Trust and corporate cash holdings

Evan Dudley, Ning Zhang

PII: S0929-1199(16)30171-7
DOI: doi: 10.1016/j.jcorpfin.2016.10.010
Reference: CORFIN 1107

To appear in: Journal of Corporate Finance

Received date: 8 March 2016

Revised date: 13 October 2016
Accepted date: 15 October 2016

Please cite this article as: Dudley, Evan, Zhang, Ning, Trust and corporate cash holdings,
Journal of Corporate Finance (2016), doi: 10.1016/j.jcorpn.2016.10.010

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Trust and corporate cash holdings

Evan Dudley+
Smith School of Business, Queens University
Goodes Hall, K7L 3N6

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Kingston, Ontario, Canada
evan.dudley@queensu.ca
613-533-6259

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Ning Zhang

SC
Smith School of Business, Queens University
Kingston, Ontario, Canada
ning.zhang@queensu.ca

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613-533-2377

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Abstract
We examine the relation between the level of trust in a country and corporate cash holdings. The
precautionary savings motive predicts that firms located in countries with less trusting societies will hoard
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more cash in order to compensate for reduced access to capital markets. The agency hypothesis predicts
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that shareholders in countries with low levels of societal trust will pressure firms to disgorge cash. The
first theory predicts a negative relation between trust and corporate cash holdings while the second theory
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predicts a positive relation between these two variables. Using data on firms located in 54 countries
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around the world, we find evidence in favor of the agency-based explanation for the relation between trust
and corporate cash holdings. Overall, our results highlight the role played by informal institutions in
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shaping corporate financial management.

Keywords: Societal trust, cash holdings, corporate governance, financial management, marginal value of
cash, informal institutions

Classification Codes: G32, G34

+
Corresponding author.
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1. INTRODUCTION

The notion of trust is central to financial relations between counterparties. Trust is defined by

Gambetta (2000), as meaning that the probability that someone will perform an action that is beneficial

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is high enough for us to consider engaging in some form of cooperation with him. Using empirical

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measures of trust, researchers have demonstrated that trust plays an important role in economic

development (Fukuyama 1995), bilateral trade (Guiso et al. 2009), financial development (Guiso et al.

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2004), peer-to-peer lending (Duarte et al. 2012 ), venture-capital activity (Bottazzi et al. 2012) and cross-

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border acquisition activity (Ahern et al. 2015). However, the role of trust in corporate finances most

basic activity, capital raising, is unexplored. This is surprising in light of the fact that virtually every
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commercial transaction has within itself an element of trust, certainly any transaction conducted over a

period of time (Arrow 1972).

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Part of the reason for the poor showing of trust in corporate finance is that repeated interactions
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between two parties can overcome lack of trust or distrust. Specifically, when describing the relation
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between a principal and an agent, two different types of trust are relevant. The first notion is personal
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trust, which is a set of beliefs about a specific person. This notion involves repeated interactions between

two individuals. For example, this version of trust describes the relation between a customer and a
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supplier or long-term investors and management. This type of trust evolves over time and is empirically

difficult to measure. The second notion of trust, societal trust, is easier to measure, but has a less obvious

relation with capital-raising activities of the firm. Societal trust refers to a set of beliefs about the behavior

of a group of individuals. This notion of trust is rooted in deep-seated beliefs about others and it involves

a persons cultural and religious backgrounds. Trust, defined in this manner, is also referred to as social

capital and is correlated with economic success (Fukuyama 1995) and firm size (La Porta et al. 1997).

In this article, we examine the effect of societal trust on a particular dimension of corporate

financial policy, the firms cash holdings. We argue that societal trust is empirically relevant in describing

the relation between a firms insiders and its shareholders and their attitudes towards corporate cash

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holdings. Corporate finance theory offers two possible reasons for why this notion of trust may affect a

firms cash policy. The first reason involves the firms desire for precautionary savings. Firms with

managers whom shareholders view as less trustworthy, or whose potential investors are distrustful, may

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have difficulty raising external capital, and may find it costlier to access capital markets. Financial

constraints of this type lead to deadweight losses through inefficient liquidation when a firms insiders

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dont have enough capital to pledge for positive net-present-value investment projects (Holmstrom &

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Tirole 1998). We therefore expect societal trust to have a negative effect on corporate cash holdings

according to this hypothesis.

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The second reason trust may matter for a firms cash holdings is related to corporate insiders
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propensity to divert resources away from outside investors. In this case, shareholders are concerned that

managers use the firms internal resources on projects that benefit insiders at the expense of outside
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shareholders. In order to mitigate such incentives, outside shareholders may choose to put pressure on
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management to disgorge cash by paying dividends or by repurchasing shares on a regular basis. By

depriving the firm from using this cash to finance its investments, this pressure also forces the firm to
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access capital markets whenever it requires funds, and it gives outsiders an opportunity to exercise control
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at that time by withholding capital (Jensen 1986). Consequently, firms with insiders who are perceived to
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be untrustworthy may face more pressure to disgorge cash, while firms with managers perceived to be

trustworthy can accumulate greater cash reserves. We therefore expect societal trust to have a positive

relation with corporate cash holdings according to this hypothesis.

We examine the two competing hypotheses using a large sample of firms across 54 countries

between 1992 and 2012. Following prior studies such as La Porta et al. (1997) and Guiso et al. (2008), we

measure trust on a country-level basis based on each countrys citizens average response to the following

question in the World Values Survey (WVS): Generally speaking, would you say that most people can

be trusted or that you need to be very careful in dealing with people? We show that societal trust

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positively affects corporate cash holdings.1 Specifically, firms in countries with higher levels of trust hold

more cash, which is consistent with the hypothesis that agency concerns lead shareholders to force

insiders to disgorge cash in low-trust countries. We also find that the effect of trust on cash holdings is

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stronger when country-level measures of governance and shareholder rights are weak. Our findings are

robust to controlling for economic output, cultural indices as well as firm-level characteristics, country,

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year and industry fixed effects.

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We provide additional support for our main argument by documenting the effect of societal trust

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on payout policy. Shareholders in low-trust countries pressure the firms managers to distribute cash

through dividends that commit the firm to higher total payouts in the long term. Specifically, firms
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operating in low-trust countries pay a greater proportion of their excess cash in the form of dividends,

where excess cash equals the amount of cash net of the predicted amount necessary to meet the firms
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demand for investments and operations. Overall, firms in low-trust countries pay a greater proportion of
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excess cash in total payout (dividends plus share repurchases) than do firms in high-trust countries.
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We also examine whether the effect of societal trust is greater when the level of private trust in
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the firms management and insiders is low. Intuitively, the development of private trust about the firms

insiders may, over time, crowd out the effect of societal trust on outside shareholders beliefs about
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corporate insiders behavior. We measure the degree of private trust between insiders and outsiders with

the firms history of interactions with outside investors and with the number of analysts who follow the

firm. Both of these measures affect how trust relates to corporate cash holdings. Specifically, the effect of

trust on corporate cash holdings is lower in firms that have raised a significant amount of capital from the

equity or debt markets in the past. Moreover, the effect of societal trust on cash holdings is lower in firms

with more analyst following. Our results suggest that societal trust substitutes for private trust and/or

information about management in firms that have high degrees of information asymmetry, and with

1
A recent stream of literature investigates whether this survey question measures trust as it is understood in Gambetta (2000).
Sapienza et al. (2013) provide empirical evidence that the response to this question is related to participants beliefs about others
behavior rather than their personal preferences such as risk aversion and altruism.

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whom outsider investors interact infrequently. Our results are robust to using alternative proxies such as

firm size and financial reporting quality to measure information asymmetry.

Our final set of tests examines how investors perceive societal trust. We measure the value of

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societal trust with the marginal value of cash to the firms shareholders. According to the agency

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hypothesis, the value of an extra dollar of cash should be more valuable for firms located in high-trust

countries. To determine the value effects of trust on cash resources, we follow Faulkender and Wang

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(2006) and measure the marginal value of cash holdings. Based on these regressions, we find that moving

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from a low-trust country to a high-trust country increases the marginal value of cash. Overall, our results

support the agency hypothesis whereby shareholders allow the firm to hold more cash when shareholders
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view managers as more trustworthy.

Our paper builds on an existing strand of literature that focuses on the role played by formal and
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informal institutions on corporate policy. Early studies of corporate liquidity policy focus on preserving
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financial flexibility (Opler et al. 1999; Whited & Riddick 2009, Acharya et al. 2007), and on agency
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problems between insiders and outsiders (Nikolov & Whited 2014, Harford 2002, Harford et al. 2008).
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However, formal institutions also play a significant role in governing firms financial management

(Pinkowitz et al. 2006). More recently, focus has shifted to the role played by informal institutions such
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as societal trust and culture on corporate financial policies. Specifically, Li et al. (2013) find that cultural

characteristics related to the level of individualism and uncertainty avoidance impact corporate risk-

taking. Chen et al. (2015) extend this analysis to corporate cash holdings and find that both of these

variables affect corporate cash holdings around the world. In a contemporaneous paper to ours, Xie and

Xin (2015) examine the role of trust in corporate policy, and they document a positive relation between

societal trust and corporate cash reserves. Our paper differs from theirs in several ways. First, our study

incorporates both countries in the World Values Survey as well as in the European Values Study. As

such, our results make conclusions on how social trust works around the world that are more

generalizable. Second, we distinguish and highlight the difference between private and societal trust.

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Third, we further identify the economic channels by examining the effect of trust on corporate payout

policy.

Overall, we contribute to the finance literature by showing that societal trust is an economically

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significant determinant of corporate financial policy. This finding is important because the firms

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managers (or insiders in a closely held family firm) do not exist in a vacuum. Both their decisions and

their ability to analyze their firms prospects are the product of the society and cultural norms to which

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they belong. Moreover, informal institutions shape the formal institutions that regulate and enforce the

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way economic agents interact with one another in society.2 In a recent commentary, Hirshleifer (2015)

calls for more studies to look at how social norms and moral attitudes affect financial behavior and
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decisions. Our study echoes his inquiry by showing that societal capital affects corporate financial policy.

We proceed as follows. Section 2 develops the hypotheses and describes how societal trust relates
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to a countrys social institutions, Section 3 describes the data, Section 4 presents our main results, Section
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5 performs robustness tests and Section 6 concludes.

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2. BACKGROUND AND HYPOTHESES DEVELOPMENT

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The notion of trust has many interpretations. The one we employ is the notion of calculative

and institutional trust described in Williamson (1993). This notion of trust involves the calculation of

individuals based on their subjective beliefs about the gambles that they face, and these beliefs take into

account societal culture, regulation and professionalization. Carlin et al. (2009) develop a theoretical

framework in which this type of trust is present in a population of agents, and in which principals infer the

level of trust based on the performance of their investments. Our treatment of trust follows their analysis

in the following respects. First, trust is a function of a countrys legal institutions that make sure agents

2
For instance, Aghion et al. (2010) present evidence that a lack of trust leads to more regulation despite the corruption associated
with low-trust countries government institutions.

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honor their fiduciary obligations. Second, trust has a cultural component that is based on social norms

prevalent in a country. Third, we measure societal trust as opposed to private trust. Societal trust evolves

little over time. In contrast, private trust may evolve as members of a principalagent pair repeatedly

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interact with each other.

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The distinction between private and societal trust is important in our context because societal trust

matters more for parties that interact infrequently with each other. For example, we would expect that

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societal trust becomes less important over time in firms that repeatedly raise capital externally (i.e., by

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issuing equity or debt). When a firm frequently raises capital from capital markets, then interactions

between the firm and its investors occur more often than if the firm relied exclusively on its internal
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resources to finance its investments. Moreover, because of the public nature of these interactions, the

quality of the information disclosed when firms go to capital markets may be very different than
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disclosures to outside shareholders made by firms that primarily rely on internal resources.
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We formulate our hypotheses in terms of the firms cash holdings. Cash holdings are important
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because they provide liquidity when the firm wishes to finance investment expenditures or cover cash
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shortfalls (Opler et al. 1999). Moreover, cash holdings enable managers to engage in asset transformation

to a greater degree than with the firms fixed assets (Myers & Rajan 1998). Consistent with Myers and
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Rajan's (1998) predictions, a large literature on corporate cash holdings finds that cash holdings are

governed by shareholders concern that the firms internal resources may be squandered by management

(Pinkowitz et al. 2006; Harford 2002).

