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Journal of Entrepreneurship and Public Policy Cultural traits and stock market development: an empirical analysis Nabamita Dutta Deepraj Mukherjee

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To cite this document: Nabamita Dutta Deepraj Mukherjee , (2015),"Cultural traits and stock market development: an empirical analysis", Journal of Entrepreneurship and Public Policy, Vol. 4 Iss 1 pp. 33 - 49 Permanent link to this document: http://dx.doi.org/10.1108/JEPP-01-2013-0003 Downloaded on: 20 April 2015, At: 07:28 (PT) References: this document contains references to 50 other documents. To copy this document: [email protected] The fulltext of this document has been downloaded 29 times since 2015*

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Cultural traits and stock market development: an empirical analysis Nabamita Dutta Department of Economics, College of Business Administration, University of Wisconsin, La Crosse, La Crosse, Wisconsin, USA, and

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Deepraj Mukherjee

Cultural traits and stock market development 33 Received 21 January 2013 Revised 11 September 2013 Accepted 12 September 2013

Department of Economics, College of Business, Kent State University, Kent, Ohio, USA Abstract Purpose – During recent times, the stock market has emerged as a major financial institution of an economy. Yet, cross-country differences, in size and role of stock market, persist. The purpose of this paper is to investigate the correlation between cultural traits and the development of the stock market in a country. Considering multiple dimensions of culture, identified in the literature by Hofstede (1980/2001) and World Value Survey, the authors construct the hypotheses: trust, a key cultural trait, should positively influence stock market development; uncertainty avoidance, Hofstede’s cultural dimension should negatively influence the development of the stock market; and individualism, an alternate cultural dimension of Hofstede’s measures, should be positively correlated with stock market development. The cross-country empirical analysis supports the hypotheses. The results hold for multiple measures of stock market development. Design/methodology/approach – This paper investigates the correlation between various cultural traits and the development of the stock market in a country. Specifically, the authors consider three different cultural trait measures. The authors consider a cross-sectional analysis of an extensive number of countries. While all explanatory variables of interest are considered over the period 2000-2007, the authors consider 2008 figures for the dependent variables of interest, financial development. Ordinary least squares is considered as the benchmark specification. Robust regression has been considered as part of robustness analysis. The authors mention throughout the paper that the results stress on significant association between the variables, only. Findings – The empirical results support the hypotheses. The first measure, trust, is positively associated with stock market development of a nation. Statistically, for one standard deviation rise in trust (1 SD ¼ 37.5), stock market capitalization will go up between 11 and 19 percentage points. Uncertainty avoidance, the second measure is negatively correlated and statistically, the impact is much greater. Finally, the third measure, individualism, is positively correlated with stock market development. Statistically, for one SD rise in individualism (SD ¼ 23.9), stock market capitalization will rise by 23 percentage points. Originality/value – Existing literature has stressed the role of cultural traits – trust, uncertainty avoidance, individualism – in the promotion of entrepreneurship, innovation and growth. Since most startups need to raise capital in order to implement their new ideas, cross-country heterogeneity in the strength of capital markets may lead to important differences in entrepreneurship and productivity growth across economies (Greenwood and Jovanovic, 1990; Jayaratne and Strahan, 1996; Levine, 1997; Beck et al., 2000; Guiso et al., 2004). Yet, the link between stock market development and cultural traits has not been established in the literature. This paper aims to fill this missing link. Keywords Social capital, Financial entrepreneurship, Informal institutions Paper type Research paper

The authors would like to thank the editor and the referees for their invaluable comments and suggestions.

Journal of Entrepreneurship and Public Policy Vol. 4 No. 1, 2015 pp. 33-49 © Emerald Group Publishing Limited 2045-2101 DOI 10.1108/JEPP-01-2013-0003

