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October 31, 2003
Moskowitz Prize-Winning Study Correlates Lower Corruption With Higher Shareowner Value
    by William Baue

The Social Investment Forum awards its annual Moskowitz Prize to a study that correlates lower political corruption with higher corporate value in international markets.

“Does virtue pay?” asks the subtitle of the study that won this year’s Moskowitz Prize, awarded annually by the Social Investment Forum (SIF) to outstanding quantitative research in the field of socially responsible investing (SRI). “Yes” is the apparent answer to this question, according to the study’s authors, David Lee and David Ng of Cornell University.

Specifically, the study applies valuation theory to firm-level data in 46 countries, and finds a robust correlation between political corruption and shareowner value. Simply put, the less prevalent corruption is in a country, the higher the shareowner value of corporations in that country, and vice versa.

"This study demonstrates that the overall ethical climate or level of corruption in a nation has a significant impact on corporate valuation," said Tim Smith, SIF’s president. "It also provides compelling evidence describing how political corruption has a corrosive impact on the private sector of a country as well as its public sector."

The study uses the definition of corruption (the misuse of public office for private gain) endorsed by academics as well as Transparency International (TI), one of the leading international non-governmental organizations (NGOs) combating corruption. It also employs TI’s annual Corruption Perception Indexes (CPIs) issued between 1995 and 1998. CPI is a “poll of polls,” including up to 12 separate surveys of corruption.

The study finds that Denmark was the least corrupt country during this time period, earning a score of 0.35 on a scale from 0 (least corrupt) to 9 (most corrupt), while
Pakistan was the most corrupt, with a score of 7.88. The US ranked fourteenth least corrupt with a score of 2.36.

The study cites existing academic findings that political corruption drives up prices, reduces investment, and reduces legal protection of shareholders. The authors extend this research to correlate corruption with corporate value by applying valuation theory in these international markets. This analysis demonstrates a robust correlation between political corruption and price-to-earnings (PE) and price-to-book (PB) ratios for firms in these countries.

“The robustness of the corruption measure as an explanatory variable for international valuation, after controlling for many other variables, suggests to us that it might capture something beyond public sector misconduct,” state Drs. Lee and Ng in the paper. “Although our corruption measures relate to a public sector phenomenon, this behavior is likely to be mirrored in private sector dealings as well.”

“In fact, we believe it is more likely that the effect we document understates the true impact of corruption on corporate values across international boundaries,” the authors conclude.

The Moskowitz Prize Committee applauds the study’s empirical advances, as it extends valuation theory developed for US markets to international markets and links literature on political corruption to valuation models, opening up new fields of inquiry for researchers.

The judges granted an honorable mention to Christopher Geczy and Robert Stambaugh of the Wharton School for their paper entitled Investing in Socially Responsible Mutual Funds.

“The Moskowitz Prize Committee, which is composed of independent judges, provided an honorable mention to the Geczy study because it raises some interesting theoretical issues and deals with them in a novel way,” said Todd Larsen, SIF’s spokesperson. “It is their assessment that the study opens up some new paths for research and deserved credit for this.”

The study’s design has been criticized, specifically the section of the paper that finds underperformance by certain SRI portfolios compared to non-SRI portfolios composed utilizing exceedingly sophisticated analytical techniques.

“It is the Forum's position that it would be extremely difficult to find a manager with the skill level required to produce the returns found in the study from investing in a portfolio drawn from the unconstrained universe,” said Mr. Larsen. “And therefore an investor in the real world would be highly unlikely to see the difference in returns found between the unconstrained universe and the SRI-only universe.”

“It is also important to note that portions of the Geczy study find that SRI funds themselves are competitive, and that SRI portfolios that seek to track the market are also competitive, providing further academic evidence for this point,” Mr. Larsen told


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