Role of Culture in Finance

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The role of Culture in Finance
Newly developed methods of communication transformed the world into highly integrated place, where new global standards and collaborative corporate systems were established. Increased importance to participate in financial and economic transactions had made it relevant for all countries to use such financial theories as Capital structure, Net Present value, and Dividend policy, Leverage and Taxes. However, each country’s unique political and legal structure, cultural ideology and economic circumstances influence the extent to which these theories are used and determine a particular approach for their implementation. In this paper I will critically discuss the role of culture in finance by examining uncertainty avoidance, individualism and power distance as cultural determinants of leverage and dividend policies. Also, I will demonstrate that each country’s tax system, legal structure and inflation are important factors that determine cross-cultural differences in approach to financial theories introduced above. First of all, it is important to understand that “cultural values are conceptions of the desirable that guide the way social actors select actions, evaluate people and events, and explain their actions and evaluations (Schwartz, 1999)” (Fidrmuc & Jacob, 2010, p. 322) Therefore, culture determines social ideology, influences and predicts behaviour of people in a particular group including organizational leaders, shareholders, and invertors. As a result, financial organizations operating in different cultures or countries naturally organize their business differently. Individualism and uncertainty avoidance are important cultural determinants of risk taking and leverage levels in organizations. According to research done by Ramirez and Kwok (2009) managers in individualistic societies such as U.S, Australia and United Kingdom are motivated by self-interest and are hesitant to contribute to collective action unless their own efforts are recognized. Therefore, they value their freedom and are “less willing to render control of their companies or projects to a bank or bondholder” (Ramirez & Kwok, 2009, p. 5). On the other hand, managers in collectivist societies such as Peru, Indonesia and China “are likely to see debt holders as partners in a common effort towards a common goal” and therefore, they view “monitoring and project screening services provided by banks as feedback on their performance and prospects, and thus, consider them very valuable services” (Ramirez & Kwok, 2009, p. 5). Overall, collectivist societies have trust in cooperating parties such as banks and bondholders, and view additional debt financing as a positive attribute to their business. Therefore, higher debt-to-equity ratios and leverage should be expected in such cultures. An earlier research conducted by Weber and Hsee (1998), also supports the idea that members of collectivist cultures are greater risk takers than those of individualist cultures. They found that “Chinese respondents were significantly less risk-averse in their pricing than Americans when risk preference was assessed in the traditional expected-utility framework” (Weber & Hsee, 1998, p. 1205). The reason is that in the culture like China, family or other community members will help their group member who encounters large losses after selecting a risky option, thus acting as a “cushion” for potential losses (Weber & Hsee, 1998, p. 1208). Therefore, the personal effect of an actual loss is greatly reduced and the option is not considered so risky anymore. However, in individualist culture like U.S. “a person making a risky decision will be expected to personally bear the consequences of their decisions” (Weber & Hsee, 1998, p. 1208). Therefore, it is less expected that corporations placed in individualist culture would risk using high levels of debt financing and participate in high-risk investments. The studies conducted by...
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