Confucianism, openness to the West, and corporate investment efficiency

DOIhttp://doi.org/10.1111/eufm.12173
Published date01 June 2019
Date01 June 2019
C
554 © 2018 John Wiley & Sons, Ltd. wileyonlinelibrary.com/journal/eufm Eur Financ Manag. 2019;25:554–590.
DOI: 10.1111/eufm.12173
ORIGINAL ARTICLE
Confucianism, openness to the West, and corporate
investment efficiency
Lei Chen
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Zhi Jin
1
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Yongqiang Ma
1
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Hui Xu
2
1
School of Accounting, Southwestern
University of Finance and Economics,
Chengdu, Sichuan, China
Emails: leichen@swufe.edu.cn;
09001-jz@163.com; myq@swufe.edu.cn
2
School of Accounting, Yunnan
University of Finance and Economics,
Kunming, Yunnan Province, China
Email: xuhui617@gmail.com
Funding information
National Natural Science Foundation of
China (Grant Nos. 71502143, 71302185,
71272245, 71472152), Fundamental
Research Funds for the Central
Universities, and Social Science
Foundation of Yunnan Province of China
(Grant No. QN2016059)
Abstract
This study presents robust findings that Confucianism
significantly improves investment efficiency of Chinese
listed firms and that the improvement is achieved through
decreasing overinvestment without inducing underinvest-
ment. Financial reporting quality is found to be an important
mechanism for the disciplinary effect of Confucianism to
work. More importantly, we provide strong and consistent
evidence that openness to the West neutralizes the role of
the Confucianism in overinvestment. Against the backdrop
of globalization, this paper offers valuable references to
emerging markets that experience intensive interactions
with developed economies.
KEYWORDS
Confucianism, financial reporting quality, investment efficiency,
openness to the West
JEL CLASSIFICATION
G31, G32, G34, M41, Z10
We thank John A. Doukas (the editor), two anonymous referees, Steven Dellaportas, Sophia Ji, Lina Xu, Jason Zezhong
Xiao, and participants at the International Workshop on Interdisciplinary Research in Accounting in SWUFE for helpful
comments and suggestions. Conflict of interest: Lei Chen has received research grants from the National Natural Science
Foundation of China (Grant No. 71502143) and is supported by the Fundamental Research Funds for the Central
Universities. Zhi Jin has received research grants from the National Natural Science Foundation of China (Grant No.
71302185). Yongqiang Ma has received research grants from the National Natural Science Foundation of China (Grant No.
71272245, 71472152). Hui Xu has received research grants from the Social Science Foundation of Yunnan Province of
China (Grant No. QN2016059).
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INTRODUCTION
Academic research on culture and finance has proliferated recently (e.g., Ahern, Daminelli, & Fracassi,
2015; Hilary & Hui, 2009; Holderness, 2017; Kumar, Page, & Spalt, 2011). Western cultures are the
primary focus of these studies, while their counterparts in East Asia remain overlooked. In fact, due to
the economic recovery and development in Japan, Singapore, and South Korea, and particularly
the Chinese boom, East Asia has arguably become the most dynamic and prominent economic zone in
the world. Thus, it is critical to understand how firms in East Asia are influenced by cultures, especially
Confucianism the spiritual pillar under the modernization of this region. This paper focuses on China
for the following reasons. First, China is the cradle of Confucianism. Despite occasional, superficial
discontinuities, such as the May Fourth Movement (1919) and the Cultural Revolution (19661976),
the basic continuities of Confucian culture remain mainstream in the latent cultural and psychological
traits of mainland Chinese and overseas Chinese (Lew, 1979). Second, Confucian atmosphere is rather
difficult to measure. To the best of our knowledge, only Chinese data allow researchers to proxy for it
using the number of Confucian Temples and to instrument it using the number of ancient Confucian
sages to mitigate endogeneity problems. Third, China was a closed, self-sufficient country until the
West cracked open its door in the late 19th century. Thereafter, China has shown increasing exposure to
the West with considerable variations across different regions/firms. Therefore, the Chinese market
represents an ideal setting for examining the effects of EastWest interactions on the relations between
local cultures and economic outcomes (see sections 2 and 3 for more details).
This paper focuses on the roles of Confucianism as a fundamental driver of firm value
and ultimately of the health of a nation's economy, namely, investment efficiency. Given that the
underlying values of Confucianism have distinct implications for overinvestment and for
underinvestment, respectively, we further explore whether the roles of Confucianism in these two
types of investment inefficiencies are comparable. Further, based on the prior finding that better
financial reporting facilitates efficient capital allocation (e.g., Biddle & Hilary, 2006; Healy & Palepu,
2001; Zhai & Wang, 2016), we check whether financial reporting quality is an important mechanism
for enabling Confucianism to exert effects on investment efficiency. More importantly, local cultures
within a region may be relatively static, but they are hardly segmented. On the one hand, cultural
exchanges and cultural clashes occur when politics, economies, or residents from different places meet.