We use these findings to motivate our hypotheses. Our first explanation for corporate cash

holdings highlights the precautionary savings motive for holding cash. According to this line of

reasoning, corporations hold more cash if they believe access to future financing is either costly or

difficult to obtain. External financing may be costly because of transaction costs (Keynes 1936) or

because of information asymmetries (Myers & Majluf 1984). Societal trust affects both of these channels.

For instance, investors in untrusting societies are less likely to participate in the stock market (Guiso et al.

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2008). Societal trust involves social interactions, and social interaction increases stock market

participation (Hong et al. 2004). Furthermore, lower participation rates increase the equity risk premium

required by investors (Brav et al. 2002). Thus higher societal trust reduces the costs of raising equity

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because equity investors require a lower risk premium on their equity investment in the firm in more

trustworthy countries.

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Greater trust also facilitates the collection and dissemination of knowledge (Guiso et al. 2008).

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Increased knowledge dissemination affects the costs of raising external capital if investors favor stocks

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about which they are informed (Merton 1987; Coval & Moskowitz 2001). Increased collection and

dissemination of knowledge also reduces the information costs of raising equity and debt capital when
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investors discount the value of securities offered by firms with greater information asymmetries (Myers &

Majluf 1984). Thus, higher societal trust reduces the costs of raising external finance because trust
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reduces the cost of obtaining information about the firm and it increases the quality of available
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information. Because external capital is more expensive to raise in low-trust countries, firms rely on

internal resources by accumulating cash reserves.

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To summarize, the precautionary savings hypothesis predicts that cash holdings are larger and

more valuable in low-trust countries. The precautionary savings hypothesis does not make any prediction
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with respect to how the effect of trust on cash holdings varies with the quality of a countrys formal

institutions, such as the rule of law, the quality of governance and the accountability of government to the

people. The precautionary savings motive implies our first hypothesis.

Hypothesis 1a: Societal trust reduces cash holdings, and this relation is invariant with respect to country

governance quality.

According to the agency hypothesis, the potential for conflicts between inside and outside

shareholders leads outside shareholders to exert pressure on management to disgorge free cash flows

instead of saving them (Jensen & Meckling 1976; Berle & Means 1932). The reason is that firms that

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disgorge cash will not squander valuable internal resources on bad projects or on projects that benefit

insiders at the expense of outsiders. The pressure to disgorge cash will be smaller in countries with high

levels of societal trust because agents in these countries are more likely to honor their fiduciary

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obligations, and to follow social norms of behavior that protect outside investors in the firm. It follows

that shareholders of firms located in countries with low levels of societal trust would prefer that

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management pay out its cash to its shareholders rather than hoard it. Trust positively affects corporate

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cash balances according to this hypothesis.

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The agency hypothesis also predicts that the effect of trust on corporate cash holdings should vary

with the quality of a countrys formal institutions. The reason is twofold. First, shareholders may have
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greater means at their disposal to force management to disgorge cash to shareholders in countries with

stronger governance and better investor protection. This effect predicts a stronger effect of trust on cash
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holdings in countries with better governance. Second, shareholders may be less worried about
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expropriation in countries in which their rights are better protected. This effect implies a weaker effect of

trust on cash holdings in countries with better governance quality.

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We formulate our first hypothesis as follows.

Hypothesis 1b. Societal trust positively affects cash holdings, and this relation is stronger in countries
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with weaker governance quality.

The propensity to squander corporate resources and engage in empire building at the expense of

outside shareholders need not be the main friction driving the agency hypothesis. Managers may instead

accumulate cash in order to insulate themselves from competitive pressures in a desire to live the quiet

life instead of active empire building (Bertrand & Mullainathan 2003).3 According to this formulation,

shareholders in low-trust countries pressure managers to disgorge cash that would otherwise be used to

continue operating unproductive plants and facilities, and to buy peace with their workers. As such, we

3
We thank an anonymous reviewer for suggesting this discussion.

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interpret the agency hypothesis broadly as encompassing any managerial preferences that are not

conducive to increasing shareholder wealth.

2.1 Private versus societal trust

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As discussed above, societal trust is important in describing the relation between two parties that

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interact infrequently. When interactions are infrequent, there is no scope for private trust to supplant

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societal trust, and if the horizon is finite, it is less likely that there will be a built-in governance

mechanism such as reputation concerns that protects the participants interests (see Fukuyama 1995). We

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therefore expect the effect of societal trust on corporate cash holdings to be more important in firms that

infrequently raise external capital, and that have greater degrees of information asymmetry.
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This type of cross-sectional variation in the relation between trust and cash holdings can occur

under both the precautionary savings and agency hypotheses. Under the former hypothesis, the effect of
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trust on corporate cash holdings is more negative in firms with greater information asymmetries because
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external financing is costliest when investors know little about the firm. Under the latter hypothesis, the
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effect of trust on corporate cash holdings is more positive in firms with greater information asymmetries
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because shareholders have less information about how management will use the firms internal resources.

These arguments imply the following two mutually exclusive hypotheses.

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Hypothesis 2a (precautionary savings channel). The effect of trust on corporate cash holdings is more

negative when the frequency with which firms accessed capital markets in the past is low, and when the

degree of information asymmetry between corporate insiders and outsiders is large.

Hypothesis 2b (agency channel). The effect of trust on corporate cash holdings is more positive when the

frequency with which firms accessed capital markets in the past is low, and when the degree of

information asymmetry between corporate insiders and outsiders is large.

2.2 Trust and the marginal value of cash

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We also examine investors valuation of the firms cash holdings. This is an important question

because trust is a measure of investor beliefs about how insiders will manage the firms internal

resources. We expect trust to influence corporate cash holdings contribution to the value of the firm

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under both hypotheses. Based on arguments made above, the precautionary savings hypothesis predicts

that trust has a negative effect on the value of corporate cash holdings, and the agency hypothesis predicts

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a positive effect of trust on the value of corporate cash holdings. We formulate the following two

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mutually exclusive hypotheses.

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Hypothesis 3a (precautionary savings channel). Trust has a negative effect on the marginal value of cash.

Hypothesis 3b (agency channel). Trust has a positive effect on the marginal value of cash.
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2.3 The joint determination of societal trust, formal institutions and cultural values
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Trust and social institutions evolve jointly. Williamson (1996) writes that the import of culture,
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for purposes of economic organization, is that it serves as a check on opportunism. Strong societal norms

inhibit strategic behaviors (such as breach of contract), lead to better enforcement of existing laws and
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increase individuals remorse after behaving opportunistically. It follows that societal trust may determine
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and be determined by the form and strength of social institutions and the level of corruption in a society.
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For example, in Aghion et al. (2010), distrust leads to more regulation and more corruption as non-

entrepreneurial citizens are worried about expropriation by un-civic entrepreneurs. Consistent with their

argument, Stulz and Williamson (2003) show that informal institutions such as religion and language can

predict the quality of a countrys creditor rights better than measures of economic growth and openness.

Thus, both formal institutions and informal institutions are jointly determined, and this may confound the

interpretation of our results.

We adopt several approaches to address this issue. First, as in other studies, we control for the

quality of a countrys legal and regulatory institutions by employing measures of government

effectiveness, regulatory quality, corruption, political stability, rule of law, voice and accountability,

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shareholder rights and economic development. We also control for societal culture along six dimensions

identified by Hofstede (1980): individualism, power distance, uncertainty avoidance, long-term

orientation, indulgence and masculinity. These variables capture the impact of the shareholders and

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managers personal preferences on corporate cash holdings such as the degree of risk aversion and the

investment horizon. To further address this issue, we make use of instrumental variables regressions.

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However, it may be the case that societal trust proxies for some unobserved factor that is correlated with

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cash holdings (an omitted variable problem). While it is hard to think of such a factor other than one of

those listed above, we provide empirical evidence that we believe rules out the omitted variables problem

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explanation for our results.
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3. DATA AND SAMPLE DESCRIPTION
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We construct our measure of societal trust (Trust) from the World Values Survey (WVS) and
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European Values Study (EVS). This survey is carried out in several waves over the sample period. 4 Our

measure uses the following question from the WVS and EWS:
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Generally speaking, would you say that most people can be trusted or that you need to be very careful in

dealing with people?

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We define the variable Trust as the percentage of people who respond that most people can be

trusted. We linearly interpolate and fill this variable for years between the two adjacent surveys. Because

the answer to this question is aggregated at the country level, it addresses whether there exist advantages

and opportunities accruing to people through membership of certain communities. (Guiso et al. 2004).

More importantly, the properties of this survey question are well understood and it is an appropriate

measure of trust. For instance, Guiso et al. (2004) find that the WVS measure of trust is positively related

4
Specifically, the World Values Survey is carried out in five waves over our sample period, 19901994, 19951998, 19992004,
20052009 and 20102014. The European Values Survey is carried out in four waves over our sample period, 19891993, 1999
2001, 20082010 and 20052010. We use the integrated longitudinal file to construct our Trust measure.

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to financial development. Moreover, Sapienza et al. (2013) establish that the WVS survey is related to

peoples beliefs about the trustworthiness of others.

We collect country level variables from other sources. The Worldwide Governance Indicators

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project gathers data on country-level governance along the following six dimensions: Regulatory Quality,

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Control of Corruption, Political Stability, Rule of Law, Voice and Accountability and Government

Effectiveness (see Kaufmann et al. 2009). These dimensions are further described in Table A1 of the

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Appendix. We measure the strength of shareholder rights with the country-level measures of governance

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quality developed by the Worldwide Governance Indicators research project. To the extent that the

dimensions of governance are highly correlated, we calculate the first principal component of this set of
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variables as Score. As such, Score, is used to control for a common countrywide governance factor that is

correlated with trust.5 We obtain data on Gross Domestic Product (GDP) per capita from the World Bank.
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Finally, we obtain the Hofstede cultural indicators from Geert Hofstedes website.6
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We examine the properties of the WVS measure of trust in Table 1, which reports the average
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level of trust and the six dimensions of country governance, as well as GDP per capita. As shown in
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Panels A, B and C, there is a positive association between trust, GDP per capita and country-level

governance. There is also variation in the level of trust across countries and within geographical regions.
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For example in South America, trust varies between 0.08 (Peru) and 0.21 (Mexico). We conclude that

there is sufficient cross-sectional dispersion in the level of trust across countries to identify variations in

the effect of trust on corporate financial policies.

We merge country-year level data with firm-level data from Worldscope across 54 countries

spanning 1992 to 2012. Table 2 reports summary statistics on firm-level characteristics. For the sake of

brevity, we report two sets of summary statistics. The first is for the sample of firms used in the cash

regressions. This subsample is smaller because it requires five years of observations to estimate the

5
Results reported in Section 4 show that that the effect of trust on cash holdings is similar in direction and magnitude when we
use explicit measures of shareholder rights developed by La Porta et al. (1998) and others.
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This data is obtained from http://geert-hofstede.com/countries.html.

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volatility of cash flows for each firm year. Based on this sample, the median firm holds 10.5% of its total

assets in the form of cash. The second set of summary statistics consists of the variables used to estimate

the marginal value of cash holdings.

