The Trust Triangle: Laws, Reputation, and Culture in Empirical Finance Research
50 Pages Posted: 31 Jan 2018 Last revised: 11 Jan 2019
Date Written: November 28, 2018
We propose a construct, the Trust Triangle, that highlights three primary mechanisms that provide ex post accountability for opportunistic behavior and motivate ex ante trust in economic relationships. The mechanisms are: (i) a society’s legal and regulatory framework, (ii) market-based discipline and reputational capital, and (iii) culture, including individual ethics and social norms. The Trust Triangle provides a framework to conceptualize the relationships between trust, corporate accountability, legal liability, reputation, and culture. We use the Trust Triangle to summarize recent developments in the empirical finance literature that examine how trust is formed and how trust, or its absence, affects financial markets, firm performance, and the incidence of financial fraud. To date, most studies examine only one leg of the Trust Triangle in isolation. The evidence, however, indicates that all three legs of the Trust Triangle have first-order effects on a wide range of financial outcomes and that they are interrelated. Attempts to model trust and trustworthiness that do not incorporate all three aspects of the Trust Triangle will therefore miss essential aspects of the basic economic problem of how counterparties overcome the risks of moral hazard, asymmetric information, and opportunism to engage in mutually beneficial exchange and production activities. We focus especially on culture-related mechanisms, a recently developed area in empirical finance research that has potential to influence the more established research on laws and reputation.
Keywords: Trust, accountability, opportunism, fraud, reputation, culture
JEL Classification: A13, G38, K40, Z10
Suggested Citation: Suggested Citation