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1. Introduction An extensive array of literature highlights the importance of financial development in terms of promoting entrepreneurship. King and Levine (1993a, b) and Levine (1997) show that individuals, in need of external finance, can access the required capital through developed stock markets. Their work brought prominence to the role of finance in Schumpeter’s creative destruction. Entrepreneurs with new ideas and technologies displace incumbents with old technologies, leading to a continued increase in productivity and economic growth. The crux of this idea relies on a notion that productivity growth in an economy mainly takes place at the extensive margin (i.e. by the birth of new firms and the shutdown of unproductive firms) and not on the intensive margin (i.e. firms becoming more productive internally). Since most startups need to raise capital in order to implement their new ideas, cross-country heterogeneity in the strength of capital markets may lead to important differences in entrepreneurship and productivity growth across economies (Greenwood and Jovanovic, 1990; Jayaratne and Strahan, 1996; Levine, 1997; Beck et al., 2000; Guiso et al., 2004). Recent studies have stressed the role of formal institutions (Huang, 2010; Clague et al., 1996; Olson, 1993) in shaping a developed financial market. Do cultural traits also play a role in stock market development and therefore can explain the cross-country heterogeneity in financial markets? In this paper, we examine the association between several cultural traits and the development of the stock market. The idea of culture adopted in the present paper emerges from three broad definitions provided in the extant literature. Hofstede (1980), in his pioneering study with IBM employees, emphasizes culture as “the collective programming of mind which distinguishes the members of one human group from another.” North (1990) in his seminal article defines culture as “the rules of the game in society or, more formally […] the humanly devised constraints that shape human interaction. In consequence they structure incentives in human exchange, whether political, social, or economic” (North, 1990, p. 3). DiMaggio defines culture as “shared cognition, values, norms, and expressive symbols”. Thus, “culture” in the relevant literature is broadly defined. Hence, in order to understand how culture influences stock market development, we have to find out which cultural traits are relevant for this process and determine how these traits influence the stock market development. We focus on three cultural traits in particular – trust from World Value Survey (WVS) and European Value Survey (EVS) database, uncertainty avoidance (risk aversion), and Individualism/Collectivism. The last two measures are taken from Hofstede’s (2001) analysis. Before proceeding further let us provide the rationale behind exploring the associations of the above mentioned cultural traits and stock market development. Hofstede (1980) refers to uncertainty avoidance as the extent to which people of a culture feel threatened by uncertain or unknown situations and the extent to which people try to minimize such uncertainty. Literature suggests that investors from high uncertainty-avoiding countries are likely to be more conservative and more risk-averse (see e.g. Barberis et al., 1998). High conservatism is likely to be associated with less risky investments and thus we expect a negative relationship between uncertainty avoidance and stock market development. Countries that are more accepting of uncertainty should have well developed stock markets. Another dimension of culture considered by Hofstede is individualism-collectivism (Hofstede, 1980, 1983; Hui and Triandis, 1986; Parson and Shils, 1958; Schwartz, 1990). Individualism refers to a self-orientation, an emphasis on self-sufficiency and control, the pursuit of individual goals that may or may not be consistent with in-group goals,

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a willingness to confront members of the in-group to which they belong, and a culture where people derive pride from their own accomplishments. Collectivism involves the subordination of personal interests to the goals of the larger work group, an emphasis on sharing, cooperation and group harmony, a concern for group welfare, and hostility toward out-group members (Earley, 1989; Hofstede, 1980; Hui, 1988). Extant literature suggests that investors from individualistic countries are more likely to be self-confident; decision oriented, and would be associated with higher willingness to take risk. According to the theoretical frameworks in Daniel et al. (1998) and Shleifer and Vishny (1997), such behavioral characteristics and high risk preference would result in sufficient stock market trading. Hence, we expect a positive association between individualism and stock market development. Trust has been defined differently in the literature. Most definitions view trust as “a psychological state comprising the intention to accept vulnerability based upon positive expectations of the intentions or behavior of another” (Rousseau et al., 1998, p. 395). Trust, that is grounded in mutual respect and shared interests, could be an effective complement (Poppo and Zenger, 2002) or supplement (Das and Teng, 1998) to any formal financial transaction mechanisms. Thus it would be extremely pertinent to observe the association of these traits with the development of the stock market, the link that has not been stressed as yet. This paper aims to fill this missing link and shows that such traits are correlated with stock market development. We should mention at the very onset that we do not claim causation in this paper and only stress on the significant association between the two variables. Based on our empirical analysis, we find that all three measures are strongly correlated with stock market development. The paper opens the door to further empirical research on different cultural aspects and how they affect the different components of stock market development. Section 2 presents a brief theoretical perspective of our analysis. Section 3 explains the data used in the paper. Section 4 presents the empirical model and Section 5 presents our benchmark results. Section 6 mentions the robustness tests and Section 7 concludes. 2. Research background and hypotheses This section introduces a supply-demand framework that determines the stock market capitalization as equilibrium of these two effects. Further, it delineates the relationship between different cultural dimensions and the stock market supply-demand framework. 2.1 Supply of capital funds/investment Supply of capital funds depends on three basic conditions: (1) Large domestic market with strong purchasing power: the availability of funds for investment depends on the purchasing power and financial endowment of the population. This endowment, in turn, is determined by the size of the country and the prosperity of its inhabitants. Capital invested in shares comes from individual and institutional investors. In countries where the institutional investors are less developed, less capital will be available for purchase of shares. Therefore, for a given supply, the price investors will be prepared to pay will be lower and the stock market will remain underdeveloped and vice versa. (2) Choice of stocks as investment options vis-à-vis other assets: the choice of investment depends on the risk and return characteristics of that investment.

