A Firm-Centered Analysis of Corruption and Reform: Evidence from Indonesia

This paper theorizes that informational asymmetries between firm insiders and outsiders generate both supply and demand pressures which result in sectoral variation in levels of corruption. Because both firms and state agents risk prosecution if they cannot disguise their illicit transactions, it is the potential to either under-report revenue or to over-report costs—or in other words, to generate hidden profits—, which should be positively related to bribery and extortion. Industries characterized by concentrated, bespoke, and uncertain costs and revenues are most amenable to the generation of hidden profits. We test our theory against data from a primary survey of 672 firm managers and business owners in Indonesia. We find that being in the construction and extractive sectors makes firms substantially more likely to report being asked for bribes by state officials and to report paying such bribes. Original qualitative evidence elaborates on the proposed mechanisms.