Misconduct and Market Development
Abstract: This paper presents individual and country-level studies of reactions to misconduct. With access to complete data, I am able to measure reactions to misconduct and study how misconduct alters the composition of markets in a way that impedes improvements in governance. The individual-level analysis studies investor reactions to a stockbrokerage fraud in Kenya's Nairobi Securities Exchange. Using the NSE's electronic databases, I know the complete universe of investors at risk of victimization, those victimized in the fraud, and all trades made by all investors before and after the fraud. Results show that victimized investors who are co-ethnic with the perpetrator are paradoxically more likely to reinvest in the market than victims who belong to rival ethnic groups. A key implication of this result is that fraud alters the composition of the market by retaining more socially homogeneous population that is less likely to demand improvements in governance. I next extend this result to the country level, where I study changes in global capital flows resulting from state-sponsored violence. Using complete data on monthly bilateral financial transfers provided by SWIFT, I find that non-African countries with natural resource trade relationships with African countries react similarly to Kenya's co-ethnic investors. The resulting pattern is similar to before, where a violent African country's foreign financial ties become more concentrated but do not reduce in overall value following state-led violence.