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4. TRUST AND CASH BALANCES

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This section investigates the relation between trust and cash holdings in both a univariate setting

and a multivariate setting that controls for firm and country-level variables. Figure 1A, which plots mean

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cash holdings (deflated by total assets) for each country relative to the countrys level of societal trust,
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illustrates our main finding. As shown, cash holdings increase with the level of societal trust. This result

is consistent with the agency hypothesis. Figure 1B, which reports the mean log cash holdings, confirms

this finding using the dependent variable employed throughout the multivariate analysis.
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One possible concern about the interpretation of this finding is that societal trust is correlated

with country-level measures of economic development and shareholder rights that are associated with
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higher cash holdings. Univariate correlations indicate that this is the case. As shown in Table 1 Panel C,
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the correlation between trust and score (our measure of governance) is 30%. Trust is also positively
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correlated with GDP per capita (34%), negatively correlated with the revised shareholder rights index (

24%) (defined in La Porta et al. (1998) and revised by Djankov et al. (2008)), and positively correlated

with the anti-self-dealing index (13%) measure of shareholder rights, also developed by Djankov et al.

(2008).7 In order to control for these variables, we estimate a multivariate regression at the firm-year level

and include the above variables as controls in addition to our primary measure of trust. We control for

unobserved differences between industries and define industry classifications using the Fama-French 48

industries based on reported Standard Industrial Classification (SIC) codes (Fama & French 1997). We

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The anti-self-dealing index is based on private enforcement mechanisms that govern a specific self-dealing transaction.

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also include country fixed effects in order to control for time-invariant unobserved country-level

determinants of corporate cash policy. The baseline regression is as follows.

Cash holdingsijkt= +1 Trustkt + 2Scorekt + 3firm-characteristics + Indj + Yrt + Cntryk + uijkt (1)

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Our primary dependent variable for cash holdings is the natural logarithm of cash and marketable

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securities scaled by total assets. Trustkt denotes the response to the World Values Survey for country k in

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year t and Scorekt is the first principal component of governance, regulatory quality, control of corruption,

political stability, the rule of law and the voice of freedom for country k in year t. We include a set of

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firm-characteristics that measure the firms operating, investing and financing activities. Finally, Indj, Yrt

and Cntryk capture industry, year and country effects, respectively.

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Table 3 reports multivariate regression results. Column (1) reports estimates of equation (1) with

our preferred definition of the dependent variable, the natural logarithm of the ratio of cash holdings
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scaled by book assets. As shown, the coefficient on Trust equals 0.528 (t-stat = 2.49, statistically
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significant at the 5% level) after controlling for firm characteristics that are known to be associated with
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corporate cash policy. Trust has an economically significant effect on firms cash holdings. Increasing
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trust from the 25th to the 75 percentile increases the cash balance by 11.8%. We also note that the sign on

the control variables is consistent with prior results in the literature. For instance, more profitable hold
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more cash as do firms with greater cash-flow volatility. High growth firms (firms with a high market-to-

book ratio) have less cash, as do firms with more leverage.8

Columns (2) to (4) report the same regression estimates with alternative definitions of the

dependent variable that either omit taking the natural logarithm or deflate cash by net assets (total assets

minus cash). The results are robust to these alternative specifications. Taken together, both the univariate

and multivariate results support the agency hypothesis (formulated in Hypothesis 1b) about the effect of

trust on corporate cash holdings.

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In unreported tests, we find that our results are robust to running the study design at the countryindustry-level of
aggregation.

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4.1 Trust and payout policy further evidence on the economic channel
The key argument behind the agency hypothesis is that in low-trust countries shareholders prefer

that managers disgorge cash by paying dividends or by repurchasing shares rather than hoarding it for

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empire building. In order to provide additional support for this channel, we examine the effect of trust on

corporate payout policy. Specifically, we examine how cash holdings, societal trust and the interaction of

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these variables relate to the firms payout policy. Since firms require a minimum level of cash to meet

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their investment needs and to fund their day-to-day operations, we focus this part of the analysis on the

amount of excess cash, defined as the difference between cash and the predicted amount given the firms

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investment-opportunity set and existing operations. We follow Harford et al. (2008) and measure excess

cash as the residual from a regression of cash holdings on firm size, leverage, growth options,
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profitability, ratio of working capital to assets, cash flow volatility, R&D to sales, capital expenditures to

assets and acquisition to sales, as well as industry and year indicator variables. Holding investment and
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financing policy constant, the agency hypothesis implies that higher levels of trust lower the proportion of
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excess cash that the firm pays out to shareholders. Intuitively, the total payout ratio is lower in high-trust
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countries because shareholders permit managers in these countries to hold more cash than in low-trust
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countries.
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Firms may return money to shareholders in the form of dividends or share repurchases.

Accordingly, trust may affect how the firm transfers excess cash to shareholders. Because dividends

imply a long-term commitment to a higher payout ratio but share repurchases do not, we expect societal

trust to have a larger effect on the relation between excess cash and dividends paid than on the relation

between excess cash and share repurchases. Thus under the agency hypothesis, cash reserves in low-trust

countries are kept low by paying out a greater proportion of excess cash to shareholders in the form of

dividends. To empirically test this hypothesis, we regress the change in total payout, the change in

dividends and the change in share repurchases on excess cash and its interaction with trust.

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Table 4 reports the results of this analysis. Following Harford et al. (2008), the dependent

variable in column (1) is the annual change in total payout (dividends plus share repurchases) net of the

mean total payout in the firms industry scaled by lagged total assets. We adjust firm payouts by the

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industry mean in order to control for variations in payout policy across industries. As shown, greater

amounts of excess cash lead to more total payouts, but this effect is smaller in high-trust countries, as

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evidenced by the significantly negative interaction term between excess cash and societal trust. Column

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(2) reports the regression estimates with the change in industry-adjusted dividends. As shown, greater

amounts of excess cash lead to a larger dividend and this effect is stronger in low-trust countries. Taken

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together, columns (1) and (2) indicate that firms in low trust countries pay a greater proportion of their
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excess cash to shareholders in the form of dividends. Column (3) reports the effect of trust on the relation

between excess cash and share repurchases. As shown, the coefficient on excess cash is not significant.

Moreover, the interaction effect of this variable with trust is (weakly) significantly positive but
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economically weak in comparison to dividends. This finding suggests that shareholders in low-trust

countries pressure the managers to distribute excess cash in a way that commits the firm to higher total
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payouts in the long term. Overall, firms in low-trust countries pay a greater proportion of excess cash in
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total payout (dividends plus share repurchases) than do firms in high-trust countries.
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4.2 Trust, repeated interactions and information asymmetry

We next investigate the effect of trust on corporate cash holdings when there is opportunity for

both parties to develop private trust through repeated interactions with each other. We measure this aspect

of the relationship between corporate insiders and outsiders along two separate dimensions. The first

dimension consists of the frequency with which the firm raised external equity or debt in the past three to

five years (i.e., from year t3 or t5 to t1). The second dimension involves the firms information

environment as measured by the number of financial analysts who follow the firm.

We measure equity issues using the sale of common and preferred stocks each year. We measure

debt issues as the annual change in total debt. To capture significant external financing events, we identify

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external financing activity whenever the sum of equity and debt issues is greater than 5% of total assets in

any year during the past three or five years. Specifically, Financing 3Y (Financing 5Y), equals one if the

amount of new capital raised from the equity or debt market is more than 5% of total assets in any one

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year during the past three (five) years and zero otherwise. We interact Trust with Financing 3Y and

Financing 5Y.

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We present the results in Table 5. As shown, the effect of societal trust is large and statistically

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significant at the 1% level for firms that have not engaged in external financing in the prior three- or five-

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year period, but is significantly smaller for those who have. Both regressions show that having raised

equity or debt capital in the past reduces the effect of societal trust on cash holdings. For example, in
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column (2), the coefficient in the non-issuing group equals 0.662 (t-stat = 3.16) compared with only 0.45

in the issuing group and the difference is significantly different.

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Panel B reports cross-sectional variation tests using indicators to capture whether the firm is
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followed by one or more analysts (Have analyst), whether the firm has more analysts than the median
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firm in the country (More analyst) and the number of analysts (log(# analysts)). Intuitively, having an
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analyst follow the firm implies that outside investors are better informed about the firms prospects, and

therefore less reliant on societal trust in their inferences about management ability and behavior. We
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obtain data on analyst following from Institutional Brokers Estimate System (IBES) International. As

shown in column (1), the effect of trust in firms with no analyst following is statistically and

economically significant. In contrast, this effect is significantly smaller in firms followed by one or more

analysts. The results are qualitatively the same when we control for country-level differences in analyst

following (column 2) or use the raw number of analysts (column 3). Overall, the results of this section are

consistent with Hypothesis 2b but not 2a, suggesting that trust matters most when the firms information

environment is poor, and when investors have had little opportunity to develop private trust in

management.

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Finally, following Zhang (2006) and Dechow and Dichev (2002), we employ firm size and

financial reporting quality as two additional measures of information asymmetry. As discussed in Zhang

(2006), small firms typically have less information available for the market than large firms. This may be

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because small firms have fewer customers, suppliers and a limited shareholder base, and cannot bear high

disclosure preparation costs. We measure firm size using total assets. Specifically, the indicator variable

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Large size takes a value of one if total assets are higher than the median firm in the country for a given

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year.9 Our second measure of information asymmetry is accruals quality, calculated based on the

modified Dechow and Dichev (2002) model proposed by McNichols (2002). Specifically, we regress

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working capital accruals on property, plant and equipment (PPE) and the change in revenues minus the
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change in accounts receivable as well as lagged contemporary and lead cash flows from operations. We

scale all variables by lagged total assets. We define the negative of the standard deviation of the residual

term from year t4 to t as accruals quality so that higher values indicate better accruals quality. As argued
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in Francis et al. (2007), information asymmetry is high if accruals map poorly into cash flows or other

firm fundamentals known to be associated with accruals (fixed assets and cash-sales changes). The
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indicator variable High AQ takes a value of one if the accruals quality is higher than the median for a
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given country in a year. We present the results in Panel C. The coefficients on the interaction terms Large

size*Trust and High AQ*Trust are both negative and statistically significant at the 5% level, consistent
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with the hypothesis that trust matters most when the information availability is poor.

4.3 Trust, country governance and financial development

We explore how the effect of trust varies across firms located in countries with differing levels of

governance quality. As explained above, the precautionary savings hypothesis does not predict any

difference in the effect of societal trust on corporate cash balances across countries with differing levels

of governance quality. In contrast, the agency hypothesis predicts that country-governance quality can

either increase or decrease the effect of trust on corporate cash balances.

9
Results and inferences are qualitatively similar if we use market value of equity instead.

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We investigate these relations by interacting country-governance quality (measured with Score or

one of its six components) with trust in a multivariate regression. Panel A of Table 6 reports these results.

As shown in column (1), the effect of trust is significantly different in countries with higher levels of

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governance (measured with Score). The interaction term between Trust and Score is negative and

statistically significant at the 5% level in column (1), implying that trust has a greater effect on corporate

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cash holdings in countries with lower levels of governance. Both this finding and our earlier results are

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consistent with the agency hypothesis. This interaction effect is also economically important. Adding the

coefficient on Trust with the product of the coefficient on the interaction term and the 25th percentile of

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score equals 0.935. In comparison, the effect of trust at the 75th percentile of Score equals 0.072 or
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approximately 90% less. As such, we conclude that trust matters more in countries with poor levels of

governance.
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We next investigate whether the interactive effect is driven by a particular dimension of country
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governance by splitting the governance measure into its six constituent components based on information

provided by the World Governance Index. To the extent that the six governance measures exhibit high
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correlations, we estimate a separate regression for each dimension. Specifically, each dimension of the
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World Governance Index is included in the regression as a stand-alone variable, along with its interaction
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with Trust. As shown, the effect of societal trust remains statistically and economically significant after

controlling for individual dimensions of country governance. Moreover, the interactive effect documented

in column (1) does not seem driven by a particular dimension of Score. For example, column (2) reports

the effect of societal trust controlling for government effectiveness, a measure of the quality of public

services and their degree of independence from political pressure. The coefficient on Trust equals 1.242,

with a t-statistic of 5.36. The interaction of Government effectiveness with Trust is negative and

statistically significant at the 1% level, implying that the effect of societal trust is smaller when

government effectiveness is greater. Regulatory quality and the rule of law also interact significantly, but

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not Control of corruption, Political stability and Voice. Overall, these results are consistent with

Hypothesis 1b, but not with Hypothesis 1a.

