Locality Stereotype, CEO Trustworthiness and Stock Price Crash Risk: Evidence from China
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ORIGINAL PAPER
Locality Stereotype, CEO Trustworthiness and Stock Price Crash Risk: Evidence from China Leilei Gu1 · Jinyu Liu2 · Yuchao Peng3 Received: 29 March 2020 / Accepted: 25 September 2020 © Springer Nature B.V. 2020
Abstract Exploring the locality stereotype with respect to CEO’s trustworthiness, we find that firms whose CEOs are from more reputable hometowns have a higher likelihood of stock price crashes, indicating the presence of a CEO “Trust Exploitation” effect, i.e. a high-trust identity does not guarantee managerial ethics; to the contrary, it could tempt CEOs to abuse outsiders’ trust, camouflage their misconducts and conceal adverse information more severely. The effect of CEO’s perceived trustworthiness on tail risk of stock price remains robust when controlling for the region-level trust of firm’s headquarters, and in 2SLS regression with an instrumental variable. Further, CEO’s “Trust Exploitation” effect is more prominent among firms with lower disclosure quality, higher capital market pressure and higher CEO incentives. Our findings highlight an unexplored imperfection of individual-level trustworthiness as a reliable substitute for formal monitoring devices in terms of improving stock market stability. Keywords Locality stereotype · CEO trustworthiness · Stock price crash risk JEL Classification G12 · G14 · G32 · Z13
Introduction Classical finance theories portray market participants as perfectly informed, homogeneous and completely rational in their independent decision-making process, free from psychological and cognitive biases. However, in the real world, people are closely connected by social networks (Arrow 1972; Shiller and Pound 1989; Kelly and O’Grada 2000), and rely heavily on interpersonal communication and cooperation guided by the prevailing social norms of the * Yuchao Peng [email protected] Leilei Gu [email protected] Jinyu Liu [email protected] 1
Business School, Central University of Finance and Economics, Beijing 100081, China
2
School of Banking and Finance, University of International Business and Economics, Beijing 100029, China
3
School of Finance, Central University of Finance and Economics, Beijing 100081, China
communities in which they reside (Fukuyama 1995; Shao et al. 2013; Bae et al. 2012). As such, mutual trust plays a key role in shaping people’s perceptions and behaviours, and hence potentially affects economic outcomes, such as the capital market efficiency (Coleman 1990; La Porta et al. 1997; Bjørnskov 2007; Wu et al. 2014). Social trust is the tendency (or estimated likelihood) of effective social cooperative actions that produce desirable outcomes, rather than deliberate deceptions or traps (Gambetta 1988; Coleman 1990; Putnam 1993).1 However, this tendency of cooperation is invisible and hard to estimate.2 1
The most representative example of the deceptive action is the case of “the prisoners’ dilemma”. Social trust plays the role of guiding people’s conformity to social norms and collaborations that maximize the ben
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