Essays on Trust and Its Economic Consequences

Abstract

The first essay examines how trust, a cultural and societal factor, can influence the profitability of momentum strategies in international stock markets. Using the trust measure developed by the World Values Survey and European Values Study for 65 markets over the period 1981–2019, I find that trust is positively associated with the magnitude of momentum profits. The trust effect on momentum is stronger in advanced economies; the positive relation is robust across size, after risk adjustment, controlling for firm characteristics and information environment, and using alternative trust measures. Empirical evidence supports the notion that trust increases stock market participation and adds disagreement in the market, which leads to momentum. Trust has stronger explanatory power than uncertainty avoidance on momentum profitability, and it includes unique information not in individualism. In the second essay, I argue that distrust significantly increases people’s perceived information asymmetry and has important economic consequences. Using the occurrence of financial restatements from 1995 to 2019 as a proxy for significant credibility reduction in financial information, I show that firms rely more on trade credit as an external financing choice after restatements because suppliers have an information advantage and address information asymmetry problems better. After comparing the predictability of sales by trade credit before and after restatements, I find that the informativeness of trade credit about firms’ prospects changes during restatement periods. In the pre-restatement periods, firm sales monotonically increase with trade credit. In the post-restatement periods, firms with the most trade credit do not have the best future performance, while firms with the least trade credit experience the lowest subsequent sales. I also find that investors in the stock market do not realize such informativeness change and underreact to the valuable negative information from suppliers.