Societal Trust and Corporate Investment Efficiency

Abstract

The prior literature establishes that trust affects investment, however, whether it leads to investment efficiency is unaddressed. This study seeks to investigate the relationship between societal trust and corporate investment efficiency. The study documents a positive association between societal trust and corporate investment efficiency. Using data from 30 diverse countries, we present evidence that societal trust is positively related to firm’s overinvestment but has a negative relationship with firm’s under-investment. Further analysis of this study also posits a stronger relationship between trust and firm's investment efficiency for financing constraint firms. We interpret these findings as supportive evidence that higher trust is related to favorable outcomes, some being good earnings quality and greater reliability of earnings news. Furthermore, this study from the perspective of social capital literature provides an alternative explanation to investors investment decisions regarding the economic consequences of enhanced trust.

Keywords: Societal Trust, Investment Efficiency, Overinvestment, Underinvestment

JEL Classification: G30, M40, M14