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However, the nature of such investments differs, based on investment in stocks (risky) and in alternative safer assets, such as treasury bonds. The attractiveness of investing in shares compared to the other assets will depend on the attitude of investors toward uncertainty. If the cultural orientation of a country is inclined toward risk aversion, investors in that country will be prepared to pay less for a share of a given firm. Further, Hofstede (1980) has shown that the investors in different countries differ in the degree of their uncertainty aversion. (3) Strong regulator environment that protects the investors’ rights: the recent and growing empirical evidence shows that weaker investor protection[1] is associated with lower stock returns in the USA (Gompers et al., 2003; Chen et al., 2004; Cremers and Vinay, 2004; Yermack, 2004). Even more closely related are the findings of Lombardo and Pagano (1999) that show that countries with weak investor protection have lower stock returns. 2.2 Demand for capital funds Demand for capital funds will depend on the costs and benefits of issuance of shares. Flotation costs can have a significant effect on the cost of capital, especially for small issues. For instance, Lee and Kim (1999) use Securities Data Company New Issue database and compute the average flotation cost as a percentage of issue size for equity and debt for the five-year period of 1990-1994. They show that the average equity flotation cost was 7.1 percent for seasoned issues and 11.0 percent for initial public offerings. In addition, with new issues of stocks, company information needs to be published to the stockholders. Such disclosers bear the risk of information leakage to the competitors and are the hidden costs of stock issuance. Existing literature on the benefits of going public (see, e.g. Pagano et al., 1998; Pagano and Roell, 1998; Roell, 1996) find the following: public offering of stocks allow funds so that firms do not have to rely so heavily on debts, issuance of stocks provide publicity, and demand of the stocks reflect the perception about the company by the general investors. How is the above framework of market for equity related to the culture of a nation? First and foremost, trust plays a major role, the trust that the overall stock market system is fair. Trust is partly based on the characteristics of the financial system including the quality of investor protection, its enforcement mechanism, and regulatory environment. In addition, trust also reflects the subjective characteristics of the person trusting. Differences in cultural background, deeply rooted in the system, can create considerable differences in levels of trust across countries. Trust, as a cultural trait, plays a major role in the stock market participation of the potential investors especially when investors are faced with information asymmetry in the stock market or suffer from lack of data to assess it. Furthermore, when mistrust is deeply rooted, people are doubtful about the authenticity of any information and are not willing to alter their portfolio decisions based on the information. Hence there exist considerable differences in levels of trust across countries that can explain the differences in the size of stock markets as well: H1. There should be a positive association between trust, a key cultural trait, and stock market development. How is uncertainty avoidance related to stock market development? Investors in countries where national cultures are uncertainty avoiding are less likely to invest in

the stock market vis-à-vis other forms of secured investments like treasury bonds. Uncertainty avoidance cultures shun ambiguous situations and thus would look for investments that are highly predictable. Consequently, the stock markets in those countries should be ill developed: H2. Uncertainty avoidance, Hofstede’s cultural dimension, and the development of the indigenous stock market should have a negative relationship.

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The cultural trait of individualism might also have a pivotal role in the development of equity markets. In individualistic cultures, emphasis is placed on individuals’ goals over group goals and personal freedom and achievements are valued. Hence, investment in equity, though risky, would be preferred as it might yield more return. Therefore countries that exhibit strong individualistic cultures would see more developed stock markets: H3. Individualism, Hofstede’s cultural dimension should be positively correlated with the expansion of the stock market. 3. Data Our data comes from several different sources. Data used for one of our explanatory variables, trust, comes from the integrated data set of World Values Survey (WVS) and EVS[2]. The WVS has been implemented in five waves so far: 1981-1984, 1990-1993, 1995-1997, 1999-2002, and 2005-2008. For our benchmark specifications, we consider the fifth[3] wave of this survey that covers the greatest number of countries. As part of robustness analysis, we have checked our results with all the waves. The next section elaborates more on this. The WVS and EVS surveys measure trust based on the following question “Generally speaking, would you say that most people can be trusted or that you can’t be too careful in dealing with people?” The measure is constructed by calculating the percentage of respondents who answer that “most people can be trusted” and the particular percentage gives the level of trust for each country for the particular time period. Hofstede’s “dimensions of culture” – uncertainty avoidance and individualism – are derived mainly from his book Culture’s Consequences, Comparing Values, Behaviors, Institutions and Organizations Across Nations (2001). According to Hofstede (2001), uncertainty avoidance measures the extent to which members of an organizational society feel threatened by and try to avoid future uncertainty or ambiguous situations. Hofstede (2001) points out that the uncertainty avoidance index (UAI) can be computed on the basis of the country mean scores for the following three questions: (1) Rule orientation: agreement with the statement “Company rules should not be broken -even when the employee thinks it is the company’s best interest.” (2) Employment stability: employee’s statement that they intend to continue with the company for two years at most, from two to five years. (3) Stress: as expressed in the mean answer to the question “How often do you feel nervous or tense at work?” UAI is computed by the following method: UAI ¼ 300−30(mean score rule orientation)– (% intending to stay less than five years)−40 (mean stress score). Hofstede measured Individualism through factor analysis. Individualism is mainly composed of the following factors: personal time, freedom, challenge, use of skills, physical conditions, and training.

