J. of Multi. Fin. Manag. 23 (2013) 113– 123

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Journal of Multinational FinancialManagement

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Does culture influence IPO underpricing?�

Bruce A. Costaa,∗, Anthony Crawforda, Keith Jakobb

a School of Business Administration, The University of Montana, Missoula, MT 59812-6808, United Statesb Donald and Carol Jean Byrnes Professor, School of Business Administration, The University of Montana, Missoula,MT 59812-6808, United States

a r t i c l e i n f o

Article history:Received 24 May 2011Accepted 13 December 2012Available online 31 December 2012

JEL classification:G15

Keywords:IPOCultural factorsUnderpricing

a b s t r a c t

This paper examines how cultural differences influence cross-sectional variation in IPO underpricing across 39 countries. Weconjecture that cultural difference across geographic boundarieswill influence the acceptance of and the expectations for IPO under-pricing. Cross-sectional differences in culture are measured usingHofstede’s six cultural dimensions. Our analysis shows that highpower distance and high long term orientation are significantlyassociated with higher IPO underpricing. We also show that under-pricing is significantly lower in countries characterized by highuncertainty avoidance. When the model is expanded to includelegal origin, market based and corporate governance variables, thethree cultural factors remain significant. Our findings provide fur-ther evidence that culture impacts capital market returns. Overall,our finding that culture impacts IPO underpricing, suggests impor-tant implications for policy makers and investors.

© 2013 Elsevier B.V. All rights reserved.

1. Introduction

Initial Public Offerings (IPOs) provide the opportunity to examine a critically important event inthe life of a firm, whereby typically large price movements or returns are observed over a very shortevent window. IPO underpricing is a well-documented phenomenon worldwide. Prior studies have

� The authors appreciate the suggestions and help from Patrick Barkey, Ron Premuroso, and Barbara Reider. This work wassupported by a School of Business Administration research grant and a professorship donated by Donald and Carol Jean Byrnes.

∗ Corresponding author. Tel.: +1 406 243 6155; fax: +1 406 243 2086.E-mail addresses: bruce.costa@business.umt.edu (B.A. Costa), tony.crawford@business.umt.edu (A. Crawford),

keith.jakob@business.umt.edu (K. Jakob).

1042-444X/$ – see front matter © 2013 Elsevier B.V. All rights reserved.http://dx.doi.org/10.1016/j.mulfin.2012.12.001

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shown underpricing exists in virtually every global financial market. IPO underpricing varies widelyacross countries, ranging from an average of 4% in Russia to an average well over 150% in China.In the United States, the level of IPO underpricing, recently, is approaching 17% (Loughran et al.,2011).

In this paper, we examine whether Hofstede’s (1980) cultural factors can help to explain the largecross-sectional variation in global IPO underpricing. Recently, a growing body of literature has focusedon the impact of cultural differences on financial measures. Stulz and Williamson (2003) examine theimpact of culture, proxied by differences in religion and spoken language on investor legal protection.They conclude religious beliefs influence investor protections better than other cultural variables, suchas openness to international trade or spoken language. Grinblatt and Keloharju (2001) examine theimpact of distance, language and culture on portfolio holdings. They conclude investors prefer nearbyfirms, same-language firms, and same culture firms.

Kwok and Tadesse (2006) as well as Aggarwal and Goodell (2009) show that culture influencesthe formation of a country’s predominant financial system. In particular, they find countries are morelikely to have bank-based financial systems where the culture is characterized by greater degreesof uncertainty avoidance. Fidrmuc and Jacob (2010) present a culturally rooted explanation for dif-ferences in dividend payouts globally, and both Ramírez and Tadesse (2009), as well as Chang andNoorbakhsh (2009), show that culture influences cash holdings. Chui et al. (2010) used one of Hofst-ede’s cultural factors, individualism, to help explain cross-country differences of investment returnson momentum strategies.

If culture impacts investor legal protections, investment choices, dividend payout ratios, firm cashholdings, and even momentum portfolio returns, a logical extension to this research stream wouldbe to examine if culture potentially influences investment returns over a short event window, with acorresponding specific focus on IPO underpricing.

In this paper, we study whether there are cultural dimensions that influence the level of ini-tial IPO returns between countries. We examine whether the six cultural dimensions identified byHofstede can explain cross-country differences in IPO underpricing. Hofstede defines six differentdimensions of culture; power distance index (PDI), uncertainty avoidance index (UAI), individ-ualism (IDV), masculinity (MAS), long term orientation (LTO), and indulgence versus restraint(IVR).