Lastly, in column (8), we investigate whether measurable dimensions of culture affect the

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coefficient on trust.10 Specifically, we include the six Hofstede cultural indices in order verify that trust is

not measuring a component of culture that relates to a persons preferences. As shown, the effect of trust

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on corporate cash holdings remains both statistically and economically significant after controlling for

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these other dimensions of a countrys culture. This result indicates that we are measuring the effect of

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investors beliefs with respect to others rather than individual preferences that are correlated with societal

trust. MA
4.3.1 Trust and shareholder rights

We next investigate whether the effect of trust on corporate cash holdings is distinct from the
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level of shareholder rights. As shown in Table 1, trust and shareholder rights are significantly correlated.
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Furthermore, prior evidence on the relation between corporate cash holdings and shareholder rights is
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mixed, leaving open the direction of the effect of shareholder rights (and thus societal trust) on cash
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holdings.11
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We use two different measures of shareholder rights. The first measure is the updated and

corrected version of the shareholder rights measure (LLSV) described in La Porta et al. (1998). The

second measure is the anti-self-dealing index developed by Djankov et al. (2008).12 The corrected version

of shareholder rights index (LLSV) and the index of anti-self-dealing are obtained from Djankov et al.

(2008). Higher values of each index indicate stronger shareholder rights. Panel B of Table 6 reports the

regression results. We first replicate the effect of shareholder rights on corporate cash holdings

10
In column (8), our sample size is slightly smaller due to the availability of the Hofstede cultural indices.
11
Dittmar et al. (2003) find that cash holdings are lower in countries with stronger shareholder rights, but Harford et al. (2008)
find a positive relation between shareholder rights and corporate cash holdings in a sample of U.S. firms. Kalcheva and Lins
(2007) paint a more nuanced picture and show that corporate cash holdings decrease with firm-level shareholder rights in
countries with weak investor protection.
12
We do not include country fixed effects in this analysis as both the LLSV index and the anti-self-dealing index are country-
specific and not time-varying.

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documented in Dittmar et al. (2003). We restrict the set of observations to the 1998 calendar year and

include industry fixed effects as in their original specification. As shown in column (1), there is a negative

relation between shareholder rights and corporate cash holdings. The coefficient estimate of 0.156 is

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similar in magnitude to their estimate of 0.11 reported in Table 2, column (3) of their paper. We next

include trust and shareholder rights (LLSV) in the regression equation using the whole sample period. As

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shown, the effect of trust is positive and significant, and the magnitude of the coefficient is similar to

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estimates reported in Table 3. The sign on the shareholder rights index changes from negative to positive

when we expand the sample and control for country governance.

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We further probe whether the effect of trust is weaker in countries with poor shareholder rights.
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We measure the relative effect of trust across countries with varying levels of shareholder rights by

interacting trust with LLSV. As shown in column (3), the interaction term between trust and LLSV is
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significantly negative. The last column confirms that this result also holds when we replace LLSV with
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the anti-self-dealing index. We conclude that trust matters more in countries with weaker shareholder

rights, which is consistent with earlier results on the differing effect of trust across countries with
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different levels of governance quality.

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4.3.2 Trust and financial development

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We next examine the effect of financial development on the relation between societal trust and

cash holdings. Higher monitoring intensity by the firms creditors may affect the relation between trust

and cash holdings, and this fact may weaken the effect of trust on cash holdings. We expect monitoring

intensity by debt markets to strengthen with the level of credit market development.

We test whether societal trust is less important when financial development is high by interacting

Trust with the measure of credit market development used in Rajan and Zingales (1998). Our proxy for

the credit development of country j in year t is Banking, defined as the ratio of a countrys domestic credit

provided by the banking sector over its GDP, where the quantity of bank credit and country GDP are

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obtained from the World Bank. Panel C of Table 6 shows that a more developed banking sector reduces

the effect of trust on corporate cash holdings. As shown, the coefficient on the interaction term between

Trust and Banking is negative and statistically significant at the 1% level, suggesting that the effect of

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societal trust on cash holdings is more important when financial development is weak.

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Overall, we conclude that the effect of trust on corporate cash holdings is robust to controlling for

shareholder rights, country-level governance measures, unobserved country-level heterogeneity, as well

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as dimensions of a countrys culture that relate to individual preferences. Moreover, trust matters most

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when the quality of a countrys formal institutions is weak, as evidenced by the significantly negative

interaction effects between societal trust and the governance and shareholder rights indices.
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4.4 Instrumental variables estimates

A potential concern with our findings is that cash balances vary across countries along some
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unobserved dimension or characteristic that may also correlate with societal trust. For example, trust is
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positively correlated with economic growth, which is also correlated with corporate profitability and the
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level of cash holdings. In order to address this concern, we employ two identification strategies, both
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based on instrumental variable regressions. The first strategy instruments trust with religion. Religion is a

more primitive aspect of societal culture that predicts differences in creditor-rights across countries (Stulz
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& Williamson 2003). Moreover, the component of religion that is related to trust is correlated with

economic growth (Blum & Dudley 2001). For this strategy to work, it must also be the case that the effect

of religion affects cash holdings only through the instrumented variable, e.g., societal trust. However,

religion is correlated with individual preferences related to an individuals attitude towards risk, which

may also affect corporate financial policies (Hilary & Hui 2009; Kumar et al. 2011). In order to ensure

that religion affects cash holdings via the societal trust mechanism and not this alternative channel, we

control for cultural characteristics such as individualism and uncertainty avoidance that are related to

peoples attitudes towards risk, as measured with the Hofstede (1980) indices described above.

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We obtain the data on the fraction of the population that practices a religious denomination from

Maoz and Henderson (2013). Survey data taken at five-year intervals provide information on the

proportion of adherents to each religion, and we linearly interpolate the missing observations. Panel A of

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Table 7 reports the first-stage regressions of trust on religion at the country-year-industry level. The sign

of the effects of Protestant and Catholic on Trust in column (IV1) are consistent with Blum and Dudley

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(2001). They argue that the rejection of the Catholic sacrament of penance by the Protestant religion

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increased the cost of defection from any contractual relationship by protestants. Specifically, Protestants

were subject to a strict system of norms defined by their peer group, making the perceived penalty of

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defection in such relationships severe. In contrast, for Catholics, feelings of guilt after defection could be
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relieved by the sacrament of penance, and defection could be excused by cooperation in a subsequent

game with the injured party (Blum & Dudley 2001 pages 217-218).
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In order to test whether the relation between trust and cash holdings is endogenous, we perform a
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Hausman test and compare the ordinary least squares estimates with the two-stage least squares estimate.

The Hausman test strongly rejects the null hypothesis that the two estimators are equivalent, which
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confirms the endogeneity of trust and cash holdings. Our first-stage estimates also reject the null
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hypothesis of weak instruments, as the F-statistic testing the joint significance of the instruments in the
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first-stage is greater than 10.13 Panel B reports the instrumented effect of trust on cash holdings. As

shown, the sign and significance of the coefficient on trust are consistent with our earlier results.

One potential issue with the use of religion as an instrument is that religion and economic growth

are endogenous (Trevor-Roper 2001). This concern applies to our study as well because economic growth

is likely to affect corporate profitability and therefore corporate cash holdings. To deal with this concern,

we employ an alternative instrumental variable based on the degree of ethnic fractionalization within each

country in our sample. The main advantage of this variable is that its relation with economic growth is

13
Staiger and Stock (1997) suggest the rule of thumb that instruments are weak if the first-stage F-statistic is less than 10.

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less endogenous than religion (Alesina et al. 2003). We use the measure of ethnic fractionalization

developed by these authors as our measure of ethnic diversity.14

Previous research shows that the ethnic composition of a countrys population significantly

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affects societal trust at both regional and country levels of aggregation. Putnam (2007) documents that

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inhabitants of diverse neighborhoods tend to withdraw from collective life, to distrust their neighbors and

to vote less. Explanations for this finding are based on the difficulty of enforcing cooperative norms in

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more diverse groups, and ethnic biases and in-group preferences that make people distrustful of

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members of out-groups (Koopmans & Veit 2014). Consistent with these earlier studies, we find that

ethnic fractionalization (Ethnic fractionalization) is negatively associated with societal trust. As shown,
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the coefficient on Ethnic fractionalization in Panel A equals 0.128 and is statistically significant at the

1% level. It also passes the instrumental variable relevance test (F-statistic >10).
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Panel B reports the effect of societal trust instrumented with Ethnic fractionalization. As shown
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in column (2), the effect of trust is positive and significant and of the same magnitude as in column (1).
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Interestingly, the magnitude of the instrumented coefficients in both columns is several orders of
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magnitude larger than the non-instrumented value. For instance, using Ethnic fractionalization as the

instrumental variable, the point estimate equals 1.29, indicating that moving from the 25th to the 75th
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percentile of trust increases the ratio of cash to assets by 29%. Instrumenting trust with religion implies a

similarly large effect compared to our baseline regression result. The large magnitude obtained with the

instrumental variable models suggests that trust may be correlated with unobserved informal institutional

qualities that affect corporate cash holdings. We conclude that, controlling for the potential endogeneity

of trust and corporate cash holdings, trust has an economically significant effect on the firms cash policy.

4.5 Trust and the marginal value of cash

14
We obtain this data from Romain Wacziargs website at http://www.anderson.ucla.edu/faculty_pages/romain.wacziarg.

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In this section, we estimate the marginal value of cash holdings to the firms stockholders. The

effect of trust on the marginal value of cash is measured by applying the method of Faulkender and Wang

(2006). Specifically, we estimate the change in shareholder value on the change in cash as well as other

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balance sheet and income statement items. We measure the change in shareholder value as the share

return in excess of each countrys market benchmark return. Since both the dependent and independent

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variables are scaled by the market value of equity, the coefficient on the change in cash measures the

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incremental dollar value to shareholders of an additional dollar of cash.

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We measure the effect of trust by interacting the annual change in cash with trust. In order to

control for the quality of the countrys governance and economic development, we also interact the
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change in cash with Score and GDP per capita. Specifically, we estimate the following regression:
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P TE
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where X indicates a change in X from year t1 to t, and Rit equals the stock return over year t, RMkt equals

the countrys market index return over year t, MEit1 equals the firms market value of equity at time t1,

Cit1 equals cash, Intit equals annual interest payments, Divit equals the common dividend paid in year t, Eit

equals earnings before extraordinary items, NAit equals assets net of cash, NFit equals net financing, Lit

equals market leverage, RDit equals research and development expense. These control variables capture

changes in firm characteristics that may be correlated with the firms financial policy, payout policy or

investment policy. All firm characteristic variables except market leverage are deflated by the market

value of equity in year t1. This deflation allows us to interpret the coefficient estimates as the marginal

values of the right-hand-side variables.

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As discussed in Section 2, the precautionary-savings motive hypothesis predicts that the effect of

trust on an extra dollar of cash is negative, and the agency hypothesis makes the opposite prediction.

Specifically, Hypothesis 3a predicts that 2, the interaction term between trust and the change in cash, is

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negative, and Hypothesis 3b predicts that this coefficient is positive. Given earlier findings in the

literature that better country governance improves the valuation of cash (Pinkowitz et al. 2006), we

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expect 3 to be positive. In order to simplify the interpretation of the results, the trust-related variables,

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Score and the logarithm of GDP per capita are demeaned in each of the interaction terms. As such, the

coefficient 1 measures the marginal value of cash for a firm with zero leverage, zero cash holdings

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located in a country with mean values of trust, governance and GDP.
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We present the results in Table 8. Column (1) reports estimates of equation (2) without fixed

effects. In column (2), we include year, industry and country fixed effects. As shown, higher levels of
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trust increase the marginal value of cash, as evidenced by the statistically significant positive coefficient
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on the interaction term between the change in cash and trust. This result indicates that societal trust

increases the value shareholders put on the firms internal resources, consistent with Hypothesis 3b. These
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results are robust to including year, industry and country fixed effects (column 2), as the inclusion of

these controls does not affect the magnitude of the coefficient on the interaction term. Consistent with
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earlier results in the literature, country governance (measured with Score) has a positive effect on the

marginal value of cash, indicating that cash is valued more highly in countries with better governance.

