National Culture and International Differences in the Cost of Equity Capital
Gray, Sidney John, Kang, Tony, Yoo, Yong Keun, Management International Review
* Prior literature suggests that national culture influences many facets of business operations including corporate governance, capital structure, managerial compensation, foreign direct investment behavior and accounting systems.
* Extending this line of literature, we examine whether key aspects of national culture are also related to international differences in the cost of equity capital.
* In a cross-country sample of 32 countries during 1992-2006, we find that the cost of equity capital tends to be higher in more individualistic and less uncertainty avoiding societies consistent with their greater risk-taking orientation.
* This finding contributes to the international business and financial literature by identifying national culture as an important institutional variable influencing firms' cost of equity capital around the world.
Keywords: National culture * Cost of equity capital * Individualism * Uncertainty avoidance * Risk-taking
It has become increasingly recognized that institutional factors are critical determinants of values and behavior in a nation and ultimately economic performance (Scott 1995; North 1990, 1994, 2005). North defines institutions at the national level as formal rules, including constitutions, laws and regulations, and informal constraints such as behavioral norms and culture that establish the 'rules of the game' which organizations tend to follow. Both elements should be taken into account in order to understand the institutional system of a nation. In this paper, we focus on the impact of informal institutional factors, i.e., national culture, on firms' cost of equity capital across 32 countries from 1992-2006. While prior research has investigated the influence of formal institutional factors such as legal systems and securities regulation (e.g., Hail and Leuz 2006), there has been no study to date that assesses the influence of national culture on the cost of equity capital i.e., capital providers' assessments of company risk. Specifically we investigate whether national culture dimensions are systematically related to firms' cost of equity capital internationally beyond formal institutional factors as well as firm- and country-specific risk factors.
Previous studies have shown that national culture influences various aspects of business operations including financial systems, firms' financing decisions, managerial compensation, reward preferences, foreign direct investment behavior, life insurance consumption, and accounting choices (e.g., Schuler and Rogovsky 1998; Chui et al. 2002; Stultz and Williamson 2003; Doupnik and Tsakumis 2004; Tosi and Greckhamer 2004; Kwok and Tadesse 2006; Radebaugh et al. 2006; Chiang and Birtch 2006; Bhardwaj et al. 2007; Chui and Kwok 2008; Han et al. 2010). However, there appear to be no studies linking national culture to firms' cost of equity capital which is a key variable in managerial performance evaluation and firm valuation. (1)
Identifying determinants of the cost of equity capital across countries is important for several reasons. Cost of equity capital is a key measure in making capital budgeting decisions. As Damodaran (2006) notes, every business needs to assess where to invest its funds and to regularly re-evaluate the quality of its existing investments. The cost of equity capital is a critical benchmark in making such evaluations. Hence, our investigation sheds some light on how national culture is related to capital providers' assessments of company risk. As capital markets around the world globalize, it is becoming increasingly important to understand the effects of national culture on the cost of equity capital around the world. Identifying additional determinants of the cost of equity capital would enable researchers/practitioners to improve its estimation, leading to more accurate evaluations of investments and more accurate valuations of equity. …