National Culture And Stock Price Crash Risk
The University of Danang
Opportunities In Special Situations With Evermore’s David Marcus
University of New South Wales (UNSW) – School of Banking and Finance
La Trobe University – La Trobe Business School – Department of Finance; Financial Research Network (FIRN)
January 5, 2016
We study how cultural norms along the dimensions of individualism and uncertainty avoidance affect stock price crash risk. Using a sample of 36 countries, we find that firms headquartered in countries with higher levels of individualism are associated with higher stock price crash risk while firms headquartered in countries with higher levels of uncertainty avoidance exhibit lower stock price crash risk. These findings suggest that individualism encourages managerial bad-news hoarding while uncertainty avoidance curbs such behavior. We also find that such effects are more pronounced in more opaque firms or countries. Overall, our findings suggest that national culture is an important determinant of stock price crash risk.
National Culture And Stock Price Crash Risk – Introduction
Crash risk, defined as the conditional skewness of return distribution, captures asymmetry in risk attributes and is important for investment decisions and risk management. In this study, we examine whether national culture affects stock price crash risk. Hofstede (2001) defines culture as the collective mental programming that leads to patterned ways of thinking, feeling, and acting, and that distinguishes one group or category of people from another. Culture influences how individuals process information and shapes their subjective mental constructs used to interpret problems faced in life, which in turn affects their decision-making (e.g., North, 1990; Williamson, 2000). Although the literature has documented various ways in which culture affects corporate decisions, as well as the factors that impact stock price crash risk, whether national culture affects stock price crash risk remains an unexplored question. We fill this gap by proposing two hypotheses that link two dimensions of national
cultures – individualism and uncertainty avoidance – to stock price crash risk.
In the first hypothesis, we posit that individualism encourages stock price crash risk. According to Hofstede (2001), people from those cultures that promote individualism usually place greater emphasis on personal achievements and individual rights. Empirical studies have shown that CEOs from these cultures tend to be overconfident and self-attribution biased (Chui et al., 2010; Ferris et al., 2013), and to have a strong preference for risk-taking (Li et al., 2013). Overconfident CEOs often overestimate future returns from their firms’ investment projects, and thus are likely to delay loss or bad-news recognition (Ahmed and Duellman, 2013). Kim et al. (2015) argue that since overconfident managers are excessively optimistic about their investment projects and ignore or explain away privately observed negative feedbacks, the poor performances of these projects could accumulate. Using a large sample of U.S. firms, these authors find that firms with more overconfident CEOs are associated with higher stock price crash risk. Based on these studies, we argue that CEOs from high-individualism cultures should engage more in bad-news hoarding activities due to their overconfidence and self-attribution bias, which leads to a higher probability of stock price crash risk.
In the second hypothesis, we hypothesize that uncertainty avoidance curbs stock price crash risk. Hofstede (2001) argue that people from cultures exhibited by a high degree of uncertainty avoidance usually try to minimize the occurrence of unknown and unusual circumstances and to proceed with careful changes by planning and implementing rules, laws, and regulations. Existing literature shows that people from these cultures are more conservative and less tolerant of ambiguity. For example, Li et al. (2013) find that managers in such cultures have a weaker preference for corporate risk-taking. Beugelsdijk and Frijns (2010) find that investors in these cultures invest less in foreign assets than in domestic assets. Chen et al. (2015) find that the firms headquartered in high-uncertainty countries tend to hold more cash to compensate for bearing the uncertainty that is associated with the future cash flows. Against this backdrop, we argue that CEOs from the cultures that promote strong uncertainty avoidance, who generally are more conservative and less tolerant of ambiguity, should be less likely to stockpile bad news, which results in lower stock price crash risk.
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