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The primary dependent variable in this study is stock market development taken from the Beck et al. (2000) database. Our benchmark measure for stock market development is stock market capitalization over GDP. It equals the value of listed shares divided by GDP. There are limitations with this measure; for example, large markets do not necessarily function well and taxes may distort incentives to list companies. Still, the market capitalization ratio as an indicator of stock market development under the assumption that stock market size is positively correlated with the ability to mobilize capital and diversify risk is widely used in the literature. We use two alternative measures as part of robustness analysis[4] – stock market total value traded to GDP and stock turnover ratio. The value traded ratio measures the organized trading of firm equity as a share of total output. Though it is not a direct measure of theoretical definitions of liquidity, high turnover is often used as an indicator of low transactions costs. The turnover ratio complements market capitalization. A large but inactive market will have a large market capitalization ratio but a small turnover ratio. Turnover also complements the total value traded ratio. The controls used are GDP, GDP growth, a proxy of formal institution from polity IV database (democracy), trade openness, legal origin dummies, and regional dummies. 4. Empirical model Our benchmark specification is as follows: SDi ¼ a1 þ a2 Culturei þ a3 X i þ ei

(1)

where the dependent variable, SDi, represents stock market development in country i, for which we consider 2008 figures. The independent variable, Culturei, represents a particular cultural trait for country i. As mentioned before, we capture Culture by the following variables namely: trust, uncertainty avoidance index, and individualism. Trust, as mentioned above, indicates to what extent individuals trust a broader group of people versus a narrower group. It is quite reasonable to assume that the more an individual trusts the system in general, the more investors’ right would be protected. Additionally, one would be prone to engage in stock market transactions and will have greater faith in the regulatory system of the stock market. Therefore it would expand the volume of stock transactions and, thus, the capitalization in the market. Therefore we should expect a positive and significant sign of the estimated coefficient of trust. Low uncertainty avoidance (UAI) score for a country indicates that it has less concern about ambiguity and uncertainty and has more tolerance for a diversity of opinions. This is reflected in a society that is less rule oriented, that readily accepts change and takes greater risk. Therefore we should expect an inverse relationship between UAI and stock market development. That is, high UAI should be correlated negatively with stock market development. Individualism is a cultural trait in which the dominant values in society are personal freedom and success. Thus the regulatory system in such a society would provide competition. Further, entrepreneurship and risk taking actions are promoted in an individualistic culture as those might yield higher return. Hence, we can expect a positive and significant coefficient associated with this variable. Xi denotes the matrix of control variables for country i. α2 is our coefficient of interest that represents the correlation between stock market development measure and a measure of cultural trait. εi denotes the random error term. As explained before, as part of benchmark specifications, we consider cross-sectional specifications.

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The main reason for this is that the different time periods for which the different measure of culture are available do not allow us to build a panel. Thus, we rely on crosssection specifications. For our “trust” measure, we consider the last wave “2005-2008” from WVS and EVS that covers the largest number of countries. In the case of Hofstede’s dimensions of uncertainty avoidance, and individualism, the scores are retrieved from Hofstede’s (1980/2001) book Culture’s Consequences: Comparing Values, Behaviors, Institutions and Organizations across Nations. Culture evolves gradually over time thus cultural characteristics do not change much over the span of a few years. Therefore, Hofstede’s scores are roughly constant over the years. The country scores on the dimensions are relative – societies are compared to other societies. The basic belief behind using Hofstede’s scores is that factors that cause cultures to shift tend to be global or continent-wide, a belief rooted in Cultural Convergence Theory (Barnett and Kincaid, 1983). This means that they affect many countries at the same time, so that if their cultures shift, they shift together, and their relative positions remain the same. We further want to reiterate that though we attempt to explain significant correlations in this paper, in order to address endogeneity, we consider all our explanatory variables in lagged form. Taking into account all the different time periods for which the culture measures exist, we choose 2008 as the year for which the dependent variable is considered so that all the explanatory variables are in lagged form. Since no consistent time period is available for our measures of cultural dimensions, we consider averages of all the controls from 1980 to 2007. Further, crosssectional specifications help us to take into account long term changes. Trust is the only measure that can allow us to build a panel since it is available over different waves. As part of robustness analysis, we recheck our results with panel data. The construction of the panel and the results are explained in the robustness section. We should mention at the very onset that we run separate specifications for the different measures of culture. As mentioned in the hypothesis, our main aim is to test how the different traits of culture affect stock market development. These measures assess different cultural traits and hence, we expect different signs for the correlation coefficients. We do not include them in the same specification as the measures are significantly correlated. For our benchmark analysis, we test the correlations in separate regressions. As part of robustness analysis, we check the results by creating an index with the different cultural traits. 5. Benchmark results In Table I, we list top ten countries in terms of their stock market development figures, based on our benchmark measure. We also list the cultural scores for these countries. As we can see, the top ten countries in terms of stock market capitalization as a percentage of GDP also have higher levels of trust, with the exception of some countries like Malaysia, Singapore and South Africa. Thus, even before any empirical analysis, the data points to some potential correlation between stock market capitalization and trust. Similarly, all the countries have low UAI. This further corroborates the fact that countries with low UAI are risk takers, indicating a negative correlation. Data points reveal a less significant association with the individualism component of culture for the top ten countries. The Asian countries of Malaysia, Hong Kong, and Singapore have low scores on individualism that is hardly surprising, given the collectivistic cultural patterns of these countries. Empirical analyses reported below further support our observations.