4.5.1 Economic impact of trust on the marginal value of cash

We assess the economic significance by adding the coefficient on the change in cash to the

product of the coefficient on the interaction term with trust with either the 25th or the 75th percentile of

trust. As in Faulkender and Wang (2006), we set cash and leverage to zero. Thus, we obtain the marginal

value of cash for the firm located in a country with mean levels of trust, governance and GDP per capita.

Panel B reports these estimates. As shown, the marginal value of cash equals $1.13 based on column (1)

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and (2) estimates. In comparison the marginal value of cash for U.S. firms obtained in Faulkender and

Wang (2006) equals $1.47, while Dittmar and Mahrt-Smith (2007) find that the marginal value of cash in

an international setting equals $1.09.

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The effect of trust on the marginal value of cash is economically significant, controlling for the

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effect of formal institutions on the value of cash holdings. For instance, based on column (2) estimates,

firms located in countries with levels of trust one standard deviation below the mean have a marginal

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value of cash of $1.09. In comparison, the marginal value of cash equals $1.19 for firms located in

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countries with trust that is one standard deviation above the mean. It follows that moving from a low-trust

country to a high-trust country increases the marginal value of cash by $0.10.

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For purposes of comparison, we execute a similar computation for Score using estimates from the

regression reported in column (2). The marginal value of cash when Score is one standard deviation
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below the mean is $1.02. The corresponding value when Score is one standard deviation above the mean
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is $1.26. Thus moving from a low-governance quality country to a high-governance quality country
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increases the marginal value of cash by $0.24. We conclude that the effect of trust on the marginal value
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of cash is close to half of the effect of a countrys formal institutions. Overall, the results of this section

are consistent with the agency hypothesis, and they illustrate the role societal trust plays in shaping
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investors valuation of the firm.

5. ROBUSTNESS TESTS

5.1 Excluding countries with high-trust levels

The majority of observations in our sample consists of firm-year observations for firms that are

located in the United States, the United Kingdom, Canada or Japan. All of these countries have high trust

scores. In order to ensure that our results are not driven by these countries, we exclude firms located in

the United States, United Kingdom, Canada and Japan, respectively. As shown in Panel A of Table 9, the

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economic and statistical significance of the effect of trust on corporate cash holdings remains similar

when we remove these firms from the sample. We conclude that a specific subsample of firms that belong

to high-trust countries does not drive our results.

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5.2 Construct validity of societal trust measure

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One concern is that trust, as measured by the WVS, captures the response of the average citizen

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and therefore does not reflect the level of trust of the firms current and potential investors. Thus, our

measure of trust would be more accurate if we knew the level of trust of the countrys stock-market

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investors. To assess the sensitivity of our baseline result to this assumption, we adopt an approach similar

to Pevzner et al. (2015) and create two alternative trust measures, TrustHI and TrustHE, respectively, based
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on different subsets of respondents to the WVS.

The WVS partitions respondents according to their annual income and education. We base our
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first measure of trust (TrustHI) on answers provided by individuals whose income is in the top tercile of
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the countrys income distribution, as reported to the WVS. The second measure of trust (TrustHE) uses
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survey responses of respondents who achieved a university-level education. Intuitively, people with
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higher incomes and higher education levels are more likely to be equity investors. Table 9 Panel B reports

the regression results using these two measures. As shown, measures of trust are positively associated
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with corporate cash holdings. Moreover, the coefficient estimates are close in magnitude to the baseline

estimates reported in Table 3, which confirms the construct validity of our measure of trust.

As a final robustness check, we also estimate the marginal value of cash equation using the

alternative measures of trust based on high-income earners and high-education respondents to the WVS.

Using these estimates (reported in Panel C) yields almost identical coefficients to those reported in Table

8.

6. CONCLUSION

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We explore the role played by societal trust in shaping firms financial policy. We test two

competing hypotheses about the effect of trust on corporate cash holdings. The precautionary savings

hypothesis predicts that firms located in high-trust countries hold less cash because they enjoy better

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access to financial markets. The agency hypothesis predicts the opposite. According to this hypothesis,

outside investors put less pressure on insiders to disgorge cash in countries where societal trust is high.

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We document three findings that support the agency hypothesis. We first show that societal trust

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has a positive effect on firm cash holdings. This result is robust to controlling for firm characteristics and

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country governance quality, as well as country fixed effects. Second, we find that the effect of trust on

cash holdings is strongest in firms located in countries with weak institutions and in firms with high
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information asymmetries and low levels of private trust between insiders and outside shareholders. Third,

we show that investors value cash more highly in firms that are located in countries with higher levels of
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societal trust. Instrumental variable tests suggest a causal interpretation of the effect of trust on cash
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holdings.
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Our findings highlight the role played by societal trust in shaping corporate financial policy.
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Societal trust becomes more important when formal institutions such as the quality of a countrys

institutions and the strength of shareholder and creditor rights are weak. We contribute to the corporate
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finance literature by highlighting the role played by informal institutions such as a countrys social capital

in shaping corporate financial policy. This finding is important because prior evidence on the

determinants of cash holdings focuses primarily on the role of formal institutions and firm-level measures

of governance.

ACKNOWLEDGEMENTS

We thank Mike Welker, Ali Nejadmalayeri (discussant) and workshop participants at the IFABS 2015 Corporate Finance

Conference for their comments. We also thank Jeff Netter (the editor) and an anonymous reviewer for very helpful comments.

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Table A1
Appendix: Variable definitions
Variable Definitions
Country-level variables:
Trust This captures societal trust, calculated based on responses to the WVS question:
Generally speaking, would you say that most people can be trusted or that you
need to be very careful in dealing with people? Specifically, it is defined as the

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percentage of people who responded that most people can be trusted. We linearly
interpolate and fill this variable for years between the two adjacent surveys.
TrustHI This captures societal trust, calculated based on responses to the WVS question:
Generally speaking, would you say that most people can be trusted or that you

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need to be very careful in dealing with people? Specifically, it is defined as the
percentage of high-income people who responded that most people can be trusted.
High-income people are defined as people who responded that their incomes are in

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the top tercile of their countries. We linearly interpolate and fill this variable for
years between the two adjacent surveys.
TrustHE This captures societal trust, calculated based on responses to the WVS question:

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Generally speaking, would you say that most people can be trusted or that you
need to be very careful in dealing with people? Specifically, it is defined as the
percentage of high-income people who responded that most people can be trusted.
High-education people are defined as people who responded that their highest
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education is the university-level. We linearly interpolate and fill this variable for
years between the two adjacent surveys.
Score This captures country-year specific level of investor protection. It is the first
principal component of component of governance (Govern), regulatory quality
(Regquality), control of corruption (Ctrlcorruption), political stability (Polstability),
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rule of law (Ruleoflaw) and voice and accountability (Voice) as described in

Kaufmann et al. (2009) and at http://info.worldbank.org/governance/wgi).
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GDP Natural logarithm of GDP per capita. (source: worldbank.org)

Country-level cultural indices along four dimensions (individualism, power
Hofstede Culture Indices distance, uncertainty avoidance and masculinity)
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This captures the development of banking infrastrucature. It is calculated as the

ratio of country i's domestic credit provided by the banking sector over its GDP.
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Banking (source: worldbank.org)

LLSV The shareholder rights index from Djankov et al. (2008).
Anti-selfdealing Index The anti-selfdealing index from Djankov et al. (2008).
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Government effectiveness captures perceptions of the quality of public services, the

Government Effectiveness
Regulatory Quality
Control of Corruption
Political Stability
Rule of Law
Voice and Accountability
quality of the civil service and the degree of its independence from political
pressures, the quality of policy formulation and implementation, and the credibility
of the government's commitment to such policies. (source:
http://info.worldbank.org/governance/wgi)
Regulatory quality captures perceptions of the ability of the government to
formulate and implement sound policies and regulations that permit and promote
private sector development. (source: http://info.worldbank.org/governance/wgi)
Control of corruption captures perceptions of the extent to which public power is
exercised for private gain, including both petty and grand forms of corruption, as
well as "capture" of the state by elites and private interests. (source:
http://info.worldbank.org/governance/wgi)
Political Stability and Absence of Violence/Terrorism measures perceptions of the
likelihood of political instability and/or politically-motivated violence, including
terrorism. (source: http://info.worldbank.org/governance/wgi)
Rule of law captures perceptions of the extent to which agents have confidence in
and abide by the rules of society, and in particular the quality of contract
enforcement, property rights, the police and the courts, as well as the likelihood of
crime and violence. (source: http://info.worldbank.org/governance/wgi)
Voice and accountability captures perceptions of the extent to which a country's
citizens are able to participate in selecting their government, as well as freedom of
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expression, freedom of association and a free media (source:
http://info.worldbank.org/governance/wgi)

Firm-level variables:
Variables used in the cash holding and payout regressions
ln(Cash/TA) Natural logarithm of cash and cash equivalent scaled by total assets.
Cash Cash and cash equivalent scaled by total assets.

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ln(Cash/Net Assets) Natural logarithm of cash and cash equivalent scaled by net assets.
Cash/Net Assets Cash and cash equivalent scaled by net assets.
Size Natural logarithm of total assets.

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Leverage Sum of long-term debt plus debt in current liabilities, divided by total assets.
MTB Market to Book ratio of equity.
Capex Capital expenditure scaled by total assets.

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RD R&D expenses scaled by total assets.
WCAP Net working capital, defined as the difference between current assets and current
liabilities excluding cash and cash equivalent, scaled by total assets.

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Payer An indicator variable that takes one if a firm pays dividend and zero otherwise.
CFO Cash from operations, scaled by total assets.
Std(CFO) Standard deviation of sales scaled by lagged total assets over the five-year rolling
window.
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Financing Cash from new equity issuance and debt issuance, scaled by total assets.
Growth Sales growth from year t1 to t
Excess return Difference between the firm's return and the market return
P/E Price-to-earnings ratio
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Annual change in dividends industry adjusted on a yearly basis using the Fama-
Industry adjusted dividends
French 48 industry classifications (scaled by total assets)
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Annual change in share repurchases industry adjusted on a yearly basis using the
Industry adjusted repurchases
Fama-French 48 industry classifications (scaled by total assets)
Variables used in the MVCash regression
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Exret Annual excess return, calculated as the difference between the annual return and
market return.
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Cash Change in cash and cash equivalent lagged scaled by market value of equity.
E Change in earnings before extraordinary items plus interest, deferred tax credits and
investment tax credits, scaled by lagged market value of equity.
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NA Change in net assets where net assets are defined as total assets minus cash
holdings, scaled by lagged market value of equity.
RD RD is change in R&D expenditures, scaled by lagged market value of equity.
Int Change in interest expense, scaled by lagged market value of equity.
Divt Change in common dividends paid, scaled by lagged market value of equity.
Casht1 Cash balance from last year, scaled by lagged market value of equity.
Lev Market leverage ratio, defined as total debt over the sum of total debt and the
market value of equity.
NF Total equity issuance minus repurchases plus debt issuance minus debt redemption,
scaled by lagged market value of equity.

Instrumental variables:
Protestant Percentage of protestants. (source: www.correlatesofwar.org)
Catholic Percentage of Catholics.
Muslim Percentage of Muslims.
Judaism Percentage of Jewish.
Buddhist Percentage of Buddhists.
Ethnic fractionalization score.
Ethnic frationalization
(source: http://www.anderson.ucla.edu/faculty_pages/romain.wacziarg)
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Figure 1A. Plot of country cash holdings against societal trust, measured using the World Values Survey

The vertical axis reports the mean over firms and years in each country of the ratio of cash to total assets. The horizontal access reports the level of societal trust averaged over
years for each country, as reported in the World Values Survey.

