Academic journal article Journal of Economics and Finance

The Impact of International Bribery on U.S. Household Stock Investments

Academic journal article Journal of Economics and Finance

The Impact of International Bribery on U.S. Household Stock Investments

Article excerpt

1Introduction

The Foreign Corrupt Practices Act (FCPA) of 1977 forbids U.S. firms from paying bribes to foreign public servants in order to attain business or affect regulations or taxes in their favor. However, the FCPA has not deterred many U.S. companies of paying bribes to foreign government officials (Weismann et al. 2004) since those companies can receive significant financial benefits through bribery.1 For instance, Cheung et al. (2012) find that "firm market value increases by 11 dollars, on average, for each dollar of bribe they pay (p. 5)". The motivation of this paper is to examine whether international bribery violations could be one of the causes of limited household stock market participation. Previous studies suggest that household nonparticipation might be attributable to shareholders' concerns about the expropriation of wealth as the result of fraudulent activities and, thus, subsequent loss of trust in the financial markets (Giannetti and Wang 2016). In this paper, we examine whether households may simply refuse to invest in companies that engage in illegal activities, even when those illegal actions such as bribery violations can increase their wealth significantly. We show that households seem to divest their holdings in the stock market if they perceive the market to be "morally corrupt," a finding that is consistent with Kim et al.'s (2015) "conscious local investor view." These authors find that local institutional investors play an important role in mitigating environmental violations. Although environmental violations do not reduce the shareholders' wealth, Kim et al. (2015) show that local institutional investors help reduce firms' toxic release. Our findings are also consistent with "the delegated philanthropy view in which some stakeholders (investors, customers, and employees) are often willing to sacrifice money (yield, purchasing power, and wage, respectively) so as to further social goals (Benabou and Tirole 2010, pg. 10)." Our results, which show that shareholders avoid investing in companies that engage in socially irresponsible behavior are supported as well by the findings of Hong and Kacperczyk (2009). They find that "sin" stocks (alcohol, casinos, tobacco) have higher returns, as socially norm-constrained investors abstain from investing in those companies. In this study, we show that households punish the stock market by "walking with their feet" if local firms commit bribery violations.

After controlling for state and household factors, we find that there is a negative effect of bribery violations in the state on the stock investments of local households: bribery violations in the state reduce households' participation in the stock market, diminish the proportion of total household stock holdings within the household's total wealth, decrease the probability that households will enter the stock market, and increase the probability that they will exit the market. We find that morality could be a potential mechanism by which bribery violations affect household stock investments.

We focus our attention on the effect on household stock investments of bribery misconduct on the part of local firms. This is because households are more likely to be informed about misconduct perpetuated by companies headquartered in the same state as theirs. The evidence from the literature suggests that investors are more informed about the activities of local companies and they also tend to invest most heavily in those firms (Grinblatt and Keloharju 2001; Ivkovic and Weisbenner 2005; Hong et al. 2008; Massa and Simonov 2006; Pirinsky and Wang 2006; Brown et al. 2008; Feng and Seasholes 2004; Coval and Moskowitz 1999; Osili and Paulson 2008; Coval and Moskowitz 2001; Huberman 2001; Loughran and Schultz 2005). Local news also tends to focus on local firms,2 and households tend to interact socially with the employees of local companies (Gurun and Butler 2012; Engelberg and Parsons 2011; Davis and Henderson 2008; Feng and Seasholes 2004; Loughran and Schultz 2005; Coval and Moskowitz 2001). …

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