National Culture and the Valuation of Cash Holdings

• Author: Ramesh Rao,Svetlana Orlova,Tony Kang
• Published date: 01 January 2017
• DOI: http://doi.org/10.1111/jbfa.12233
• Date: 01 January 2017

Journal of Business Finance & Accounting

Journal of Business Finance & Accounting, 44(1) & (2), 236–270, January/February 2017, 0306-686X

doi: 10.1111/jbfa.12233

National Culture and the Valuation

of Cash Holdings

Svetlana Orlova, Ramesh Rao and Tony Kang∗

Abstract: Prior studies document that national culture traits are systematically related to

cash holdings and attribute this to managerial cultural predispositions. However, it is possible

that these preferences reflect investors’ cultural preferences and that managers are simply

catering to investors’ preferences. It is also not clear whether the cash holding effects previously

documented are value maximizing. By examining the impact of national culture traits on cash

valuation, we are able to provide insight into these questions. Specifically, we examine the effect

of three national culture traits – individualism, uncertainty avoidance and long-term orientation –on

firm cash valuation. Our results suggest that the previously observed effects of cultural traits on

cash holdings and attributed to managerial cultural biases do not reflect investors’ preferences

and are not value maximizing.

Keywords: cash holdings, national culture, valuation

1. INTRODUCTION

Increasingly, national culture is being recognized as an important factor that

influences many economic and financial decisions. Cultural characteristics have been

shown to influence investment decisions (Guiso et al., 2008; and Bottazzi et al., 2010),

capital structure decisions (Chui et al., 2002), cash holdings management (Chen

et al., 2015), corporate risk taking (Li et al., 2013), dividend payout (Shao et al.,

2010), mergers (Ahern et al., 2015), choice of auditors (Hope et al., 2008), earnings

management (Han et al., 2010), cost of capital (Gray et al., 2013), managerial

compensation (Nash et al., 2012), entrepreneurial risk taking (Kreiser et al., 2010),

and insurance consumption (Chui and Kwok, 2008).

This study focuses on the role of national culture in the valuation of cash holdings.

The influence of cultural variables on the level of cash holdings has been established

in Chen et al. (2015) and Chang and Noorbakhsh (2009). These studies find that

such national cultural characteristics as individualism (Chen et al., 2015), uncertainty

avoidance (Chang and Noorbakhsh, 2009; and Chen et al., 2015), and long-term

orientation (Chang and Noorbakhsh, 2009) explain the variation in the level of cash

∗The first author is from University of Tulsa, Tulsa, OK, USA. The second author is from Oklahoma State

University, Stillwater, OK, USA. The third author is from McMaster University, Hamilton, ON, Canada.

(Paper received February 2015, revised version accepted December 2016)

Address for correspondence: Ramesh Rao, Oklahoma State University, Finance, 309 Business, Stillwater,

OK 74078, United States.

e-mail: ramesh.rao@okstate.edu

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NATIONAL CULTUREAND THE VALUATION OF CASH HOLDINGS 237

holdings across a large number of countries. The studies hypothesize that managers’

preferences for cash holdings derive, at least partially, from their innate cultural traits

by virtue of their nationality. For example, managers of firms in cultures known for

uncertainty avoidance are relatively more likely to hold higher cash balances.

However, as Chen et al. (2015) appropriately point out, there are at least two chan-

nels through which country-level cultural characteristics can influence the level of cash

holdings: first, through managerial decisions, which could be influenced by cultural

differences, and second, by investors’ preferences, which are also subject to cultural in-

fluences. Given the latter channel, it is conceivable that managers cater to investors and

that the cash holdings reflect investors’ cultural biases rather than managerial cultural

preferences. The Chen et al. (2015) study is focused on the first channel, while we em-

phasize the second channel, i.e.: the effect of country-level cultural characteristics on

investors’ valuation of cash. Our motivation to focus on the investors’ perspective stems

from the rich literature in behavioral finance documenting the relevance of investor

characteristics and biases to asset pricing. For example, prior literature documents

that investor traits influence investment choice, trading volume, volatility, returns, and

level of cash holdings (e.g., Grinblatt and Keloharju, 2001; Barberis and Shleifer, 2003;

Gaspar et al., 2005; Kumar, 2009; Chui et al., 2010; Neamtiu et al., 2014; Hirshleifer,

2015; and Dou et al., 2016). Differences in national cultural characteristics present

an opportunity to examine the effect of investors’ cultural traits on firm (and cash)

valuation.