On the other hand, local cultures might be (partially) substituted by or complemented with
institutionalized mechanisms learned from foreign countries. Consequently, the second set of our
analyses address an important question that is neglected by the prior literature: will the effects of
indigenous cultures be moderated by openness to the outside world?
Our main findings are as follows. Using the number of Confuc ian Temples in the neighborhood
of a firm as the major proxy, we document that Confucianis m improves the investment efficiency of
Chinese listed firms. On the one hand, the va lues of collectivism and risk aversion that are embedded
in Confucianism significantly reduce corpo rate overinvestment. On the other hand, Conf ucianism
does not exacerbate underinvestment a manifestation of managersover-conser vatism. Our results
hold if we use an alternative proxy that is base d on the key decision-maker of the firm, that is , the
CEO's early-life exposure to Confucianis m. To further address any endogeneity concern s, we
employ the number of ancient Confucian sages in a given area to inst rument for the strength of local
Confucian norms. The instrumented result s reaffirm that Confucianism improves investment
efficiency and that the improvement is ac hieved through decreasing overinvestm ent without
increasing underinvestment. Next, we show th at a Confucian atmosphere is strongly negati vely
related to abnormal accruals, financial res tatement, and fraud, suggesting that fina ncial reporting
quality is an important mechanism for the discipli nary effect of Confucianism to work. In additio n,
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we explore the variations in openness to the West ac ross Chinese regions/firms, taking into acco unt:
(1) the historical treaty system that existed duri ng the period 18421943; (2) the contemporan eous
marketization level of Chinese regions; and (3) the internat ionalization of Chinese firms
boardrooms. In line with foreign cultures being diff erent from the local cultures along the
dimensions of collectivism and risk avoidance, we find that the nega tive relation between a
Confucian atmosphere and overinvestment di sappears when openness to the West is strong, but
persists when openness to the West is weak. Further, openne ss to the West is found to be positively
related to local corporate governance quality. This suggests string ent corporate governance
mechanisms, which have arisen from a high level of interactions with the We st, to some extent
substitute for the disciplinary role that cou ld otherwise be played by indigenous cultures .
This paper contributes to the literature in the following ways. First, the extant finance and
accounting literature gives prominence to the topic of investment efficiency, showing that it is related
to a variety of firm-level economic factors, such as capital structure, internal capital markets,
accounting quality, ownership structure, executive compensation and managerial overconfidence
(Biddle & Hilary, 2006; Bushman, Piotroski, & Smith, 2011; Childs, Mauer, & Ott, 2005; Eisdorfer,
Giaccotto, & White, 2013; Hovakimian, 2011; Malmendier & Tate, 2005). We add to this literature by
moving beyond economic variables and confirming that cultures, as part of informal institutions, are
also an important determinant of corporate investment.
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Second, although Confucianism is considered
a fundamental ethical and philosophical system in East Asia, our knowledge about the influences of
Confucianism on modern corporations is rather limited (Du, 2015, 2016). Thus, our paper represents an
important addition to this literature. Most importantly, this paper enriches our understanding of the
implications of the coexistence of different cultures. For instance, ex ante cultural distance is found to
deter cross-border investment, which is in line with the theory that greater social differences inhibit
communication and undermine effective decision-making (Ahern et al., 2015; Siegel, Licht, &
Schwartz, 2011). Further, based on the evidence from financial reporting and unethical activities (e.g.,
illegal parking, wage misreporting, and tax noncompliance), researchers have shown that ex post the
cultural spillover/interactions have significant impacts on the behaviors of firms and individuals, and
that such impacts seem to go both in a positive direction and a negative direction (Braguinsky &
Mityakov, 2015; Brochet, Naranjo, & Yu, 2016; DeBacker, Heim, & Tran, 2015; Fisman & Miguel,
2007). To the best of our knowledge, no research has documented that the governance effect of the local
cultures can be moderated by openness to the outside world. Therefore, our study fills in a gap in the
literature.
Corporate investment efficiency sets the ground for the well-being of national economies and is
certainly one of the major concerns of governments, especially during the current global economic
stagnation. Thus, our study lends support to the concept of Confucian capitalism,in which
Confucianism can provide the fuel to make the engines of industry work(Franke, Hofstede, & Bond,
1991; Jacobs, Guopei, & Herbig, 1995; Zhu, Nel, & Bhat, 2006). Further, the economic growth in
developing countries in the last several centuries was accompanied with gradual openness to developed
economies. During the process of opening-up, exchanges and clashes between local and foreign
cultures occur frequently on the one hand, and developing countries continuously learn from their
developed counterparts (e.g., by establishing modern corporate governance mechanisms) on the other
hand. As a result, the roles played by indigenous cultures might change. Thus, our study provides
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Hilary and Hui (2009) and Jiang et al. (2015) investigate the relations between religions and investment intensity.
Nevertheless, without incorporating investment efficiency, we are unable to assess the value of an investment and the
performance of a firm. As a result, our paper also contributes to the corporate investment literature in general.
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