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Table II reports the correlation matrix. It displays the correlation among the different culture measures as well as the other variables. Tables III-V report the results of ordinary least square (OLS) specifications with robust standard errors. In Table III, we use our benchmark measure of stock market development for testing our hypotheses. The cultural trait considered is trust from WVS and EVS survey. While in column (1) we do not include controls, controls are included in subsequent columns. The coefficient of trust is positive and significant for all columns, implying that with higher trust, there is greater stock market development for a country. Statistically, for a one standard deviation increase in trust (1 SD ¼ 37.5), stock market capitalization will increase to between 11 and 19 percent of GDP. Among the controls, GDP and GDP growth lose their significance once we control for democracy, legal origin dummies and regional dummies. The coefficients of trade and democracy are significant. The legal origin dummies as well as the regional origin dummies are significant. In Table IV, we consider the other cultural trait mentioned in our hypothesis – UAI. As the results show, the coefficient of UAI is negative and significant for all the specifications. This confirms our hypothesis that with higher UAI, stock market development is hampered. In terms of statistical significance, for one standard deviation rise in UAI, stock market capitalization will be reduced between 22 and 44 percentage points (specifications (1)-(3)). Apart from legal origin dummies and regional dummies, the other controls are not significant for the alternate measure.

Country

Table I. Top 12 countries in terms stock market capitalization and corresponding cultural traits

Stock mkt. cap./GDP

Trust

UA index

Ind.

6.0 3.2 3.1 1.8 1.7 1.7 1.7 1.6 1.5 1.5 1.4 1.4

69.7 77.8 24.6 9.7 65.8 52.8 17.2 80.6 122.1 59.2 183.2 42.9

29.0 58.0 49.0 36.0 48.0 40.0 8.0 51.0 59.0 46.0 29.0 35

25.0 68.0 65.0 26.0 80.0 48.0 20.0 90.0 63.0 91.0 71.0 89

Hong Kong, China Switzerland South Africa Malaysia Canada India Singapore Australia Finland USA Sweden UK

Stock mkt. cap. Trust

Table II. Correlation coefficients

Stock mkt. cap. Trust UA Individualism GDP (PPP) GDP growth Trade Democracy Note: *p o0.1

1 0.21 −0.43* 0.11 0.07 0.29* 0.42* 0.27*

1 −0.35* 0.40* 0.15 0.07 −0.04 0.25*

UA

Individualism

GDP (PPP)

GDP growth

1 −0.23 −0.07 −0.36* −0.42* −0.19

1 0.32* −0.42* −0.12 0.56*

1 0.004 −0.24* 0.18

1 0.17 −0.28*

Trade Democracy

1 0.05

1

Independent variables

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Trust

Dependent variable: stock market capitalization as a ratio of GDP (1) (2) (3)

0.00319* (0.00165) Trade 0.00380*** (0.000938) GDP (PPP, 2005, in billions) – 0.0001 (0.0001) GDP growth – 0.0154 (0.0731) Democracy – 0.104** (0.0423) Legal origins No No Yes Regional dummies No No Yes Constant 0.727*** −0.108 −0.710 (0.137) (0.419) (0.428) Observations 59 59 54 R2 0.044 0.246 0.355 Notes: Robust standard errors in parentheses. ***p o0.01; **p o0.05; *p o 0.1

Independent variables UA index Trade

0.00506* (0.00263) –

41

Table III. Impact of trust on stock market development

Dependent variable: stock market capitalization as a ratio of GDP (1) (2) (3) −0.0182** (0.00711) –

GDP (PPP, 2005)



GDP growth



Democracy



Legal origins Regional dummies Constant

0.00523** (0.00254) 0.00580 (0.00419) 0.0001** (0.0001) 0.100** (0.0484) –

Cultural traits and stock market development

−0.0197** (0.00890) 0.00462 (0.00582) 0.0002*** (0.0003) −0.105 (0.172) –

No No No No 2.238*** 2.424* (0.568) (1.240) Observations 49 36 R2 0.181 0.259 Notes: Robust standard errors in parentheses. ***p o0.01; **p o0.05; *p o 0.1

−0.00641* (0.00368) 0.00123 (0.00115) 0.0001 (0.0001) 0.0989 (0.0712) 0.0959 (0.0609) Yes Yes 0.318 (0.772) 48 0.309

Table V considers our third measure of cultural trait based on our hypothesis – individualism. As we can see from the table, the coefficient of individualism is positive and significant for all the specifications, confirming our hypothesis. Statistically, for one standard deviation rise in individualism (SD ¼ 23.9), stock market capitalization will rise by 23 percentage points. Apart from the dummies, the controls, again, are not significant. 6. Robustness We conduct various robustness tests to check our results. These include constructing an index with the benchmark measures of culture, checking our results to alternate

Table IV. Impact of uncertainty avoidance index on stock market development

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Independent variables

Dependent variable: stock market capitalization as a ratio of GDP (1) (2) (3)