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Figure 1B. Plot of country log cash holdings against societal trust, measured using the World Values Survey

The vertical axis reports the mean over firms and years in each country of the natural logarithm of cash to total assets. The horizontal access reports the level of societal trust
averaged over years for each country, as reported in the World Values Survey.

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Table 1: Trust and property rights around the world

Panel A: Trust and country governance
This panel reports average levels of trust and various country-level measures of governance around the world.

Country Year Range Trust Government Regulatory Control of Political Rule of Voice and

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Effectiveness Quality Corruption Stability Law Accountability
Argentina 1994-2013 0.17 0.00 -0.29 -0.37 -0.12 -0.45 0.28
Australia 1992-2013 0.47 1.72 1.54 1.93 1.07 1.73 1.46
Austria 1992-2013 0.35 1.83 1.53 1.90 1.18 1.84 1.42

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Belgium 1992-2013 0.32 1.75 1.24 1.39 0.97 1.31 1.40
Brazil 1995-2013 0.09 -0.07 0.21 -0.03 -0.12 -0.29 0.34
Bulgaria 2006-2013 0.18 0.08 0.60 -0.23 0.32 -0.12 0.50

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Canada 1992-2013 0.42 1.88 1.56 2.08 1.04 1.71 1.53
Chile 1992-2013 0.18 1.22 1.50 1.44 0.54 1.21 0.89
China 1995-2013 0.56 -0.03 -0.25 -0.44 -0.43 -0.42 -1.49
Colombia 1993-2013 0.10 -0.15 0.14 -0.34 -1.73 -0.68 -0.38

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Croatia 2006-2013 0.20 0.60 0.48 0.01 0.58 0.13 0.46
Cyprus 2006-2013 0.10 1.44 1.26 1.09 0.53 1.11 1.04
Czech Republic 1996-2013 0.28 0.84 1.07 0.34 0.86 0.85 0.93
Denmark 1992-2013 0.70 2.07 1.80 2.43 1.21 1.87 1.60
Egypt 1998-2013 0.27 -0.38
MA -0.39 -0.50 -0.68 -0.12 -1.00
Finland 1992-2013 0.58 2.07 1.70 2.39 1.46 1.93 1.58
France 1992-2013 0.23 1.54 1.07 1.35 0.63 1.41 1.24
Germany 1992-2013 0.36 1.70 1.46 1.90 1.01 1.62 1.36
Greece 1992-2013 0.23 0.68 0.75 0.34 0.38 0.78 0.95
D

Hungary 1995-2013 0.24 0.83 1.07 0.52 0.87 0.82 1.02

India 1992-2013 0.32 -0.08 -0.36 -0.42 -1.11 0.13 0.38
Indonesia 1992-2013 0.47 -0.37 -0.24 -0.77 -1.33 -0.64 -0.42
TE

Ireland 1992-2013 0.39 1.61 1.67 1.62 1.23 1.60 1.39

Israel 1993-2013 0.23 1.17 1.09 1.07 -1.27 0.99 0.62
Italy 1992-2013 0.32 0.64 0.87 0.35 0.72 0.65 1.04
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Japan 1992-2013 0.41 1.24 0.89 1.21 1.04 1.30 1.00

Jordan 2007-2013 0.31 0.11 0.26 0.18 -0.43 0.34 -0.76
CE

Luxembourg 1992-2013 0.28 1.87 1.73 2.01 1.39 1.77 1.52

Malaysia 1992-2013 0.09 0.98 0.57 0.34 0.23 0.51 -0.31
Mexico 1992-2013 0.21 0.19 0.36 -0.34 -0.61 -0.57 0.09
Morocco 1998-2013 0.17 -0.10 -0.15 -0.19 -0.35 -0.08 -0.62
Netherlands 1992-2013 0.57 1.93 1.81 2.18 1.22 1.73 1.59
AC

New Zealand 1992-2013 0.52 1.80 1.83 2.33 1.25 1.84 1.63
Nigeria 2010-2013 0.15 -1.06 -0.70 -1.12 -2.07 -1.18 -0.76
Norway 1992-2013 0.70 1.94 1.41 2.18 1.33 1.91 1.60
Pakistan 1993-2013 0.25 -0.57 -0.60 -0.97 -1.81 -0.81 -0.92
Peru 1994-2013 0.08 -0.23 0.42 -0.28 -0.95 -0.65 -0.16
Philippines 1992-2013 0.06 -0.06 0.04 -0.46 -1.09 -0.33 0.09
Poland 1995-2013 0.21 0.59 0.79 0.43 0.66 0.61 0.99
Portugal 1992-2013 0.16 1.09 1.09 1.21 1.07 1.15 1.34
Romania 2006-2013 0.13 -0.27 0.57 -0.20 0.18 0.00 0.42
Singapore 1992-2013 0.23 2.13 2.01 2.22 1.10 1.49 0.01
Slovenia 2001-2013 0.21 1.00 0.78 0.88 1.01 0.96 1.05
South Africa 1992-2013 0.16 0.63 0.45 0.43 -0.23 0.07 0.70
South Korea 1992-2013 0.30 0.86 0.68 0.38 0.38 0.86 0.64
Spain 1992-2013 0.29 1.43 1.19 1.15 0.04 1.24 1.22
Sweden 1992-2013 0.66 1.98 1.52 2.28 1.28 1.84 1.59
Switzerland 1992-2013 0.46 1.96 1.63 2.13 1.34 1.87 1.52
Taiwan 1992-2013 0.31 0.97 1.05 0.66 0.77 0.85 0.79
Thailand 1992-2013 0.42 0.26 0.25 -0.22 -0.32 0.22 0.02
Turkey 1992-2013 0.10 0.10 0.28 -0.18 -1.02 -0.02 -0.25
United Kingdom 1992-2013 0.35 1.76 1.83 1.95 0.62 1.65 1.32
United States 1992-2013 0.38 1.67 1.55 1.53 0.58 1.53 1.26
Venezuela 1998-2013 0.16 -0.99 -1.08 -1.00 -1.12 -1.34 -0.61

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Panel B: GDP and corporate cash holdings

This panel reports average levels of per capita GDP in natural logarithm, Score, average cash holdings scaled by total assets, median
cash holdings scaled by total assets, the number of unique firms and the number of observations by country.

Country GDP Score Average cash Median cash # firms # firm-year

observations
Argentina 9.05 -0.36 0.08 0.06 65 533
Australia 10.30 3.92 0.23 0.13 1,737 10,970

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Austria 10.41 4.01 0.13 0.08 87 681
Belgium 10.36 3.34 0.13 0.08 125 1,006
Brazil 8.64 0.06 0.14 0.11 110 594
Bulgaria 8.76 0.49 0.10 0.03 163 600

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Canada 10.31 4.06 0.22 0.11 2,595 13,104
Chile 8.82 2.84 0.08 0.04 145 1,439
China 7.49 -1.18 0.18 0.14 2,140 14,227

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Colombia 8.13 -1.18 0.08 0.06 30 229
Croatia 9.51 0.94 0.09 0.05 86 351
Cyprus 10.24 2.70 0.10 0.04 68 210
Czech Republic 9.32 2.03 0.09 0.05 30 143

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Denmark 10.62 4.55 0.15 0.08 185 1,781
Egypt 7.49 -1.19 0.17 0.13 86 484
Finland 10.36 4.60 0.13 0.08 147 1,598
France 10.30 3.02 0.15 0.10 863 6,719
Germany 10.36 3.75
MA 0.15 0.08 837 6,913
Greece 9.73 1.63 0.09 0.05 275 1,897
Hungary 8.99 2.12 0.11 0.05 39 294
India 6.47 -0.51 0.07 0.03 2,040 10,531
Indonesia 7.18 -1.45 0.13 0.08 334 2,906
D

Ireland 10.38 3.76 0.16 0.10 85 664

Israel 9.96 1.63 0.21 0.13 88 475
TE

Italy 10.17 1.77 0.12 0.08 278 2,202

Japan 10.51 2.77 0.17 0.14 2,963 31,358
Jordan 8.35 -0.04 0.12 0.05 120 520
Luxembourg 11.09 4.25 0.15 0.11 22 124
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Malaysia 8.57 1.01 0.13 0.08 952 7,314

Mexico 8.81 -0.30 0.09 0.06 126 1,273
CE

Morocco 7.62 -0.55 0.10 0.05 48 203

Netherlands 10.41 4.33 0.12 0.07 49 498
New Zealand 9.97 4.41 0.10 0.03 133 897
Nigeria 7.87 -2.72 0.10 0.08 33 69
AC

Norway 10.86 4.29 0.18 0.11 271 1,972

Pakistan 6.50 -2.22 0.12 0.06 128 1,130
Peru 7.98 -0.69 0.08 0.04 92 717
Philippines 7.18 -0.66 0.14 0.08 143 1,270
Poland 8.88 1.69 0.11 0.06 386 1,973
Portugal 9.63 2.87 0.06 0.03 83 718
Romania 9.02 0.31 0.11 0.04 99 359
Singapore 10.28 3.74 0.18 0.14 726 5,501
Slovenia 9.84 2.35 0.10 0.04 40 174
South Africa 8.37 0.90 0.14 0.09 317 1,827
South Korea 9.60 1.61 0.15 0.10 1,731 12,024
Spain 9.93 2.64 0.10 0.06 123 732
Sweden 10.50 4.34 0.16 0.09 499 3,604
Switzerland 10.81 4.32 0.17 0.12 247 2,608
Taiwan 10.03 2.12 0.18 0.14 830 7,762
Thailand 7.97 0.15 0.10 0.05 449 3,652
Turkey 8.57 -0.35 0.14 0.07 247 1,623
United Kingdom 10.29 3.81 0.17 0.09 2,419 16,550
United States 10.56 3.39 0.19 0.10 4,304 42,346
Venezuela 8.82 -2.46 0.09 0.06 15 79

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Panel C: Correlations

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This panel reports the sample correlations of country and firm-level variables. Correlations are measured using firm-year observations based on the panel of firms located
across 54 countries. Pearsons (Spearmans) correlation coefficients are presented in the lower (upper) triangle. Italic indicates significance at the 1% level or better.

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Variables Trust Cash log(Cash/TA) Score Government Regulatory Control of Political Rule Voice and GDP LLSV Anti-
Effectiveness Quality Corruption Stability of Accountability selfdealing

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Law
Trust 0.12 0.13 0.21 0.20 0.16 0.27 0.24 0.23 0.05 0.22 -0.35 0.01

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Cash 0.14 0.78 0.13 0.14 0.14 0.13 0.09 0.14 0.07 0.17 -0.05 0.06
log(cash) 0.14 1.00 0.08 0.10 0.08 0.08 0.11 0.09 -0.01 0.16 -0.06 0.02
Score

MA
0.30 0.06 0.06 0.96 0.96 0.97 0.85 0.98 0.86 0.88 0.26 0.01
Government
Effectiveness 0.23 0.07 0.07 0.95 0.94 0.95 0.81 0.95 0.74 0.86 0.25 0.13
Regulatory Quality 0.20 0.08 0.08 0.93 0.91 0.94 0.77 0.93 0.78 0.86 0.19 0.14

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Control of
Corruption 0.26 0.07 0.07 0.97 0.95 0.91 0.80 0.95 0.79 0.83 0.25 0.09
Political Stability

PT
0.32 0.08 0.08 0.71 0.65 0.57 0.69 0.82 0.64 0.81 0.14 -0.09
Rule of Law 0.35 0.09 0.09 0.96 0.90 0.89 0.92 0.66 0.84 0.88 0.27 0.03
Voice and
CE
Accountability 0.30 0.03 0.03 0.90 0.81 0.78 0.84 0.59 0.87 0.73 0.35 -0.23
GDP 0.34 0.19 0.19 0.67 0.63 0.68 0.65 0.52 0.75 0.64 0.09 -0.07
AC

LLSV -0.24 -0.06 -0.06 0.06 0.04 0.05 0.11 0.11 0.07 -0.07 -0.10 0.21
Anti-selfdealing 0.13 0.05 0.05 0.08 0.16 0.26 0.11 -0.21 0.09 -0.10 -0.02 0.16

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Table 2: Summary statistics

This table reports firm-level summary statistics for all of the variables used in the study. Variable definitions are located in Table A1.