There are two questions this study hopes to shed light on. First, are cash holdings

driven by managerial or investors’ cultural traits? While both parties are subject to

the same cultural traits in a given nationality, their perspectives may yield similar

or opposite (off-setting) impacts. For example, in cultures with high uncertainty

avoidance, managers are likely to be more conservative (i.e., they will opt for higher

cash balances) as they hold a significant and undiversified position in the company,

which leads to a positive association between uncertainty avoidance and level of cash

holdings. However, the diversification principle suggests that shareholders can deal

easily with uncertainty, thus the observed positive relation between cash holdings and

uncertainty avoidance may reflect managerial preference but not necessarily investor

preference in cultures characterized by high uncertainty avoidance. Second, are the

previously documented effects of national culture on cash holdings value enhancing

from the investor’s perspective? For example, based on the Chen et al. (2015) study

results, managers in individualistic cultures are motivated to hold lower cash holdings.

But this raises the question of whether this translates to higher stock valuation. So

it would be a natural extension to examine how previously documented impacts of

culture on cash holding levels translate to valuation consequences.

We address the above research questions in this study by examining the role

of culture in explaining the variation in investor’s valuation of firm cash reserves

in different countries. This allows us to more clearly identify the effect of cultural

characteristics on cash holdings. As valuations are determined by market forces,

focusing on the moderating role of cultural factors on cash valuation (rather than

cash levels) permits us to draw inferences on how investors’ cultural backgrounds

at the national level influence their perceptions about cash holdings. Additionally,

they inform us on whether the previously documented impact of cultural traits on

cash holdings are value maximizing from the perspective of investors. By examining

the cash valuation consequences of the cultural traits, our study also contributes

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238 ORLOVA, RAO AND KANG

to the stream of literature focusing on cash valuation. Several studies investigate

the valuation of corporate cash holdings in the US (Faulkender and Wang, 2006;

Dittmar and Mahrt-Smith, 2007; and Tong, 2010) and internationally (Pinkowitz

et al., 2006; and Kalcheva and Lins, 2007). These studies concentrate on firm-

level characteristics and corporate governance effects on cash flow valuation. Our

study extends this literature to include the valuation impact of investors’ cultural

dimensions.

In this study we focus on three cultural traits that are a subset of the six cultural

dimensions that make up the Hofstede (1983, 2001) cultural index: individualism,

uncertainty avoidance,andlong-term orientation. We focus on these three cultural char-

acteristics as they have been shown to influence the level of cash holdings in previous

studies (Chang and Noorbakhsh, 2009; and Chen et al., 2015), and are likely to influ-

ence investors’ valuation of firm cash holdings. Prior studies show that individualism

has a negative correlation with corporate cash holdings (Chen et al., 2015), while long-

term orientation and uncertainty avoidance have a positive correlation with cash holdings

(Chang and Noorbakhsh, 2009; and Chen et al., 2015). Additionally, these factors

have been shown to affect a number of other corporate decisions and asset pricing at-

tributes. Individualism is shown to influence corporate investments (Shao et al., 2010),

momentum (Chui et al., 2010), corporate debt maturity (Zheng et al., 2012), earnings

momentum profit (Dou et al., 2016), investors’ risk preferences (Rieger et al., 2014),

post-acquisition performance (Chakrabarti et al., 2009), and M&A activity (Ferris et al.,

2013). Uncertainty avoidance is shown to have an effect on corporate debt maturity

(Zheng et al., 2012), investors’ risk preferences (Rieger et al., 2014), and leverage

decisions (Wang and Esqueda, 2014). Finally, long-term orientation is shown to impact

firm’s hedging (Lievenbr¨

uck and Schmid, 2014), M&A activity (Ferris et al., 2013), IPO

underpricing (Costa et al., 2013), and leverage decisions (Wang and Esqueda, 2014).

We incorporate these three cultural traits into an empirical model of cash valuation

developed by Faulkender and Wang (2006), which we adapt to the international

setting of our study.1Additionally, as a robustness check, we employ Pinkowitz et al.’s

(2006) valuation methodology, which is based on the Fama and French (1998) model,

to study cross-country cash valuation effects. Our results in brief are as follows. When

examined separately, each of the cultural variables has a statistically significant effect

on the valuation of cash. Countries that have high values of uncertainty avoidance and

long-term orientation place a lower value on cash, while countries with a high degree

of individualism value cash more. These results hold even in a multivariate setting

that considers all three cultural variables simultaneously and controls for the level

of governance, as well as the economic and financial development of the countries,

factors that have been known to be related to cultural differences.

Our results are in contrast to findings with respect to the level of cash holdings. For

all three cultural traits examined (individualism,uncertainty avoidance,andlong-term

orientation), the sign of the relationship between the cultural characteristic and the

valuation of cash holdings is opposite to that found with respect to the level of cash

holdings. The differential results support the notion that investors may not share the

same view as managers with respect to cash holdings, or that managers’ culture-based

impacts on cash holdings are not value maximizing from investors’ perspective.

1 The original Faulkender and Wang (2006) methodology was developed for a sample of US firms.

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