Collective Reputations, Trust Premium, and Corporate Misconduct

Abstract

We examine the relationship between collective country reputations and foreign stock returns following news of corporate scandals. We find that investors punish not only the scandalous foreign firm but also other firms from the same country of origin, especially those coming from more trustworthy countries. The effect is more salient for firms with more imperfect information as measured by higher information asymmetry, lower reporting quality, and higher bankruptcy risk. Our findings suggest that investors incorporate a trust premium into stock prices based on foreign firms’ country-of-origin. However, they reclaim such a premium when a country’s trustworthiness is compromised by its affinity firm’s misconduct. Overall, we provide novel evidence that collective country reputations affect the pricing of foreign firms listed on the U.S. stock market.

Keywords: Collective reputation, country trustworthiness, trust premium, corporate misconduct, imperfect information

JEL Classification: G12, G14, G15, G33, G41, L14, M14, Z10