Preference for Appearance over Substance and Corporate Investment

• Author: Boochun Jung,Xiao Li,Woo‐Jong Lee,Jing Zhou
• DOI: http://doi.org/10.1111/ajfs.12252
• Published date: 01 April 2019
• Date: 01 April 2019

Preference for Appearance over Substance

and Corporate Investment*

Boochun Jung

Shidler College of Business, University of Hawaii at Manoa, United States

Woo-Jong Lee

College of Business Administration, Seoul National University, Republic of Korea

Xiao Li**

School of Accountancy, Central University of Finance and Economics, China

Jing Zhou

SHU-UTS SILC Business School, Shanghai University, China

Received 28 July 2018; Accepted 9 February 2019

Abstract

Preference for appearance over substance (AOS) refers to people’s desire to look better than

their actual appearance. In this paper, we explore the economic implications of AOS on cor-

porate investment. Using novel country-level proxies for AOS based on the prevalence of

plastic surgery and cosmetic industry concentration, we first document that AOS is negatively

(positively) associated with investment sensitivity to growth opportunities (cash flows). Sec-

ond, external financing is less (more) affected by growth opportunities (cash flows) in stron-

ger AOS countries than in weaker AOS countries. We conclude that people’s preference for

AOS leads firms to suboptimal investment.

*We would like to thank Bohui Zhang (Editor), two anonymous referees, Tae-Sik Ahn, Vin-

cent Chen (discussant), Simon Fung, Lee-Seok Hwang, Oliver Li, and seminar participants at

Seoul National University, the University of Hawaii at Manoa, CityU-NTU-SUFE Joint

Accounting Research Symposium 2016, and the 2016 Korean Accounting Association Sum-

mer Conference. Lee appreciates financial support from the Institute of Management

Research at Seoul National University. Li appreciates financial support from the National

Natural Science Foundation of China (No. 71802205) and the Development Fund for Junior

Faculty at the Central University of Finance and Economics (No. 011350317001). Zhou

appreciates financial support from the National Natural Science Foundation of China (No.

71502095).

**Corresponding author: School of Accountancy, Central University of Finance and Economics,

Beijing, China 100081. Tel: +86-10-6228-8611, Fax: +86-10-6228-9422, email: afxiaoli@

cufe.edu.cn.

Asia-Pacific Journal of Financial Studies (2019) 48, 236–268 doi:10.1111/ajfs.12252

236 ©2019 Korean Securities Association

Keywords National culture; Agency theory; Preference for appearance over substance;

Corporate investment

JEL Classification: G30, G31, G32

The elevation of appearance over substance, of celebrity over character, of short-

term gains over lasting achievement displays a poverty of ambition. It distracts you

from what’s truly important. Barack Obama (Arizona State University Commence-

ment Speech, May 13, 2009)

1. Introduction

Firms worldwide have distinct investment patterns, and researchers have

attempted to attribute these patterns to differences in formal and informal insti-

tutions across countries. Recent studies confirm that cross-country variations in

formal and informal institutions play significant roles in explaining firm-le vel

investment behaviors (e.g., McLean et al., 2012; Li et al., 2013; Shao et al.,

2013).

Extending this stream of research, we introduce a novel informal institution ,

people’s desire to look better than they truly do (i.e., preference for appearance over

substance, AOS hereafter), and conduct cross-country analyses to investigate how

AOS affects corporate investment policies. Our study is related to the literature on

national culture, particularly that of Shao et al. (2013) and Li et al. (2013), in shar-

ing the premise that country-level informal institutions permeate residing compa-

nies’ culture and in turn influence an individual manager’s risk-taking and

investment decisions. This premise is also consistent with social identity theory

(Hogg and Abrams, 1988), which states that an individual’s characteristics are sig-

nificantly affected by social values.

We adopt the traditional q-framework and examine how sensitivity of corpo-

rate investment to qvaries with AOS (Fazzari et al., 1988; Baker et al., 2003).

