Can I Trust You with My Money? The Role of Social Trust in Corporate Cash Policy

52 Pages Posted: 1 Oct 2015

See all articles by Fei Xie

Fei Xie

University of Delaware - Lerner College of Business and Economics; European Corporate Governance Institute (ECGI)

Xiangang Xin

City University of Hong Kong

Date Written: September 30, 2015

Abstract

We examine how corporate cash policy is related to the level of social trust in a country, with trust defined as the subjective probability that an individual assigns to the event of a potential counter-party performing an action that is beneficial or at least not harmful to that individual. We explore two competing hypotheses. On the one hand, in a high-trust country, shareholders are less concerned about managers abusing corporate cash resource for personal gains and therefore allow firms to maintain larger cash holdings. On the other hand, the reduced concern about managerial moral hazard in high-trust countries increases investors’ willingness to provide capital to firms. The resultant greater accessibility of external finance weakens firms’ precautionary saving motive and leads to lower corporate cash reserve. Our analysis of a large sample of firm-year observations from 41 countries supports the first hypothesis. Specifically, corporate cash holding is significantly and positively related to a country’s level of social trust. In addition, consistent with a substitutive relation between subjective belief and formal rules and regulations, the impact of trust is more pronounced in countries with poorer investor protection and weaker legal enforcement. We also observe an elevated effect of trust following negative shocks to investors’ confidence in formal institutions created by high-profile corporate scandals. Finally, we find that the market value of corporate cash holding is significantly higher in high-trust countries. Overall, our results highlight the importance of social trust as an informal institution in influencing corporate cash policy.

Suggested Citation

Xie, Fei and Xin, Xiangang, Can I Trust You with My Money? The Role of Social Trust in Corporate Cash Policy (September 30, 2015). Available at SSRN: https://ssrn.com/abstract=2668026 or http://dx.doi.org/10.2139/ssrn.2668026

Fei Xie (Contact Author)

University of Delaware - Lerner College of Business and Economics ( email )

42 Amstel Ave
Newark, DE 19716
United States
(302) 8313811 (Phone)

HOME PAGE: http://sites.google.com/site/feisresearch/

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Xiangang Xin

City University of Hong Kong ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong
Hong Kong

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