Risk perception and the financial system
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Risk perception and the financial system
Lynnette D Purda Queen’s School of Business, Queen’s University, Kingston, Ontario, Canada Correspondence: LD Purda, Queen’s School of Business, Queen’s University, Kingston, Ontario, Canada K7L 3N6. Tel: þ 1 613 533 6980; Fax: þ 1 613 533 2321; E-mail: [email protected]
Abstract I examine how a country’s financial system influences assessments of firm-level risk. Consistent with theories of financial intermediation, I find that firms located in a country with a bank-oriented financial system are perceived as posing a lower credit risk and correspondingly are assigned higher credit ratings than otherwise similar firms in a market-oriented setting. Even after considering elements of a country’s legal infrastructure that relate to creditor protection and insolvency proceedings, the financial system remains an important determinant of credit-rating assignment. The results are robust to the inclusion of several firm-level controls, including financial performance, industry, ownership concentration, political connections, and the ease with which the firm’s assets can be monitored. Journal of International Business Studies (2008) 39, 1178–1196. doi:10.1057/palgrave.jibs.8400411 Keywords: credit ratings; financial markets; institutional environment
Received: 15 June 2005 Revised: 30 October 2007 Accepted: 18 December 2007 Online publication date: 19 June 2008
INTRODUCTION International business research has a long history of documenting that a country’s institutional infrastructure can influence how its risk is perceived by investors. These investors may be multinational companies considering direct investment in the country or, equally important, financial investors deciding whether to inject capital into a nation’s financial system. Financial investors are concerned primarily with the risk that borrowed funds will not be repaid. As a result, specialized measures of country risk have been developed to measure the creditworthiness of borrowing nations. Using a variety of these credit assessments, research by Cossett and Roy (1991), Vaaler, Schrage, and Block (2005) and Butler and Fauver (2006) has concluded that a country’s perceived credit risk is impacted by factors such as political risk, macroeconomic conditions, and monetary policy. I advance this stream of research by moving from assessments of country risk to perceptions of firm-level creditworthiness. In this context, I examine how a country’s financial infrastructure influences these perceptions. Drawing on a large body of theory and evidence outlining the role of financial intermediaries, I hypothesize that a firm’s perceived credit risk will be influenced by whether it is located in a country with a bank- or a market-oriented financial system. In bank-based systems, firms receive the bulk of their external funding through financial intermediaries, whereas firms in market-oriented systems arrange most of their financing through
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