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We examine whether political corruption impedes innovation. Using a comprehensive sample of U.S. firms, we find that corruption has a substantial, negative relation with the quantity and quality of innovation. These results are robust to using various fixed effects, proxies for corruption and innovation, and subsamples. To establish causality, we employ 2 instruments for corruption: local ethnic diversity and the corruption of the state a firm’s founder grew up in. Corruption appears to reduce innovation output both on average and for the most innovative firms. Overall, this evidence is consistent with the notion that corruption reduces social welfare by impeding innovation.

Using data on corruption convictions from the U.S. Department of Justice, we find that auditors charge higher fees when a firm is headquartered in a more corrupt district. This result is robust to a wide range of time and location fixed effects, using capital city isolation as an instrument, and propensity score matching. We also find that, relative to those in non-corrupt districts, firms in corrupt districts are more likely to have weak internal controls and to restate earnings and that their auditors exert greater effort. This evidence suggests that auditing firms in corrupt areas entails additional risk, which auditors price into fees.

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