We find a significant relationship between initial IPO underpricing and several cultural dimen-sions defined by Hofstede. Our findings indicate that cultural variables help explain the level ofreturn associated with this critical portion (i.e., IPOs) of the capital market system. When the cul-tural model is expanded to include legal origin, market based and corporate governance variables,the cultural factors remain significant. The rest of the paper is organized as follows. In Section 2,we discuss earlier relevant literature from the two separate fields of IPO underpricing and nationalculture. In Section 3, we discuss the details of Hofstede’s cultural dimensions and our hypothe-ses regarding how each cultural dimension may help to explain IPO underpricing. In Section 4,we present the data and methodology. The empirical results are presented in Section 5. Section6 summarizes our main conclusions and provides suggestions for further research in this subjectarea.

2. IPO underpricing and culture

The underpricing of IPOs has been the focus of both theoretical and empirical research in the finan-cial economics literature for more than three decades. These studies have generally fallen into one oftwo categories: those empirically documenting the underpricing phenomenon, and those attemptingto explain why underpricing occurs.

A large portion of the early IPO literature falls into the first category and documents underpricingin the United States (see Reilly and Hatfield, 1969; Ibbotson, 1975; Ritter, 1984; Ibbotson et al., 1994).These papers examine the return behavior of U.S. IPOs shortly after they begin trading in the secondarymarket. These studies show that U.S. IPOs are significantly underpriced by more than 15% on average.

These U.S. IPO studies stimulated similar empirical IPO studies using data from non-U.S. finan-cial markets. A comprehensive meta-study by Loughran et al., 1994 documents that IPOs of common

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stock, for all 25 countries for which data are available, are underpriced. Loughran et al. (2011) haveexpanded the IPO data sample to include 48 countries. All countries in the newest study exhibitpositive underpricing; however the level of underpricing varies widely from country to country.For example, in their revised data set, the average IPO underpricing in Russia and Argentina wasjust 4.2% and 4.4% respectively, while underpricing in India, and China averaged 92.7% and 156.1%,respectively.

The second category of IPO research focuses on the theoretical explanations for the underpricingphenomenon. Early studies focused on information asymmetries. For example, Rock (1986) constructsa model in which information asymmetries between investors and issuers leads to a “lemons problem”or “winner’s curse.” In Rock’s model, some underpricing is necessary in order to keep uninformedinvestors in the market.

Ibbotson (1975) conjectures that IPO firms might intentionally underprice their shares to “leavea good taste in investors’ mouths”, in anticipation of coming back to the market to sell securities onmore favorable terms. This “good taste” would allow firms to issue future shares as part of a secondaryequity offering at more favorable terms.

More recent literature has focused on the contractual mechanisms used in the IPO process aswell as the characteristics of the firms going public to explain cross-sectional variation in IPO under-pricing. Globally there are a wide variety of contract mechanisms, regulatory differences, and firmspecific differences that impact the IPO process, and consequently may also impact the level ofunderpricing within a country. One important contract mechanism is the share allocation process.Some countries, such as France, Hong Kong, and Singapore, use predominately non-discretionaryor pro rata allocation methods. The U.S., Canada, and Australia have historically used predom-inately discretionary allocation methods. However, Loughran et al. (1994) cannot identify anyobvious relationship between average IPO underpricing and either of these two IPO share allo-cation methods. Beyond the IPO process, the characteristics of firms going public vary. Thesefirm specific characteristics, including firm age and firm risk, can also influence the IPO’s initialreturns.

Boulton et al., 2010 study how differences in country-level governance impact the underpricing ofIPOs across 29 countries. They find that underpricing is higher in countries with corporate governancethat strengthens the position of investors relative to insiders. They suggest that underpricing is a costthat insiders pay to maintain control in countries with legal systems designed to empower outsiders.While market and corporate governance factors do explain some of the cross-sectional variation in IPOunderpricing between countries, there are still significant differences in underpricing not investigatednor explained adequately in the literature.

In this paper, we examine whether there are cultural dimensions that significantly influence thelevel of IPO returns between countries. Culture is commonly defined as a set of shared values, norms,beliefs and expected behaviors that are deeply embedded. In his seminal study of cultural dimen-sions, Hofstede (1980) analyzed a large data base of measures of employee values collected by IBMbetween 1967 and 1973, covering more than 70 countries. Hofstede defines culture as “the collectiveprogramming of the mind which distinguishes the members of one human group from another.” Theresults of Hofstede’s initial study yielded four primary dimensions of culture: power distance index(PDI), uncertainty avoidance index (UAI), individualism (IDV), and masculinity (MAS). Later work byHofstede and Bond (1988) identified two additional cultural dimensions: long term orientation (LTO)and indulgence verses restraint (IVR). Hofestede’s six cultural dimensions provide continuous variablefactors for a large number of countries, and are the most widely cited cultural measures in the vastcultural literature.

