Managerial Social Capital and Financial Development: A Cross‐Country Analysis

Date01 February 2016
Published date01 February 2016
The Financial Review 51 (2016) 37–68
Managerial Social Capital and Financial
Development: A Cross-Country Analysis
David Javakhadze
Florida Atlantic University
Stephen P. Ferris
University of Missouri
Dan W. French
University of Missouri
This study examines the issue of whether managerial social capital, defined as aggregate
benefits of social obligations and informal contacts formed through social networks, has an
impact on financial development. Utilizing a large cross-country sample for the period 1999–
2012, we provide evidence that higher levelsof social capital have a positive effect on financial
development. We are able to examine different types of social connections for our sample
firms and find that informal and nonprofessional relationships matter the most for financial
market development. These findings are robust to alternative model specifications, variable
measurement, and estimation techniques.
Keywords: s ocialcapital, social networks, financial development
JEL Classifications: F19, G29, Z13
Corresponding author: University of Missouri, Robert J. Trulaske,Sr. College of Business, 407 Cornell
Hall, Columbia, MO 65211; Phone: (573) 882-6688; E-mail:
The authors acknowledge assistance from Chris Try and Joseph Guagenti of BoardEx and Lada Micheas
from the University of Missouri Social Science Statistics Center. We also appreciate helpful comments
from Mary Lynn Davidek.
C2016 The Eastern Finance Association 37
38 D. Javakhadze et al./The Financial Review 51 (2016) 37–68
1. Introduction
A considerable body of modern finance and economics literature documents
a strong positive relation between the level of financial development, defined as
the ease with which any entrepreneur or company with a sound project can obtain
financing (Rajan and Zingales, 2003), and economic growth in countries around the
world (Demirg¨
uc-Kunt and Maksimovic, 1998; Levine and Zevros, 1998; Levine,
2003; Demetriades and Andrianova, 2004; Bekaert, Campbell and Lundblad, 2005).
Because the factors that determine financial development are not fully understood,
examining these factors has become an increasingly important research topic in recent
Both theory and some exploratory survey evidence suggest that social capital,
defined as the information, trust, and norms of reciprocity inherent in a social network
(Woolcock, 1998), could be an important determinant of financial development.
Empirical investigation of a link between social capital and financial developmentto
date, however, has been limited. This is surprising in light of our existing theoretical
and empirical knowledge regarding the determinants of financial development. The
purpose of this study is to address that omission by investigating the implications
of social capital for financial market development. Particularly, we ask the question:
does the social capital in managerial social networks with financiers affect national
financial development?
Social capital is emerging as one of the most prominent topics in modern social
science research. It can encourage certain socioeconomic effects that have the po-
tential to facilitate national economic development. At the same time, improvements
in social capital have been associated with democratic participation and the support
of democracy. Powerful agents such as the World Bank and various national gov-
ernments have embraced social capital as a strategy to mitigate market shortcomings
and minimize reliance on costly state interventions to promote financial development
(e.g., Dasgupta and Serageldin, 2000; Woolcock and Narayan, 2000; Grootaert and
Van Bastelaer, 2002; Bebbington, Guggenheim, Olson and Woolcock, 2004).
Social capital alleviates potential impediments to financial developmentthrough
its effects on trust, information-sharing, and contract enforcement. Baier (1986, pp.
234–235) defines trust “as the trustor’s expectation of being the recipient of the
trusted party’s good will.” Trust is important because, as La Porta, Lopez-de-Silanes,
Shleifer and Vishny (1997) argue, public and private institutions, including financial
markets, are less effective in countries exhibiting lowlevels of trust. Guiso, Sapienza
and Zingales (2004) posit that financial exchange depends not only on the legal
enforceability of contracts, but also on the extent to which both parties of a financial
contract trust each other. Guiso, Sapienza and Zingales (2008) show that a lack of
1Existing studies discuss a large number of exogenous and endogenous factorsthat could explain financial
development: legal tradition, institutions, macroeconomic policies, openness, political economy factors,
geography, and culture (for an extensivereview, see Huang, 2010).
D. Javakhadze et al./The Financial Review 51 (2016) 37–68 39
trust reduces the demand for equity, and therefore, firms findit more difficult to raise
equity capital in a low-trust environment. They find that trust has a positive effect
on stock market participation and conclude that differences in trust help to explain
cross-country differences in financial development.
Social capital induces efficiency within the social structure because it provides
a means of creating trust (Dasgupta, 1988). Further, social capital can trigger agents
to adopt more altruistic preferences that are a major source of trust (Camerer, 2003;
Fehr and Schmidt, 2003). Since social capital fosters trust, it has the potential for
being a positive influence on financial market development.
A number of authors link information-sharing to financial development. Infor-
mational transparency promotes capital market development because investors in a
transparent environment are more confident in their security valuation and there-
fore have a greater willingness to invest. Pagano (1993) argues that the existence
of transparency increases investor confidence and has a large positive impact on the
development of financial markets. Japelli and Pagano (1999) find that the breadth
of credit markets is directly related to the characteristics of the information-sharing
mechanisms that reduce information asymmetry. Mayer and Sussman (2001) de-
scribe how stricter regulations on information disclosure and accounting standards
affect financial development. Benston (1973), Fischel and Grossman (1984), and
Miller (1991) show that private stock exchanges reduce information asymmetry by
mandating optimal disclosure and monitoring compliance of listed firms, thus en-
couraging securities market development. La Porta, Lopez-De-Silanes and Shleifer
(2006) document that laws mandating disclosure benefit stock market development.
Social capital facilitates the sharing of information and reduces information
asymmetry within a network (e.g., Hong, Kubik and Stein, 2004; Kuhnen, 2009).
In addition, information sharing can promote efficiency by reducing costly search
for information (e.g., Granovetter, 1973; Shiller and Pound, 1989; Montgomery,
1991; Barr, 2000; Rauch and Casella, 2001). Because the reduction in information
asymmetry between the firm and its investors increases investor confidence while
promoting financial development, we propose that social capital encourages financial
The effective enforcement of contracts is essential for financial market devel-
opment. La Porta, Lopez-De-Silanes and Shleifer (2006) show that legal regulations
facilitate private enforcement and foster financial development. Other studies such
as Coffee (2007), Roe and Siegel (2009), Jackson and Roe (2009) and Daines and
Jones (2012) demonstrate that active law enforcement in the corporate and securities
area promotes stock market development. La Porta, Lopez-de-Silanes, Shleifer and
Vishny(1997, 1998) show that legal traditions influence the degree of investor protec-
tions and the efficiency of contract enforcement, thereby affecting the development
of financial systems. Pistor, Raiser and Gelfer (2000) highlight that both the quality
of the legal system and the effectivenessof contract enforcement are crucial for finan-
cial development. Barth, Caprio and Levine (2003) find that the private monitoring
of contract compliance is positively correlated with the size of the banking sector.

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