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National Culture and International Differences in the Cost of Equity Capital

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Abstract

  • 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.

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Notes

  1. Cost of equity capital refers to the minimum rate of return a firm must offer shareholders to compensate them for waiting for their returns and for bearing the risk involved (e.g., Fama and French 1992, 1993, 1997; Easley and O’Hara 2004; Francis et al. 2004; Khurana and Raman 2004; Hail and Leuz 2006).

  2. Specifically, countries with high scores on the cultural dimensions of “conservatism” and “mastery” tend to have lower corporate debt ratios.

  3. Doupnik and Tsakumis (2004) find that Gray’s (1988) model is likely relevant in explaining (1) systemic differences in financial reporting across countries with different cultures and institutions, together with inter-country differences in the way rules are interpreted.

  4. Salter and Niswander (1995) tested the relationship of Gray’s accounting values and Hofstede’s original social values and confirmed the direction and significance of most of the propositions. They revealed that Hofstede’s cultural dimension indices have statistically significant relationships with the measures of accounting system attributes across countries.

  5. Gebhardt et al. (2001) and Botosan and Plumlee (2005) indicate that tests of the relevance of information for asset valuation require measures of ex ante rather than ex post returns (see also Fama and French 1997; Vuolteenaho 2002).

  6. To estimate beta, we require at least 24 monthly observations be available.

  7. Using the MSCI World Index assumes that the capital markets in our sample countries are integrated, which may not be the case. No inferences are affected by excluding Beta as a control variable.

  8. Guay et al. (2005) indicate that if analysts are delayed in incorporating good (bad) news contained in recent stock returns, the implied cost of equity capital is systematically biased downward (upward).

  9. This criterion follows Frankel and Lee (1999).

  10. We calculate cum-dividend stock returns for non-U.S. firms from the data of stock prices and dividends extracted from COMPUSTAT Global.

  11. As noted by Gode and Mohanram (2003), empirical implementation of the PEG model (Easton 2004) and the Ohlson-Juettner model (Ohlson and Juettner-Nauroth 2005) requires this condition.

  12. We adjust all per share numbers for stock splits and stock dividends using I/B/E/S adjustment factors. Also, when I/B/E/S indicates that the consensus forecast for that firm-year is on a fully diluted basis, we use I/B/E/S dilution factors to convert those numbers to a primary basis.

  13. The country groups are (1) Less developed Asian; (2) Less developed Latin; (3) Near Eastern; (4) Japan; (5) African; (6) Asian Colonial; (7) More developed Latin; (8) Nordic; (9) Germanic; (10) Anglo.

  14. Given there is no widely agreed upon measure of earnings quality, we measure earnings quality as the absolute value of the residuals from the Jones (1991) model estimated cross-sectionally in each country-year. Discretionary accruals are differentiated from from total accruals by using the cross-sectional Jones model as follows:

    $$ \textit{TAcc}_{t} = {\delta _1} + {\delta _2}\textit{GPPE}_{t}+{\delta _3}\Delta \textit{REV}_{t} + {v_t} $$

    where \( \textit{TAcc}_{t} \) is the total accruals during time t; \( \textit{GPPE}_{t} \) is the gross property, plant, and equipment at the end of time t; \( \Delta\textit{REV}_{t} \) is the change of revenue during time t; All variables, including the constant term (\( {\delta _1} \)), are scaled by total assets at the beginning of time t; \( {v_t} \) is the error term (i.e., discretionary accruals).

  15. The cost of equity under the Sharpe–Lintner version of CAPM is estimated as \( {\rm{E(}}{{\rm{R}}_{\rm{i}}}) = {{\rm{R}}_{\rm{f}}} + {{\rm{\beta }}_{\rm{i}}}[{\rm{E(}}{{\rm{R}}_{\rm{m}}}) - {{\rm{R}}_{\rm{f}}}] \), where \( {{\rm{R}}_{\rm{f}}} \) is the risk-free rate, \( {\rm{E(}}{{\rm{R}}_{\rm{m}}}) \) is the market return, \( {{\rm{\beta }}_{\rm{i}}} \) is the firm-year specific beta derived from the one factor model, i.e., \({\rm{Cov(}}{{\rm{R}}_{\rm{i}}},{{\rm{R}}_{\rm{m}}})/{\rm{Var(}}{{\rm{R}}_{\rm{m}}})\). To estimate the cost of capital under this approach, we assume a risk free rate of 1 % and a market equity premium of 5 %. While both the risk free rate and risk premium are based on U.S. studies and they are likely to vary with space and time, our country and time controls will likely explain the variations that are specific to jurisdictions and economic periods.

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Acknowledgments

We thank Okada Yoshitaka, June Uenishi, and seminar participants at Sophia University, the University of Tennessee and the 2010 American Accounting Association International Section Midyear Meeting for constructive comments on an earlier versions of this paper. We also thank the Editor and reviewers’ for their helpful comments.

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Authors and Affiliations

  1. University of Sydney Business School, University of Sydney, Sydney, Australia

    Sidney John Gray

  2. Spears School of Business Oklahoma State University, Oklahoma, USA

    Tony Kang

  3. Korea University Business School, Seongbuk-Gu, Seoul, Republic of Korea

    Yong Keun Yoo

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Correspondence to Sidney John Gray.

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Gray, S., Kang, T. & Yoo, Y. National Culture and International Differences in the Cost of Equity Capital. Manag Int Rev 53, 899–916 (2013). https://doi.org/10.1007/s11575-013-0182-3

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  • DOI: https://doi.org/10.1007/s11575-013-0182-3

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