Schwartz (1994) expands on Hofstede’s cultural dimensions by developing his own approach. Hisapproach did not rely on factorial analysis, but was instead a theoretically-grounded approach builtfrom social theories. While culture dimensions have been widely used in Management, InternationalBusiness and Economics research, until recently they have been largely absent from Finance research.Reuter (2011) identifies 29 working-papers and published articles that examine the impact of culturaldimensions in corporate finance. Of these studies, only six reference Schwartz’s cultural dimensions,while 24 use Hofstede’s measures (two papers use both). For this reason, we chose to use Hofestede’scultural dimensions in our study.

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In the next section, we discuss in detail each dimensional cultural factor and formulate our researchhypotheses.

3. Our IPO hypotheses

For each cultural dimension defined by Hofstede, we propose a hypothesis about the influence anddirection of the impact the cultural dimension may have on IPO underpricing.

Hofstede recognizes six fundamental cultural dimensions.1 According to Hofstede,

“Power Distance (PDI) is the extent to which the less powerful members of organizations andinstitutions accept and expect that power is distributed unequally. This represents inequality(more versus less), but defined from below, not from above. It suggests that a society’s levelof inequality is endorsed by the followers as much as by the leaders. Power and inequality, ofcourse, are extremely fundamental facts of any society and anybody with some internationalexperience will be aware that all societies are unequal, but some are more unequal than others.”

We conjecture that IPO underpricing generally benefits the wealthiest individuals with the mostpower in a particular country. Cultures with higher levels of PDI are generally more accepting of theselevels of inequality. Therefore, the PDI cultural dimension and the IPO process, together, suggest thatthe level of IPO underpricing will be positively related to the PDI measure for a particular society. Thisleads to our first hypothesis,

Hypothesis 1. IPO underpricing is positively related to power distance (PDI).

The next cultural dimension defined by Hofstede is uncertainty avoidance (UAI).

“Uncertainty avoidance (UAI) deals with a society’s tolerance for uncertainty and ambiguity.It indicates to what extent a culture programs its members to feel either uncomfortable orcomfortable in unstructured situations. . .Uncertainty avoiding cultures try to minimize the pos-sibility of such situations by strict laws and rules, safety and security measures . . .The oppositetype, uncertainty accepting cultures, are more tolerant of opinions different from what they areused to; they try to have as few rules as possible”

As the UAI measure increases, we would expect underpricing to decrease. In a cultures characterizedby low uncertainty (high UAI), we expect that firms would be less likely to underprice and investorswould expect an unambiguous price to be established before the opening day of trading of an IPO.Therefore,

Hypothesis 2. IPO underpricing is negatively related to Uncertainty Avoidance (UAI).

The third cultural dimension from Hofstede is Individualism (IDV).

“Individualism (IDV) . . . is the degree to which individuals are integrated into groups. On theindividualist side, we find societies in which the ties between individuals are loose: everyoneis expected to look after her/himself and her/his immediate family. On the collectivist side, wefind societies in which people from birth onwards are integrated into strong, cohesive in-groups,often extended families (with uncles, aunts and grandparents) which continue protecting themin exchange for unquestioning loyalty.”

As IDV decreases (smaller value), meaningful groups become more prevalent within a society. Itis well known that IPO shares are often allocated to the most important clients in exchange for theirloyalty to the firm. In more group oriented societies the IPO underpricing is used as a reward forthe clients’ loyalty. Therefore, one could infer that an increased group mentality would increase IPOunderpricing, since there would be more inclination to reward members of the best clientele cohort.Therefore,

1 The cultural dimension descriptions and values can be found on Geert and Gert Jan Hofstede’s webpage located atwww.geerthofstede.nl.

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Hypothesis 3. IPO underpricing is negatively related to Individualism (IDV)

The last dimension of Hofstede’s initial four cultural dimensions is Masculinity (MAS).

“Masculinity versus its opposite, femininity, refers to the distribution of emotional rolesbetween the genders . . .The assertive pole has been called masculine and the modest, caringpole feminine. The women in feminine countries have the same modest, caring values as themen; in the masculine countries they are more assertive and more competitive, but not as muchas the men, so that these countries show a gap between men’s values and women’s values.”

We hypothesize that the greater the degree of masculinity within a society, the greater the compet-itive nature of the parties involved and the more willing a person or group would be to take advantageof others. This would suggest higher underpricing with increased masculinity. Therefore,

Hypothesis 4. IPO underpricing is positively related to Masculinity (MAS).

