Individualist-collectivist culture, ownership concentration and earnings quality^*

Abstract

In this study we explore the effects of individualist-collectivist culture, an important dimension of national cultures, on the entrenchment incentives of large shareholders. Specifically, we investigate how individualist-collectivist culture affects the relationship between ownership concentration and earnings quality. We predict that the social connections among corporate insiders are stronger in collectivist societies, thus reducing corporate monitoring efficiency and exacerbating agency problems. Consistent with our prediction we find the poor earnings quality that normally goes hand-in-hand with concentrated ownership, is improved when the firm’s national culture is individualist. We further find that the poor earnings quality induced by ownership concentration is more pronounced in East Asia, where cultures are rooted in Chinese cultures and collectivism. This study sheds light on the role that individualist-collectivist culture plays in shaping corporate insiders’ ethical behavior.

Keywords:

• Earnings quality
• ownership concentration
• cultures
• individualism
• collectivism

JEL Classification:

• G3
• M1
• M4

View correction statement:

Erratum

Acknowledgements

We would like to thank Jeong-Bon Kim (Editor), Sandra Chamberlain (Associate Editor), two anonymous referees, and the seminar participants at University of Macau for their valuable comments and suggestions.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

^* Accepted by Sandra Chamberlain upon recommendation by Jeong-Bon Kim.

1. Hofstede (2001) claims that people’s attitudes toward others are independent of group members in individualist societies. Furthermore, Steensma, Marino, and Weaver (2000) document that people in collectivist societies exhibit a stronger preference for cooperative strategies.

2. Haw et al. (2004) apply the same method to measure accruals quality in a cross-country comparison.

3. Whereas Haw et al. (2004) focus on cash flow – voting right divergence and ownership, our primary focus is on the relation between individualism – collectivism and ownership concentration.

4. Stulz (2005) compares the results of using the two proxies (i.e. closely held ownership extracted from Worldscope vs. family-controlled ownership data developed by La Porta, Lopez-De-Silanes, and Shleifer (1999) and Claessens, Djankov, and Lang (2000)), and shows consistent results to explain the government expropriation risk and shareholders’ anti-director rights. The ownership data reported by Worldscope for block holdings has important limitations because the reporting requirements and accuracy of firm disclosures vary widely across countries. Further, insider ownership consists of the sum of blocks of shares owned, which may include blocks unrelated to the controlling shareholders. Nevertheless, the data from Worldscope has the advantage of providing a measure of fractional cash flow ownership by insiders.

5. To facilitate the interpretation of the coefficient on IDV, the individualism index from Hofstede (2001) is scaled by 100.

6. The revised anti-director rights index is obtained from Djankov et al. (2008). It is an aggregate of six minority shareholders’ legal rights based on laws and regulations applicable to public firms in 2003. It ranges from 0 to 6, with a higher value indicating strong shareholder rights.

7. The positive coefficients on RADR*Own in both columns (4) and (5) are likely to be driven by the high correlation between Origin and RADR (The Pearson correlation coefficient is 0.892 in Table 3).