Variable N Mean P25 Median P75 Std

Country-level variables
Trust 994 0.316 0.185

PT
0.299 0.408 0.169
TrustHI 984 0.380 0.240 0.355 0.488 0.195
TrustHE 982 0.372 0.212 0.340 0.486 0.199
Score 994 1.970 -0.037 2.299 3.868 2.027

RI
GDP 994 9.386 8.488 9.818 10.380 1.259
LLSV 975 3.439 2.500 3.500 4.000 1.063
Anti-selfdealing 975 0.482 0.283 0.444 0.642 0.227

SC
Banking 964 44.161 8.090 20.408 48.312 90.224

Firm-level variables

NU
Variables used in the cash holding regression
Cash/AT 229,428 0.165 0.041 0.105 0.220 0.178
Log(Cash/AT) 229,428 -2.462 -3.189 -2.254 -1.512 1.356
Cash/Net Assets 229,409 -2.243 -3.147 -2.144 -1.264 1.589
Ln(Cash/Net Assets)
MA
229,409 0.366 0.043 0.117 0.283 1.106
Size 229,428 12.226 10.932 12.171 13.468 1.971
Leverage 229,428 0.252 0.026 0.183 0.416 0.248
MTB 229,428 2.348 0.812 1.456 2.644 2.977
Capx 229,428 0.056 0.015 0.035 0.071 0.066
D

RD 229,428 0.019 0.000 0.000 0.009 0.050

WC 229,428 0.035 -0.068 0.025 0.142 0.178
TE

Payer 229,428 0.550 0.000 1.000 1.000 0.497

CFO 229,428 0.044 0.004 0.060 0.114 0.141
Std(CFO) 229,428 0.085 0.034 0.058 0.101 0.086
P

Financing 229,428 0.041 -0.003 0.000 0.037 0.134

CE

Variables used in the MVCash regression

Exret 342,400 0.026 -0.284 -0.047 0.226 0.488
Cash 342,400 0.017 -0.037 0.003 0.056 0.146
E 342,400 0.016 -0.037 0.007 0.055 0.184
AC

NA 342,400 0.111 -0.060 0.060 0.256 0.507

RD 342,400 0.001 0.000 0.000 0.000 0.006
Int 342,400 0.001 -0.003 0.000 0.004 0.019
Divt 342,400 0.001 0.000 0.000 0.003 0.015
Casht-1 342,400 0.244 0.052 0.140 0.316 0.285
Lev 342,400 0.267 0.034 0.206 0.445 0.250
NF 342,400 0.052 -0.001 0.000 0.051 0.177

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Table 3: Baseline regression estimates

This panel reports a regression of cash balances at the firm-year level. In column (1), the dependent variable equals the natural
logarithm of cash and marketable securities to total assets. Columns (2) to (4) use alternative definitions of the dependent variable. T-
statistics are in parentheses and standard errors are clustered by firm and by year. Superscripts ***, **, and * indicate significance at
the 1%, 5%, and 10% levels, respectively. Variable definitions are in Table A1.

PT
(1) (2) (3) (4)
Cash holdings
Measures Main Alternative measures
ln(Cash/TA) Cash/TA ln(Cash/Net Assets) Cash/Net Assets

RI
Trust 0.528** 0.111*** 0.720*** 0.491***
(2.49) (5.16) (3.04) (4.50)
Score -0.312*** -0.0179*** -0.337*** -0.0633***

SC
(-5.80) (-2.76) (-5.35) (-3.29)
GDP 0.101* 0.0230*** 0.133** 0.0356**
(1.84) (4.09) (2.16) (2.07)
Size -0.0129*** -0.00948*** -0.0303*** -0.0468***

NU
(-2.81) (-15.00) (-5.73) (-9.95)
Leverage -2.041*** -0.253*** -2.416*** -0.710***
(-40.84) (-47.09) (-43.98) (-31.67)
MTB -0.0139*** MA -0.00201*** -0.0173*** -0.00774***
(-5.39) (-5.03) (-5.27) (-3.78)
Capex -1.721*** -0.383*** -2.457*** -2.097***
(-11.38) (-27.32) (-15.52) (-13.33)
RD 4.091*** 0.759*** 5.513*** 3.631***
(21.97) (22.73) (24.39) (11.70)
WC -1.181*** -0.204*** -1.541*** -0.902***
D

(-13.92) (-24.27) (-16.50) (-29.33)

Payer 0.0231 0.000880 0.0303 0.0531***
TE

(0.88) (0.30) (0.98) (3.45)

Financing 1.195*** 0.215*** 1.604*** 1.107***
(17.35) (13.59) (15.97) (8.54)
CFO 0.700*** 0.0357*** 0.628*** -0.762***
P

(9.63) (2.81) (6.65) (-8.04)

Std(CFO) 1.285*** 0.217*** 1.694*** 1.136***
CE

(17.05) (19.78) (18.86) (12.25)

Year fixed effects Yes Yes Yes Yes
Industry fixed effects Yes Yes Yes Yes
Country fixed effects Yes Yes Yes Yes
AC

N 229,428 229,428 229,409 229,409

adj. R-sq 0.330 0.410 0.360 0.241

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Table 4: Trust and cash holdings as they relate to payout policy

This table examines the relation between payout decisions and societal trust. The dependent variables are the change in industry-
adjusted dividends and repurchases. All the dependent variables are industry-adjusted on a yearly basis using the Fama-French 48
industry classification system. The firms cash position is the unexplained portion of cash holdings. Specifically, the residual from
regressing cash holdings on firm-specific characteristics represents the firms excess cash holdings. The control variables for the cash
regression in the first stage include firm size, leverage, growth options, profitability, ratio of working capital to assets, cash flow
volatility, R&D to sales, capital expenditures to assets, and acquisition to sales as well as industry and year indicator variables.

PT
Additional control variables include: Excess return (defined as the realized return minus market return), Growth (defined as the sales
growth), WCAP (defined as the net working capital minus cash), leverage (defined as the market leverage ratio), P/E (defined as the
price-earnings ratio ), and size (defined as total assets). T-statistics are in parentheses and standard errors are clustered by firm and by

RI
year. Superscripts ***, **, and * indicate significance at the 1%, 5%, and 10% levels, respectively. All models include industry and
year indicators as well an intercept term.

SC
(1) (2) (3)
ind. Adjusted ind. Adjusted ind. Adjusted
Dependent variable (Dividends+Repurchases) Dividends Repurchases

NU
Excess cash * Trust -0.122** -0.104*** 0.0345*
(-2.49) (-4.01) (1.66)
Excess cash 0.0755*** 0.0534*** -0.000625
(4.42) (5.72) (-0.09)
MA
Trust 0.428*** 1.204*** 0.328***
(2.68) (12.63) (4.34)
Score -0.000927 0.0703*** -0.0480***
(-0.04) (5.44) (-3.94)
D

GDP 0.114*** 0.357*** -0.00549

(3.53) (21.02) (-0.36)
TE

Excess return 0.0861*** 0.0905*** -0.0452***

(6.27) (14.93) (-5.63)
Leverage -0.906*** -0.546*** -0.244***
(-40.97) (-46.62) (-20.70)
P

Size 0.0717*** 0.0407*** 0.0273***

CE

(25.29) (27.61) (17.06)

Growth 0.157*** 0.0957*** 0.0135
(9.02) (12.28) (1.50)
WC -0.162*** -0.0125 -0.0723***
AC

(-4.67) (-0.73) (-3.99)

P/E -0.744 0.802 -1.620**
(-0.63) (1.64) (-2.43)
Year fixed effects Yes Yes Yes
Industry fixed effects Yes Yes Yes
Country fixed effects Yes Yes Yes
N 157,115 215,452 157,115
adj. R-sq 0.010 0.023 0.002

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Table 5: Cross-sectional variation in the relation between trust and cash holdings
This table reports the cross-sectional variation regressions of cash policy. The dependent variable is the natural logarithm of cash
scaled by total assets. The unit of observation is the firm-year. All regressions contain country, year and industry fixed effects. T-
statistics are in parentheses and standard errors are clustered by firm and by year.

Panel A: Past financing activity

PT
Financing3Y (Financing5Y) equals to one if the annual amount of new equity and debt issuance in any of the past three (five) years is
higher than 5% of total assets and zero otherwise.

RI
(1) (2)
log(Cash/TA)

SC
Trust 0.604*** 0.662***
(2.94) (3.16)
Trust*Financing3Y -0.147***
(-2.83)

NU
Financing3Y -0.0162
(-0.67)
Trust*Financing5YMA -0.212***
(-3.53)
Financing5Y 0.0163
(0.62)
Firm characteristics Yes Yes
Year fixed effects Yes Yes
D

Industry fixed effects Yes Yes

Country fixed effects Yes Yes
TE

N 229,428 229,428
adj. R-sq 0.331 0.331
P

Panel B: Analyst following

CE

Have analyst equals to one if the firm-year is covered by at least one analyst and zero otherwise. More analyst equals to one if the
number of analysts following the firm is greater than the median firm in this country each year and zero otherwise. log(# of analyst) is
the natural logarithm of the number of analysts.
AC

(1) (2) (3)

ln(Cash/TA)
Trust 0.842*** 0.790*** 0.851***
(3.94) (3.69) (4.13)
Trust*Have analyst -0.652***
(-9.05)
Have analyst 0.324***
(11.40)
Trust*More analyst -0.623***
(-8.90)
More Analyst 0.287***
(11.08)
Trust*log(# of analyst) -0.238***
(-9.68)
log(# of analyst) 0.101***
(9.11)
Firm characteristics Yes Yes Yes
Year fixed effects Yes Yes Yes
Industry fixed effects Yes Yes Yes
Country fixed effects Yes Yes Yes
N 229,428 229,428 229,428
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adj. R-sq 0.332 0.331 0.331

Panel C: Firm size and financial reporting quality

Large size equals to one if total assets is higher than the median firm in this country each year and zero otherwise. High AQ equals to
one if accruals quality is higher than the median firm in this country each year and zero otherwise. Accruals quality is defined as the
negative of the five-year rolling-window standard deviation of the residual terms from the modified Dechow and Dichev (2002)

PT
regression from McNichols (2002). Specifically, the modified Dechow and Dichev regression estimates working capital accruals on
Rev AR, net PPE and lagged, contemporaneous and lead cash flows from operations.

RI
(1) (2)
Log(Cash/TA)
Trust 0.898*** 0.594***

SC
(4.21) (2.81)
Trust*Large size -0.701***
(-8.87)
Large size 0.277***

NU
(8.41)
Trust*High AQ -0.124***
(-4.08)
High AQ 0.696***
MA
(4.68)
Firm characteristics Yes Yes
Year fixed effects Yes Yes
Industry fixed effects Yes Yes
D

Country fixed effects Yes Yes

N 229,428 229,428
TE

adj. R-sq 0.332 0.331

P
CE
AC

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Table 6: Country governance and the effect of trust on cash policy

Panel A: Interaction with country governance

This panel reports regressions in which Trust is interacted with Score and its subcomponents. The unit of observation unit is a firm-
year. Each of the six dimensions of country governance is interacted with trust in a separate regression (columns 2-7). Column (8)

PT
includes the Hofstede cultural indicators. Firm characteristics are included but not reported. T-statistics are in parentheses and
standard errors are clustered by firm and by year.

