Abstract
Exploring the locality stereotype with respect to CEO’s trustworthiness, we find that firms whose CEOs are from more reputable hometowns have a higher likelihood of stock price crashes, indicating the presence of a CEO “Trust Exploitation” effect, i.e. a high-trust identity does not guarantee managerial ethics; to the contrary, it could tempt CEOs to abuse outsiders’ trust, camouflage their misconducts and conceal adverse information more severely. The effect of CEO’s perceived trustworthiness on tail risk of stock price remains robust when controlling for the region-level trust of firm’s headquarters, and in 2SLS regression with an instrumental variable. Further, CEO’s “Trust Exploitation” effect is more prominent among firms with lower disclosure quality, higher capital market pressure and higher CEO incentives. Our findings highlight an unexplored imperfection of individual-level trustworthiness as a reliable substitute for formal monitoring devices in terms of improving stock market stability.
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Notes
The most representative example of the deceptive action is the case of “the prisoners’ dilemma”. Social trust plays the role of guiding people’s conformity to social norms and collaborations that maximize the benefits of the community. See Gambetta (1988) and Coleman (1986a, b, 1988, 1990) for details.
Social trust has multiple levels. Country-level social trust has been proved to affect the economic growth rate, international trade and cross-border M&A (Putnam 1993; Knack and Keefer 1997; Knack and Zak 2003; Guiso et al. 2008; Ahern et al. 2015). At the regional level, studies have shown that firms headquartered in high-trust regions have lower financing costs, lower risks and higher financial reporting quality (Gray et al. 2013; Garret et al. 2014; Wu et al. 2014; Li et al. 2017). However, few studies have explored social trust at the individual level, which is the focus of our paper.
The heterogeneous reputation of different geographical locations has been examined in a number of studies. For instance, Terracciano et al. (2005) argue that the beliefs held by people regarding others’ characteristics are generated from their (inaccurate) stereotypes. Falk and Zehnder (2013) point out that the reputation of a district impacts peoples’ expectations of the trustworthiness of the local people, and the effects depend on the district’s socioeconomic status and degree of ethnic heterogeneity. Tighe (2011) examined the influence of regional stereotypes on residential intentions, which may trigger concerns among neighbours and community groups, and lead to public opposition to affordable housing.
Ang et al. (2015) find that cultural variations in China are greater than in European countries.
In rational expectations equilibrium models, rational investors have the incentive to acquire costly information from the market-clearing price, which incorporates the aggregated information of the whole market (Grossman and Stiglitz 1980).
Ever since 1945, the economic and social backwardness of a village in Basilicata, depicted in the book “Cristo si è fermato ad Eboli” by Carlo Levi, has aroused the interests of social scientists and non-academic writers. See Ferragina (2009) for an excellent summary.
The influence of these early research efforts was limited due to their incompatibility with the prevailing economic models. However, in response to the emerging criticism of economists who were “busy building models” and incapable of serving public interests in real life (see, for example, Granovetter 1985; McCloskey 1993; Krugman 1996), economic research began to pay more attention to social ties and norms.
Broadly speaking, sociologists and economists describe social actions from two slightly different perspectives (Coleman 1988): one focuses on how the social norms, cultures and informal rules come into being, while the other emphasizes the community-level beneficial outcomes reached by self-interested individuals on the basis of their assessments of others’ credibility. Coleman (1986a, b, 1988) incorporate the components of these two intellectual streams into a theoretical framework of social trust.
Refer to the “Several Provisions on Strengthening the Legal Supervision on the Judgment of the First Instance of Duty Crime Cases (Trial Implementation)” issued by the Supreme People's Procuratorate of China on November 18, 2010.
The results remain robust if we use the Crime measurement of other years as the instrumental variable.
Note that the IV we employ here is the level of duty crimes of a CEO’s hometown, which is not necessarily the place where he or she works.
Anecdotally, when we search “dialect recognizability” on Baidu Search, the most authoritative search engine in China, the most frequently pop-up results are the northeast provinces, which are exactly the provinces with the least diversified dialects in our dataset (among them, Jilin province is the least diversified one). Relatedly, a person from the provinces with high dialect recognizability is much easily recognizable even if they work in faraway regions, compared with a person from a highly-diversified-dialect province (among them, Hunan is the most diversified one). See, for example, https://new.qq.com/omn/20190325/20190325A0BTAB.html?pc (in Chinese).
We thank the anonymous reviewers for pointing out this issue.
Here for brevity we only plot the results of the placebo test with Ncskew as the dependent variable. The evidence also holds if we instead use Duvol, and the results are available upon request.
For brevity, we only report the results with Ncskew as the dependent variable, but the results remain robust if we instead use Duvol. Same for the following tables.
Note that in this regression, to capture the effects of firm’s location-level trust, we cannot control for firm fixed effects for collinearity issues. See also Li et al. (2017).
The results remain robust if we use the alternative proxy Duvol to measure stock price crash risk. In untabulated results, we also use the residuals from the OLS regression in Column (1) as dependent variable, and find it still positively and significantly correlated with CEOTrust.
By simply calculation, the absolute value of the indirect effect of CEOTrust is around |0.525 * (− 0.054)| = 0.028, much smaller in magnitude compared with the estimated absolute value of its direct effect (i.e. 0.167), suggesting the strong explanatory power of CEO’s perceived trustworthiness on stock price crashes beyond the social trust of the firms’ headquarter location.
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We gratefully thank Greg Shailer (the editor) and two anonymous reviewers. We also acknowledge financial support from the National Science Foundation of China (71803018, 71903208), the Program for Innovation Research in Central University of Finance and Economics, and “the Fundamental Research Funds for the Central Universities” in UIBE (CXTD10-03).
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Gu, L., Liu, J. & Peng, Y. Locality Stereotype, CEO Trustworthiness and Stock Price Crash Risk: Evidence from China. J Bus Ethics 175, 773–797 (2022). https://doi.org/10.1007/s10551-020-04631-0
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DOI: https://doi.org/10.1007/s10551-020-04631-0