Individualism

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Table V. Impact of individualism on stock market development

0.00847* 0.00962* (0.00437) (0.00476) Trade 0.00157 0.00201 (0.00101) (0.00151) GDP (PPP, 2005) 0.0001 0.0002 (0.0004) (0.0003) GDP growth 0.134** 0.135 (0.0629) (0.0908) Democracy 0.0482 0.0623 (0.0288) (0.0551) Regional dummies No No Legal origins No No Constant −0.363 −0.624 (0.335) (0.683) Observations 48 48 R2 0.232 0.303 Notes: Robust standard errors in parentheses. ***p o0.01; **p o0.05; *p o0.1

0.0125* (0.00656) 0.00290 (0.00187) 0.0003 (0.0003) 0.0997 (0.102) 0.0498 (0.0640) Yes Yes −1.039 (0.716) 48 0.365

model specifications, considering panel specifications for an alternate index of culture and considering alternate measures of stock market development. So far we have considered the different cultural traits in separate specifications. As evident in Table II, the different cultural traits are significantly correlated. Thus, including them together in the same specification will result in multicollinearity issues. So, instead, we create an index of culture via principal component analysis (PCA)[5] with the different measures of culture. The results are presented in Table VI.

Culture index GDP (PPP, 2005)

(2)

(3)

(4)

0.218* (0.142) 0*** (0) 0.0910 (0.162) 0.132*** (0.0453) 0.0110 (0.00884) – – –

0.182** (0.0841) −0 (0) 0.0752 (0.0886) 0.0585 (0.0370) 0.00295* (0.00161) Yes Yes No

0.204** (0.0855) −0 (0) 0.0774 (0.0892) 0.0473 (0.0383) 0.00305* (0.00156) Yes Yes 0.451** (0.212) −0.187 (0.330) 42 0.470

GDP growth



Democracy



Trade



Regional dummies Legal origin Colonial dummy

– – –

1.045*** −0.661 −0.223 (0.144) (0.843) (0.327) Observations 43 31 42 R2 0.099 0.473 0.434 Notes: Robust standard errors in parentheses. *** p o0.01; **p o 0.05; *p o0.1 Constant

Table VI. Impact of culture index on stock market development

(1) 0.236*** (0.0857) –

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While column (1) presents the results from a univariate regression, we add controls in the subsequent columns. For all the columns, the coefficient of culture is positive and significant. We also add a dummy based on whether a country had been an ex-colony or not. Our results remain robust to the inclusion of the colonial dummy variable. In fact, the coefficient of the dummy is positive and significant. Trade remains significant for most of the specifications. Our data certainly contains outliers that can distort the OLS estimates. If outliers are present in the data, Koenker and Bassett (1978) suggested quantile regression methodology. Quantile regression provides information of location shift both in terms of central tendency location and also other quantile locations (Koenker and Bassett, 1978). Hence, more than one regression line can be modeled, covering the whole conditional distribution including the outliers. Quantile regression, thus, reveals information about the relationship between variables that OLS fails to capture. Therefore, we check our results with quantile regressions. The results are reported in Table VII. The results for the different measures of culture are presented in the different columns. The results remain robust to the alternate model. Previous studies have shown that inflation can have a significant impact on stock market development of a nation (Rousseau and Wachtel, 2002; Hondroyiannis and Papapetrou, 1996). The results showed a significant and negative relationship between inflation, credit, and cash debts. The recognized threshold level of inflation was 14 percent. The inflation relation was strongly negative and significant before threshold but was negative and insignificant after threshold. We also check our results after controlling for legal origin dummies and regional[6] dummies and the results stay robust. As explained before, due to the absence of common time periods among the different measures of culture, it is a challenge to construct a panel in order to test our hypothesis. Instead we consider a measure of culture that is popular in the literature and test our

Cultural traits and stock market development 43

Dependent variable: stock market capitalization as a ratio of GDP (1) (2) (3) Trust Uncertainty avoidance Individualism 0.00663** −0.00822 (0.00250) (0.00529) Trade 0.00314** 0.00125 (0.00140) (0.00135) GDP (PPP, 2005) 0 0 (0) (0) GDP growth 0.0896 0.160* (0.0767) (0.0852) Democracy 0.00856 0.125*** (0.0349) (0.0387) Inflation 0.00128 0.00113 (0.000958) (0.00110) Colonial dummy 0.389 0.0532 (0.243) (0.251) Constant −0.357 −0.119 (0.410) (0.662) Observations 54 48 Notes: Standard errors in parentheses. ***p o0.01; **p o0.05; *p o0.1 Culture measure

0.00979* (0.00556) 0.00219* (0.00121) 0 (0) 0.229*** (0.0740) 0.0799* (0.0431) 0.00104 (0.000987) 0.262 (0.217) −1.167** (0.441) 48

Table VII. Quantile regressions: impact of uncertainty avoidance index on stock market development