RI
(1) (2) (3) (4) (5) (6) (7) (8)
ln(Cash/TA)
Trust 0.927*** 1.242*** 1.082*** 0.922*** 0.791*** 1.387*** 0.696*** 0.517**

SC
(3.95) (5.36) (4.29) (3.92) (3.81) (5.42) (3.40) (2.44)
Score -0.238*** -0.315***
(-4.02) (-5.84)
Score*Trust -0.221**

NU
(-2.23)
Government effectiveness -0.222**
(-2.54)
Government effectiveness*Trust -0.747***
(-3.93)
MA
Regulatory quality -0.283***
(-3.63)
Regulatory quality*Trust -0.451**
(-2.33)
Control of corruption -0.124
D

(-1.39)
Control of corruption*Trust -0.220
TE

(-1.16)
Political stability -0.130
(-1.63)
Political stability*Trust -0.0833
P

(-0.44)
Rule of law 0.163
(1.48)
CE

Rule of law*Trust -0.575**

(-2.55)
Voice -0.335**
(-2.44)
AC

Voice*Trust -0.314
(-1.49)
Power distance -0.00899***
(-3.22)
Individuality 0.00485*
(1.74)
Masculinity 0.00834***
(3.10)
Uncertainty avoidance -0.0172***
(-7.26)
Long term orientation 0.0308***
(6.79)
Indulgence 0.0129***
(3.67)
GDP 0.0917 0.1000** 0.0905 0.0960 0.0745 0.0720 0.108 0.105*
(1.60) (1.99) (1.61) (1.51) (1.13) (0.99) (1.46) (1.91)
Firm characteristics Yes Yes Yes Yes Yes Yes Yes Yes
Year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes
Industry fixed effects Yes Yes Yes Yes Yes Yes Yes Yes
Country fixed effects Yes Yes Yes Yes Yes Yes Yes Yes
N 229,428 229,428 229,428 229,428 229,428 229,428 229,428 226,632
adj. R-sq 0.331 0.330 0.330 0.329 0.329 0.328 0.329 0.329

46
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PT
RI
SC
NU
MA
D
TE
P
CE
AC

47
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Panel B: Interaction with shareholder rights indices
This panel reports the results after controlling for investor protection index in La Porta et al. (2003). Column (1) replicates column (3)
of Table 2 in Dittmar et al. (2003). We restrict the sample to 1998 for the sake of comparison. Columns (2) to (4) use the entire sample
with year fixed effects. T-statistics are in parentheses and standard errors are clustered by firm and by year.

(1) (2) (3) (4)

ln(Cash/TA)
1998

PT
sample Full sample
Trust 0.731*** 3.100*** 2.485***
(10.17) (11.55) (7.07)
LLSV -0.156*** 0.121*** 0.356***

RI
(-12.90) (8.85) (14.92)
LLSV*Trust -0.601***
(-7.97)

SC
Score -0.272*** -0.155*** -0.116***
(-15.46) (-5.37) (-3.85)
Score*Trust -0.197*** -0.215***
(-5.03) (-5.31)

NU
Anti-selfdealing 1.382***
(13.31)
Anti-selfdealing*Trust -3.049***
(-6.22)
GDP
MA
0.0192 0.407*** 0.401*** 0.323***
(1.26) (11.78) (15.55) (12.20)
Common Law -0.321*** -0.376***
(-9.65) (-12.70)
Firm characteristics Yes Yes Yes Yes
D

Year fixed effects - Yes Yes Yes

Industry fixed effects Yes Yes Yes Yes
N 7,206 229,044 229,044 229,044
TE

adj. R-sq 0.263 0.301 0.308 0.304

P
CE

Panel C: Interaction with credit market development

This panel reports the results when Trust is interacted with Banking. Banking is calculated as the ratio of country i's domestic credit
provided by the banking sector over its GDP. All variables are defined in Appendix A. T-statistics are in parentheses, and robust
standard errors are clustered by country.
AC

(1)
ln(Cash/TA)
Trust 0.992***
(4.45)
Trust*Banking -1.49***
(-5.00)
Banking 0.597***
(5.18)
Firm characteristics Yes
Year fixed effects Yes
Industry fixed effects Yes
Country fixed effects Yes
N 221,307
adj. R-sq 0.328

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Table 7: Instrumental variable estimates
Panel A: First-stage regressions
This panel reports the first-stage instrumental variable estimates using 2SLS. The unit of observation is the firm-year. Columns (1)
and (2) instruments trust with religion and the ethnic fractionalization index, respectively. Protestant, Catholic, Muslim, Judaism and
Buddhist measure the proportion of the population that follows a given religious denomination. Ethnic fractionalization is the ethnic
fractionalization score described in Alesina et al. (2003). First stage variables also include firm-level controls, year and industry fixed
effects, as well as the Hofstede (1980) cultural indices. T-statistics are in parentheses, and robust standard errors are clustered by firm.

PT
Trust
(IV1) (IV2)

RI
Protestant 0.300***
(0.004)
Catholic -0.042***

SC
(0.004)
Mulim -0.132***
(0.008)
Judaism -6.088***

NU
(0.148)
Buddhist 0.167***
(0.003)
Ethnic fractionalization -0.128***
MA
(0.004)
Firm-level controls Yes Yes
Year FE Yes Yes
Industry FE Yes Yes
D

Cultural indices Yes Yes

N 214,608 214,608
TE

adj. R-sq 0.685 0.553

P
CE
AC

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Panel B: Second stage regressions
This panel reports the second-stage instrumental variable estimates using 2SLS. T-statistics are in parentheses, and robust standard
errors are clustered by firm. Diagnostic statistics test for endogeneity and instrument relevance. The Hausman test is based on the
different between the 2SLS estimates (consistent) and OLS estimates (efficient). The F-test tests for the joint significance of the
instruments (Protestant, Catholic, Muslim, Judaism and Buddhist) or (Ethnic fractionalization) in the first stage.

Log(Cash/TA)
(IV1) (IV2)

PT
Trust 1.511*** 1.291***
(0.118) (0.286)
Score -0.111*** -0.109***
(0.013) (0.013)

RI
Log(GDP) 0.354*** 0.354***
(0.016) (0.016)
Size -0.011*** -0.010***

SC
(0.004) (0.004)
Leverage -2.045*** -2.046***
(0.027) (0.027)
MTB -0.015*** -0.015***

NU
(0.002) (0.002)
CAPX -1.782*** -1.777***
(0.076) (0.077)
RD 4.012*** 4.004***
MA (0.099) (0.099)
WCAP -1.211*** -1.216***
(0.036) (0.036)
Payer 0.022* 0.020*
(0.012) (0.012)
Financing 1.208*** 1.211***
D

(0.028) (0.028)
CFO 0.705*** 0.695***
TE

(0.036) (0.037)
Std(CFO) 1.269*** 1.258***
(0.061) (0.062)
Year FE Yes Yes
P

Industry FE Yes Yes

Cultural indices Yes Yes
CE

N 214,608 214,608
adj. R-sq 0.32 0.32
Diagnostics
Hausman test endogeneity 257.30 12.61
AC

P-value 0.00 0.01

F-test first stage 3235.87 859.21
P-value 0.00 0.00

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Table 8: Trust and the marginal value of cash

Panel A: Regression estimates

This panel reports results of regressing annual excess return on Cash and its iteraction with trust and other firm characteristics. Trust,
Score and GDP are demeaned. T-statistics are in parentheses and standard errors are clustered by firm and by year.

(1) (2)
Ri,t-RM

PT
Cash 1.130*** 1.139***
(30.70) (32.54)
Cash*Trust 0.328** 0.303**

RI
(2.20) (2.31)
Cash*Score 0.0444 0.0580**
(1.32) (2.43)
Cash*GDP

SC
-0.0192 -0.0369
(-0.48) (-1.26)
NAt 0.102*** 0.116***
(5.90) (8.43)
NA*Trust 0.0878* 0.0766

NU
(1.65) (1.35)
NA*Score 0.00537 0.00739
(0.53) (0.76)
NAt*GDP -0.0128 -0.0111
MA
(-0.82) (-0.82)
Casht-1*Cash -0.824*** -0.787***
(-11.69) (-13.21)
Lev*Cash -1.151*** -1.191***
(-15.60) (-16.55)
D

Casht-1 0.207*** 0.222***

(8.53) (8.69)
TE

Lev -0.309*** -0.358***

(-8.87) (-15.82)
E 0.463*** 0.453***
(17.26) (17.38)
P

RD 1.194*** 1.364***
(2.58) (3.24)
CE

Int -2.010*** -1.709***

(-8.65) (-8.49)
Div 1.733*** 1.943***
(5.07) (8.05)
AC

NF 0.0755** 0.0931***
(2.50) (4.61)
Trust 0.0231 -0.115
(0.33) (-0.67)
Score -0.0190* -0.00613
(-1.69) (-0.20)
GDP 0.0100 0.0666
(0.68) (1.23)
Year fixed effects No Yes
Industry fixed effects No Yes
Country fixed effects No Yes
N 342,400 342,400
adj. R-sq 0.141 0.168

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Panel B: Marginal value of cash estimates

This panel reports the marginal value of cash estimates. These estimates are calculated using the coefficients on the change in cash and
the interaction terms between Cash and Trust and Score and Trust, setting leverage and lagged cash balances to zero.

(1) (2)
MV cash $1.13 $1.14
MV cash: Trust = -1SD $1.07 $1.09

PT
MV cash: Trust = +1SD $1.19 $1.19
MV cash: Score = -1SD $1.04 $1.02
MV cash: Score = +1SD $1.22 $1.26

RI
SC
NU
MA
D
P TE
CE
AC

52
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Table 9: Additional robustness analyses

Panel A: Excluding countries with highest number of observations

This panel reports the effect of trust on cash holdings after excluding the United States, the United Kingdom, Canada, and Japan. T-
statistics are in parentheses and standard errors are clustered by firm and by year.

PT
(1) (2) (3) (4)
log(Cash/TA)
Excluding Excluding

RI
Excluding US Excluding US, UK US, UK, CA US, UK, CA, JP
Trust 0.466** 0.528** 0.570*** 0.532**
(2.20) (2.38) (2.77) (2.45)

SC
Firm characteristics Yes Yes Yes Yes
Fixed effects Year, industry and country
N 187,082 170,532 157,428 126,070

NU
adj. R-sq 0.263 0.271 0.279 0.273

Panel B: Cash holdings using alternative trust measures

MA
This panel reports the results of using alternative measures of trust. In column (1), TrustHI is defined as the percentage of high-income
people who responded that most people can be trusted. High-income people are defined as people who responded that their incomes
are in the top tercile of their countries. In column (2), TrustHE is defined as the percentage of high-education people who responded
that most people can be trusted. High-education people are defined as people who responded that their highest education is the
D

university-level. T-statistics are in parentheses and standard errors are clustered by firm and by year.
TE

(1) (2)
log(Cash/TA)
TrustHI 1.067***
P

(5.29)
TrustHE 0.501***
CE

(2.75)
Firm characteristics Yes Yes
Fixed effects Year, industry and country
N 229,090 229,428
AC

adj. R-sq 0.331 0.330

Panel C: Marginal value of cash using alternative trust measures

The panel reports marginal value of cash estimates as described in Table 8 using alternative measures of trust. In column (1), TrustHI is
defined as the percentage of high-income people who responded that most people can be trusted. High-income people are defined as
people who responded that their incomes are in the top tercile of their countries. In column (2), TrustHE is defined as the percentage of
high-education people who responded that most people can be trusted. High-education people are defined as people who responded
that their highest education is the university-level. T-statistics are in parentheses and standard errors are clustered by firm and by year.

(1) (2)
Ri,t-RM
Cash*TrustHI 0.333***
(-2.77)
Cash*TrustHE 0.338**
(-2.50)
Control variables Yes Yes
Fixed effects Year, industry and country
N 341,930 337,551
adj. R-sq 0.163 0.169
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PT
RI
SC
NU
MA
D
TE
P
CE
AC

54
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Trust and corporate cash holdings Highlights

1. Societal trust has a positive effect on corporate cash holdings.

2. The effect of societal trust on corporate cash holdings is stronger in countries with weak governance quality.
3. The effect of of societal trust on corporate cash holdings is stronger in firms with greater information
asymmetries and lower levels of private trust between management and shareholders.

PT
4. Societal trust increases the marginal value of cash.

RI
SC
NU
MA
D
P TE
CE
AC

55