﬁrm ﬁnancial fragility

3.3. Basic model

The basic model is as follows:

3.4. The inﬂuences of economic freedom and press freedom

+LESS ECOFREEj,t × (ϕ1 + ϕ2 × Corruptionj,t )

+CountryDummiesj + YearDummiest + εi,j,t

+PRESS FREEDOMj,t × (ϕ1 + ϕ2 × Corruptionj,t )

+CountryDummiesj + YearDummiest + εi,j,t

4.1. Data sources

Panel A – Developing Countries Panel B – Developed Countries

ZSCORE CORRUPT ADJ CORRUPT ICRG

Developing countries 3.153 5.617 0.971 3.645

4.2. Descriptive statistics

Panel A. Sample distribution by year

Year N Year N Year N

2012 9,786 2015 14,983 2018 16,419

Panel B. Sample distribution by industry

Industry 2-digit SIC N Industry 2-digit SIC N

Panel C. Summary statistics

VARIABLE N MEAN SD P25 P50 P75

(1) ZSCORE 1.000

Dependent variable: ZSCORE

(1) (2) (3) (4) (5) (6)

ZSCOREt -1 0.953*** 0.959*** 0.631*** 0.631*** 0.890*** 0.890***

5.1. Baseline results

5.2. Endogeneity concerns

5.2.1. Firm ﬁxed-effects regression

5.2.2. Two-stage least squares approach

Dependent variable: ZSCORE

(1) (2) (3) (4) (5) (6)

CORRUPT −0.041*** −0.002*** −0.007

Panel A.– First stage regression results

(1) (2) (3) (4) (5) (6)

COR NEIBOR 0.036*** 0.017*** 0.108*** 0.077*** 0.094** 0.027**

Panel B. Second stage regressions results

Dependent variable: ZSCORE

(1) (2) (3) (4) (5) (6)

CORRUPT (IV) −0.082*** −0.097** −0.012

Dependent variable: ZSCORE

(1) (2) (3) (4) (5) (6)

ZSCOREt -1 1.591*** 1.580*** 0.885*** 1.570*** 0.620*** 0.620***

5.3. The roles of economic freedom and press freedom

Independent Dependent variable: ZSCORE

(1) (2) (3) (4) (5) (6)

5.4. Robustness check

5.4.1. Alternative measure of corruption

5.4.2. The effect of economic policy uncertainty

Dependent variables: ZSCORE

(1) (2) (3) (4) (5) (6) (7) (8) (9)

5.4.3. Further analysis

Dependent variables: ZSCORE

Full Developing Developed Full Developing Developed Full Developing Developed

ZSCOREt -1 0.953* 0.959* 0.631* 0.631* 0.890* 0.890*

CORRUPT −0.041* −0.002* −0.007

COR NEIBOR 0.036* 0.017* 0.108* 0.077* 0.094 0.027

CORRUPT (IV) −0.082* −0.097 −0.012

ZSCOREt -1 1.591* 1.580* 0.885* 1.570* 0.620* 0.620*

TOBIN Qt -1 0.536* 0.669* 0.468* 0.603* 0.987* 0.984*