We argue that managers of firms in countries with strong AOS place excessive

importance on appearance and thus likely manage underlying performance to

make the firm look better. Accordingly, external investors in strong AOS coun-

tries are often misled by biased performance indicators, which prevent stock

prices from correctly reflecting fundamental values. Moreover, managers in stron-

ger AOS countries likely make investment decisions not based on true funda-

mentals, but rather on their desire to make the firm’s performance look bette r.

Consequently, we expect to find that investments in stronger AOS countries are

less responsive to growth potential (measured by q) than those in weaker AOS

countries. In addition, if managers in such countries have difficulty in effectively

convincing outside investors of potential investment opportunities, then they are

more likely to rely on internal cash flows than external financing to satisfy their

investment opportunities. Thus, we expect that the sensitivity of investment to

AOS and corporate investment

©2019 Korean Securities Association 237

internal cash flows is greater in stronger AOS countries than in weaker AOS

countries. In sum, we predict that the degree of AOS is negatively associated

with investment efficiency.

1

We also examine whether strong AOS limits firms’ ability to gain access to

external financing and hence reduces firms’ external financing opportunities (Myers

and Majluf, 1984). Limited access to external financing in stronger AOS countries is

aligned with weaker investment-qsensitivity and stronger investment-cash flow sen-

sitivity. Thus, we also predict that external financing is less (more) sensitive to q

(internal cash flows) in stronger AOS countries than it is in weaker AOS countries

because firms in these countries have limited ability to issue shares or debt to fund

their investment opportunities.

We construct four empirical proxies to measure the degree of AOS at the coun-

try-year level. First, we employ two proxies based on the prevalence of plasti c sur-

gery, which is the number of plastic surgeries and the number of plastic surgeons

for each country-year.

2

According to the American Society for Aesthetic Plastic Sur-

gery, Americans spent more than US$12 billion on plastic surgery in 2014, and aes-

thetic cosmetic procedures for men have increased by 43% over the past 5 years.

Sarwer et al. (2003) suggest that growing awareness of beauty bias may be an

important determinant of the growing number of people improving their appear-

ance through plastic surgery. Furnham and Levitas (2012) document a negative

relation between religious beliefs and attitudes toward cosmetic surgery, implying

that people with religion are less concerned with physical appearance because such

people believe that true beauty comes from an individual’s personality. We assume

that the prevalence of plastic surgery in each country reflects people’s desire to

improve their appearance to embellish the underlying substance. Thus, it is a valid

empirical proxy for the degree of AOS. Second, we employ two additional measures

of AOS by identifying cosmetic industries with SIC codes of 2840-2844 based on

the assumption that the size of the cosmetic industry in a country effectively reflects

the degree of AOS. Specifically, we use the number of firms in the cosmetic

1

Following prior studies (e.g., Biddle and Hilary, 2006), we interpret throughout the paper

that investment efficiency increases with the sensitivity of investment to q, but decreases with

the sensitivity of investment to cash flows. However, high sensitivity of investment to qdoes

not always indicate more efficient investment. For example, catering theory suggests that high

qsensitivity may simply reflect managers’ catering to market sentiment (e.g., Baker et al.,

2003). In this regard, the traditional qframework does not distinguish between two joint

explanations: (i) whether and to what extent qis deviated from fundamentals; and (ii)

whether and to what extent managers rely on qin investment decisions. We address this issue

by decomposing qinto fundamental and non-fundamental portions of q(Campello and Gra-

ham, 2013). The tenor of our results does not change with the replacement of qwith funda-

mental q, consistent with our interpretation of high q-sensitivity of investment as efficient

investment.

2

Plastic surgery is defined as the “maintenance, restoration or enhancement of one’s physical

appearance through surgical and medical techniques” (Swami et al., 2009, p. 7).

B. Jung et al.

238 ©2019 Korean Securities Association