CULTURAL DISTANCE AND BOND PRICING: EVIDENCE IN THE YANKEE AND RULE 144A BOND MARKETS

• Author: Hui Zhu,Kelly Cai
• Date: 01 September 2014
• Published date: 01 September 2014
• DOI: http://doi.org/10.1111/jfir.12040

CULTURAL DISTANCE AND BOND PRICING: EVIDENCE IN THE YANKEE

AND RULE 144A BOND MARKETS

Hui Zhu

University of Ontario Institute of Technology

Kelly Cai

University of Michigan–Dearborn

Abstract

In this article we examine the impact of cultural distance on the pricing of corporate bonds

issued in the United States. We find that greater cultural differences between U.S.

investors and foreign issuers increase the cost of debt. We also find that the cost of Rule

144a offers is less sensitive to cultural distance and creditor protection effects because of

the different market structure and investor bases in the Yankee and Rule144a bond

markets. Our results suggest that cultural differences influence bond pricing through an

information asymmetry channel.

JEL Classification: G12, G15, G34

I. Introduction

In this article we examine whether cultural differences between borrowers and lenders

influence non‐U.S. firms’cost of debt in the Yankee and Rule 144a bond markets. Studies

have identified that cultural differences have a profound impact on corporate financial

decisions and economic development.

1

Although cultural distance can be used to measure

the degree to which shared norms and beliefs differ from one country to another, people

from dissimilar cultures are less likely to build trust with one another, and there are more

uncertainties in predicting the behavior of others as well. Consequently, for corporate

bonds issued in the United States by foreign firms, cultural differences may increase the

cost of information gathering and may serve as a measure of information asymmetry

between creditors (U.S. investors) and issuers (foreign firms).

The literature on the cost of debt suggests that information asymmetry between

borrowers and lenders increases the credit premium required by investors (Wittenberg‐

Moerman 2010; Derrien et al. 2012). In the context of international capital markets, it has

been argued that a relatively high level of differences in accounting disclosure

requirements and legal protections is likely to lead to an increase in information

We are grateful to the associate editor (Andy Naranjo) and Eastern Finance Association 2014 conference

participants for valuable comments and constructive suggestions.

1

For example, Fan, Titman, and Twite (2012) suggest that national culture determines the capital structure

choice. Zheng et al. (2012) find that even after controlling for legal, political, and financial systems, national culture

significantly influences the maturity of corporate debt.

The Journal of Financial Research Vol. XXXVII, No. 3 Pages 357–383 Fall 2014

357

© 2014 The Southern Finance Association and the Southwestern Finance Association

RAWLS COLLEGE OF BUSINESS, TEXAS TECH UNIVERSITY

PUBLISHED FOR THE SOUTHERN AND SOUTHWESTERN

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asymmetry between investors and foreign borrowers. Therefore, investors may demand

higher yield spreads to ameliorate this uncertainty, especially to issuers domiciled in

countries with weak investor protection provisions (La Porta et al. 1997; Miller and

Puthenpurackal 2002; Qian and Strahan 2007; Miller and Reisel 2012).

In this article, we extend the literature by considering the impact of culture

distance in determining a foreign firm’s cost of debt in the two U.S. corporate bond

markets: the public Yankee bond market and the privately placed Rule 144a bond market.

We use a sample of Yankee bonds and Rule 144a bonds issued by foreign firms from 37

countries during 1996–2012 as these are two major markets that foreign firms use to

borrow U.S. dollars in the United States.

2

We examine several important issues in the two U.S. corporate bond markets that

have not yet been addressed in the literature. First, we test whether a greater cultural

difference between the United States and other countries increases the cost of debt for

issuers domiciled in non‐U.S. countries. Following Kogut and Singh (1988) and

Morosini, Shane, and Singh (1998), we measure the multidimensional cultural differences

between the United States and other countries by using Hofstede’s (2001) four dimension

scores: uncertainty avoidance, individualism, masculinity, and power distance.

3

We find

that greater cultural differences between U.S. investors and foreign domiciled issuers

increase the cost of debt in both the Yankee and Rule 144a bond markets. Our findings are

robust to controlling for a country’s legal environment, financial development, prior U.S.

public debt, and equity listing. We interpret our results as consistent with the asymmetric

information hypothesis (Wittenberg‐Moerman 2010; Halov and Heider 2011; Derrien

et al. 2012). Cultural dissimilarities increase the cost of information gathering; thus, bond

issuers from countries with a greater cultural difference with the United States may be

considered risker by U.S. investors. Therefore, U.S. investors typically require a higher

yield for the bonds issued by these foreign firms.

In addition, we address the consequences of the four subcomponents of cultural

differences separately. The four subcomponents are defined as the absolute value of the

difference between the issuing country and the United States on Hofstede’s (2001) four

cultural dimensions. We find a positive relation between the cost of debt and uncertainty

avoidance subcomponent (UAI), and the individualism subcomponent (IDV). The

dimension of uncertainty avoidance measures the level of acceptance of uncertainty and

ambiguity (i.e., risk aversion level of a country). In contrast, the individualism dimension

is linked to overconfidence behavior (Chui, Titman, and Wei 2010) and overconfidence in

the perception of risk (Hackbarth 2008). The results suggest that risk‐averse U.S. creditors

may demand higher yields when their risk preference and interpretation of risk are

different from foreign borrowers.

2

Non‐U.S. firms can also borrow in the eurodollar market. However, eurodollar bonds are issued in bearer

(unregistered) form, which is different from Yankee bonds and Rule144a bonds. Also, the primary market for

eurodollar bonds is in London, not in the United States.

3

Long‐term orientation is a fifth dimension, developed later based on the Chinese Value Survey of students,

which covered only 23 countries. Long‐term orientation emphasizes a forward‐looking perspective. However,

because the long‐term orientation dimension has a quite different sample coverage as compared to the other four

dimensions, it is not comparable to them and thus is excluded from our study.

358 The Journal of Financial Research