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hypothesis. This measure incorporates trust and some other cultural traits that are important in shaping the cultural outlook of a nation and, thus, affecting its stock market development. The aggregate index of culture used in the paper has been constructed by Tabellini (2007) by using the first principal component of four important traits namely trust, respect, control,[7] and obedience. These traits are considered from WVS and EVS surveys. Along with trust comes respect and, thus, it should be positively correlated with stock market development. Control implies greater control over one’s life and, thus, individuals will invest greater effort toward controlling their financial situation as well. Finally, Obedience (see, definition in the footnote), suggest less risk taking behavior and thus, lower investment in stock market. We run both OLS and quantile specifications. Though our results remain robust to both specifications, keeping the space constraint in mind, we present the results only for quantile specifications. Table VIII presents the results with this index of culture. We include several proxies of formal institutions and present the results in the different columns. The coefficient for the index of culture is positive and significant for all the alternate specifications. As can be seen from the tables, some of the controls gain or lose significance as control variables are added subsequently. For example, in Table IV, while trade is not significant in the specification in column (2), it becomes significant when democracy is included as a separate control in column (3). As we include democracy, we find that the significance of trade is enhanced as well. One of the reasons this can happen is due to the correlation between trade and democracy. But as we can see from Table II, the correlation between trade and democracy is not significant. Yet, stock market development is correlation with both the variables. Thus, as we include both variables, R2-values increase. In order to test for possible bias due to multicollinearity, we check the variation inflation factor (VIF). Extant literature suggests that a VIF of less than ten does not call for a concern in (1) Informal

Table VIII. Quantile regressions (panel): impact of uncertainty avoidance index on stock market development

0.0510** (0.0216) Regional dummies No Legal origin No GDP (constant, US 0.0001*** $, in billions) (0.00004) Trade 0.00119 (0.000792) Gross capital – formation Initial executive – constraints (1970) Expropriation risk – (1982-1997) ELF index –

(2)

(3)

(4)

0.0668*** 0.0609*** 0.0615*** 0.0475** (0.0159) (0.0181) (0.0189) (0.0212) Yes Yes Yes Yes Yes Yes Yes Yes 0.0001*** 0.0001*** 0.0002*** 0.0002*** (0.00003) (0.00004) (0.00004) (0.00005) 0.00414*** 0.00414*** 0.00777*** 0.00433*** (0.000403) (0.000460) (0.00100) (0.000894) – −0.00224 – – (0.00578) – – −0.0402** – (0.0169) – – – −0.0271 (0.0318) – – – –

−0.00650 −0.426*** −0.334* −0.379*** (0.121) (0.113) (0.198) (0.131) Observations 131 131 128 97 Notes: Standard errors in parentheses. ***p o0.01; **p o 0.05; *p o0.1

Constant

(5)

−0.0389 (0.276) 109

(6) 0.0728* (0.0406) Yes Yes 0.0001 (0.00008) 0.00416** (0.00189) – – – 0.244 (0.320) −0.439 (0.290) 103

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terms of multicollinearity (Hair et al., 1995). Our VIFs for all the specifications are less than ten. Thus, it seems like our estimates are not hugely biased due to multicollinearity issues. We consider several robustness tests to check our results. Alternate measures of stock market development are considered from Beck et al. (2000) database. These measures are stock market total value traded to GDP and stock market turnover ratio. We have not reported these results. They are available on request. In the case of trust, for both the alternate measures, the coefficient of trust is positive and significant. Statistically, the correlation is the strongest for the stock market total value traded to GDP measure – 1 SD increase in trust improves stock market total value traded to GDP by almost 38 percentage points. In the case of UAI , the coefficient of trust is negative and significant for the stock market total value traded to GDP measure, but not for the other measure. 7. Conclusion In this paper, we establish a link between alternate measures of cultural traits and different measures of stock market development considering a cross-section of countries. We confirm that heterogeneity in the stock market development, among other factors, can be traced to the different values and norms of the indigenous societies across the globe. Empirically, our results point to a significant positive association between trust and stock market development. Our results also show that the relationship between stock market development and uncertainty avoidance is negative, but the relationship with Individualism is positive. Thus, societies with a greater trust level; that are more individualistic, and are willing to undertake greater risk, will experience faster growth in their stock markets. The results have strong policy implications for entrepreneurship, innovation and growth. New business creations and entrepreneurship, key engines of growth essentially rely upon the ability of borrowing funds from the market that in turns depend on strong and efficient financial market. We conclude that the heterogeneity in the sizes of stock markets is not going to disappear only with the process of economic growth and prosperity. Hence, globally cultural convergence toward accepting uncertainty, increasing mutual trust, and promoting an individualistic view is a key to reach economic prosperity that is the aim of many developing countries. The differences in the size of stock markets are the result of the value structures that are deeply embedded in the indigenous culture. Over the time, the heterogeneity among the size and role of the stock market will diminish gradually as cultures across the globe evolve through the process of “creative destruction[8].” Finally, we want to mention that our results should be interpreted with caution. We are not inferring any causality in our analysis. A more developed stock market may improve the trust of the investors, who may be encouraged to invest. It could also be argued that rather than individualism driving the stock market development of a country, a sound and healthy stock market, a sign of a strong and robust economy, makes the country individualistic with more financial freedom. All these arguments suggest there could be a reverse causality present in the model that needs further investigation. Integrating cultural traits and its several dimensions into research related to the macroeconomic indicators, is a recent phenomenon. We sincerely hope that the present attempt will stimulate research interests along these lines.

