Communication,Corporate Governance

Cultural diversity matters for corporate disclosure

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A new study reveals that cultural diversity among investors can lead to abnormal stock trading volume, and firms headquartered in culturally diverse places are more prone to crash risk

By Pan Jingyi, Principal Writer, China Business Knowledge @ CUHK

Corporate earnings can ultimately affect stock prices. In February, when chipmaker Nvidia announced its record-high quarterly revenues of US$22.1 billion, almost triple from the previous year, the company’s stock price soared by 14 per cent within hours. Meanwhile, in the same month, Alibaba Group’s disappointing quarterly earnings sent its stock price lower by 6.1 per cent year-on-year.

Publicly traded companies are required to disclose their profits so external investors can learn crucial information when making financial decisions. Consequently, investors’ concerns regarding corporate performance will be reflected in the stock markets.

stock trading
Different understandings of identical earnings reports among investors lead to elevated trading volume and stock return volatility.

Considering the significant impact of such disclosure, it is crucial to understand the factors that influence investors’ perceptions. A new study entitled Investor cultural diversity and market reactions to corporate earnings announcements delves deep into this question. Specifically, it focuses on the role of cultural diversity, measured by the extent of linguistic diversity, among investors.

After analysing earnings reports issued by listed companies in China, the results suggest that a wider variety of dialects spoken among investors leads to greater differences in interpretations, which eventually affects stock trading activities.

“Heterogeneous interpretations of identical public signals among investors lead to elevated trading volume and stock return volatility,” says Kevin Tseng, Associate Professor of the School of Accountancy at the Chinese University of Hong Kong (CUHK) Business School.

Professor Tseng conducted this study in collaboration with Professor Chang Yen-Cheng of National Taiwan University, Professor Su Yu-Siang of National Chi Nan University, and Professor Wang Na of Hofstra University.

Different cultures yield varied interpretations

Previous research have demonstrated that different understandings of news surrounding earning reports can cause elevated trading volume and stock return volatility, but how could the same announcement have various interpretations? Professor Tseng argues that investors may use the same announcement but infer value-relevant information differently.  In other words, investors can have unique “economic models” that help them interpret market news and signals.

“Linguistic diversity is our empirical measure to capture cultural diversity among investors,” says Professor Tseng. “We test whether investor diversity translates into diverse views on how an earnings announcement maps into stock valuations. If investors have divergent views regarding stock valuations, they will trade more in the market, leading to elevated volatility.”

“A diverse investor base has more heterogeneity, and they may have more creativity in interpreting the value relevance of market signals. ”

Professor Kevin Tseng

To test their hypothesis, the researchers collected data from the China Stock Market and Accounting Research, as well as a nationwide record called the Language Atlas of China, which contains a detailed classification of local linguistic features. While the country has the same written language, there is a rich variation in spoken languages. In this research, investor cultural diversity is defined as the number of languages spoken in a province.

Using this data, Professor Tseng and his collaborators studied how investor cultural diversity in a company’s home region is related to trading volume and return volatility around earnings announcements. The sample period ranges from reports issued from 1998 to 2019.

Cultural diversity spurs market reactions

The researchers use two metrics to measure how different investors interpret information when a company announces its earnings: abnormal trading volume and return volatility in a three-day window. Abnormal trading volume refers to the unusual amount of stock trading during a specific period, while abnormal return volatility refers to the deviation of a stock’s return volatility around an earnings announcement from what would be expected based on historical patterns or market norms.

The result showed a significant positive effect of linguistic diversity on abnormal trading volume. A one-standard-deviation increase in the cultural diversity measure leads to an increase in abnormal trading volume by 10.29 per cent. Similarly, investor cultural diversity is also positively associated with abnormal return volatility.

cultural diversity investors
Negative information is more discernible during a slowdown when investors have different understandings of the market.

“A diverse investor base has more heterogeneity, and they may have more creativity in interpreting the value relevance of market signals,” Professor Tseng explains, adding that the results remain strong even when they consider various factors such as demographics and different ways of measuring cultural diversity and trading volume.

Existing literature shows that negative information tends to be more noticeable during market downturns when investors have different interpretations of what to do. This can lead to stock price crash risk, referring to the tendency of stock prices to experience significant downward movements.

Professor Tseng and his collaborators then investigated whether stocks with elevated levels of investor cultural diversity have higher stock price crash risk. They anticipated that companies located in areas with high cultural diversity, where investors exhibit greater disagreement regarding firms’ financial disclosure, would encounter a higher level of crash risk. “Overall, our results are consistent with the prediction that investor cultural diversity leads to elevated stock price crash risk,” he says.

Clear and concise announcements matter

One of the purposes of accounting disclosure is to make sure that all investors have equal opportunities, and this study offers a fresh perspective for addressing this objective. On top of that, Professor Tseng suggests that firms should be aware of the local social landscape, apart from purely financial or accounting factors, which also plays a role in how investors responding news.

“Linguistic diversity is our empirical measure to capture a critical aspect of investor cultural diversity,” he adds. “More broadly, our results apply to other aspects of diversity, to the extent that investors may have differential views on economic issues, which may include nationalities, ethnicities, and gender.”

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Overall, the study highlights a social factor that has implications for capital markets. The findings emphasise the significance of diversity and underscore the effectiveness of communication with investors through disclosures.

To avoid ambiguities, Professor Tseng suggests firms cover quantitative and qualitative aspects of their announcements as clearly and concisely as possible. Additionally, allocating resources towards investor relations and collaborating with media outlets or financial intermediaries, such as analysts, would be useful to improve communication with diverse investors.