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Notes 1. In this context, La Porta et al. (1998) have shown that there is a positive relationship between the size and scope of capital markets and investor protection. Also, they have shown cross-country differences in investor protection can be explained by legal origins. Thus, we have controlled for legal origins in our specifications. 2. The WVS and EVS surveys are mainly based on opinion polls covering various topics encompassing subjective measures of cross-country values and beliefs.

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3. In a future research endeavor, we aim to undertake a detailed panel analysis to investigate the causation between different cultural traits and stock market development. We aim to include all waves for such an analysis. 4. Measures like average age of companies or net proceeds from IPOs would be very useful measures, but data for such measures on a cross country basis is hard to find. Such data is more available for micro studies. As a future research endeavor we think it might be interesting to re-check our findings for a micro sample using such measures. 5. PCA, a multivariate statistical technique, is used to examine relationships among different quantitative variables. This method can be used to reduce the number of variables in a data set into a smaller number of “dimensions”. Mathematically speaking, if there are n correlated variables, PCA generates uncorrelated indices or components, where each component is a linear weighted combination of the n variables. For example for a set of variables: X1, X2, …, Xn PC 1 ¼ w11 X 1 þw12 X 2 . . . þ w1n X n . . .: . . .: PC m ¼ wm1 X 1 þwm2 X 2 . . . þwmn X n where, wmn represents the weight for the mth principal component and the nth variable. These weights are the eigenvectors of the co-variance matrix (since we have standardized our data; otherwise it is the correlation matrix). The eigenvalue of the corresponding eigenvector is the variance (σ) for each principal component. The first principal component, PC1 explains P the largest possible variation in the data set subject to the constraint, ni¼1 w21i ¼ 1. Since the sum of the eigenvalues equals the number of variables in the original data set, the proportion of total variation accounted for by each principal component is the ratio sni . Similarly, all subsequent principal component ðPC 2 ; . . . ; PC n Þ are uncorrelated with the previous principal components but explain smaller and smaller proportions of the variation of the original variables. 6. The results are available on request. 7. The variable control is defined by the average response (multiplied by 10) of the following question: “Some people feel they have completely free choice and control over their lives, while other people feel that what we do has no real effect on what happens to them. Please use this scale (from 1 to 10) where 1 means “none at all” and 10 means “a great deal” to indicate how much freedom of choice and control in life you have over the way your life turns out.” The trait, respect, is constructed by the percentage of people for various countries that has responded that the quality “tolerance and respect for other people” as being important. The specific question asked in the survey is “Here is a list of qualities that children can be encouraged to learn at home. Which, if any, do you consider to be especially important? Please choose up to five.” The final trait “obedience” is defined as the percentage of respondents who believe that that obedience is an important quality for children. 8. As Cowen (2002) explains, creative destruction in the case of culture implies the alteration and recreation of different cultures of the world through the process of intermingling.

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Rousseau, D.M., Sitkin, S.B., Burt, R.S. and Camerer, C. (1998), “Not so different after all: a cross-discipline view of trust”, Academy of Management Review, Vol. 23, pp. 393-404. Rousseau, P.L. and Wachtel, P. (2002), “Inflation thresholds and the finance-growth nexus”, Journal of International Money and Finance, Vol. 21, pp. 777-793. Schwartz, S.H. (1990), “Individualism-collectivism: critique and proposed refinements”, Journal of Cross-Cultural Psychology, Vol. 21 No. 2, pp. 139-157. Shleifer, A. and Vishny, R. (1997), “The limits of arbitrage”, Journal of Finance, Vol. 52, pp. 35-55. Tabellini, G. (2007), “Culture and Institutions”, CEPR Discussion Papers No. 6589, CEPR. World Bank (2010), “World Development Indicators”, Online Database. Yermack, D. (1996), “Higher market valuation of companies with a small board of directors”, Journal of Financial Economics, Vol. 40, pp. 185-211. Yermack, D. (2004), “Remuneration, retention, and reputation incentives for outside directors”, The Journal of Finance, Vol. 59, pp. 2281-2308. About the authors Nabamita Dutta is an Assistant Professor of Economics at the University of Wisconsin, La Crosse. She received her PhD in Economics from the West Virginia University in 2009. Her research focus consists of institutional economics, development economics and labor economics. Broadly speaking, her papers explore the role played by various types of institutions in economic development. Nabamita Dutta is the corresponding author and can be contacted at: [email protected] Deepraj Mukherjee is an Assistant Professor of Economics at the Kent State University. He received his PhD in Economics from the University of Memphis. His areas of specializations are international trade and development, and cross-cultural issues in international business.

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