The fifth dimension is Long-Term Orientation (LTO).

“Long- term oriented societies foster pragmatic virtues oriented towards future rewards, inparticular saving, persistence, and adapting to changing circumstances.”

The LTO dimension influences two major participants in the IPO process, the firm and the initialinvestors. If firm management has a long term orientation, its main focus during the IPO process israising capital for the long term benefit of the company. Management, therefore, will more likelyaccept higher levels of underpricing as long as the company can raise the funds necessary to helpmeet its long term goals. Investors who obtain shares prior to the IPO secondary market trading datewith a long term orientation will not be interested in flipping their shares for short term gains. Thisshortage of willing sellers due to their investor orientation will alter the supply and demand of theshares in the event window leading to higher price gains, i.e. more underpricing. Therefore,

Hypothesis 5. IPO underpricing is positively related to Long Term Orientation (LTO).

The final cultural dimension in this study is Indulgence versus Restraint (IVR).

“Indulgence stands for a society that allows relatively free gratification of basic and natu-ral human drives related to enjoying life and having fun. Restraint stands for a society thatsuppresses gratification of needs and regulates it by means of strict social norms.”

“Indulgence Orientation” (high IVR) indicates a society is especially tolerant to individuals’ desiresto enjoy themselves, and spend money. We conjecture that IVR influences IPO underpricing by alsoimpacting the level of supply and demand in the post IPO market. The more likely a society is toindulge, the quicker IPO investors will willingly sell their shares in the open market to capture profits.This suggests that higher indulgence leads to increased supply in the open market and therefore lessunderpricing in equilibrium. Thus,

Hypothesis 6. IPO underpricing is negatively related to IVR.

4. Data and methodology

The data for our study are acquired from several sources. The cultural dimensions data are availablefrom Geert and Gert Jan Hofstede (www.geerthofstede.nl). Geert Hofstede is recognized as the pre-eminent scholar of measuring cultural dimensions. According to the Web of Science citation database,more than 800 peer-reviewed articles in scientific journals cite one or more of Geert Hofstede’s pub-lications. Hofstede’s cultural dimensions’ values are available for 110 different countries or regionsaround the world.

IPO return data comes from Jay Ritter’s IPO Data webpage (http://bear.warrington.ufl.edu/ritter/ipodata.htm). In the last twenty years, Ritter has written extensively about IPOs. Loughran et al. (1994)collected and analyzed IPO data for 25 countries. Their data are compiled from multiple theses, books,working papers and journal articles. In an updated version of the information contained in the 1994

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article, Loughran et al. (2011) expand the IPO data to include 48 countries. We also collect legal,market based and corporate governance factors to incorporate into additional tests. This data comesfrom Andrei Schleifer’s Data webpage (www.economics.harvard.edu/faculty/shleifer/dataset).

For our initial sample, we combine Hofstede’s cultural dimensions with Ritter’s IPO return data.We include only countries that have IPO return data and reported values for all six of the culturaldimensions defined in our hypotheses. From this sort we are left with 40 countries. When we addcorporate governance and market based factors our final sample size includes data from 39 countriesfrom every continent other than Antarctica. The Ritter meta-data includes country specific IPO returndata with differing sample sizes and collection periods. Given the large sample period for IPO returns,one concern we have is that country-specific cultural attributes could potentially shift over time. Withregards to this issue Hofstede states that:

“The country scores on these dimensions are relative - societies are compared to other societies.These relative scores have been proven to be quite stable over decades. The forces that causecultures to shift tend to be global or continent-wide - they affect many countries at the sametime, so that if their cultures shift, they shift together, and their relative positions remain thesame.”2

Table 1 presents the average initial returns, the number of IPOs used in the reported meta-datasample for each country, as well as the cultural dimension values for the 39 countries. Table 2 providessummary statistics for all cultural variables. Minimum and maximum value countries are reported tohelp the reader conceptualize the direction and magnitude for each cultural dimension.

To analyze the importance of the six cultural dimensions on IPO returns, we run various weightedleast squares multi-factor regression models. Since there are varying numbers of observations of IPOsfor each country in our dataset, we use a weighted multi-factor regression approach to control for eachcountry’s sample size. One of the common assumptions underlying most linear regression methodsis that each data point provides equally precise information about the deterministic part of the totalprocess variation. A procedure that treats all of the data equally would give less precisely measuredpoints more influence than they should have and, at the same time, would give highly precise pointstoo little influence. To fairly weight countries with larger original IPO sample sizes, we use the squareroot of the number of observations as the weight to improve the precision of our overall model. Thesquare root of the number observations is chosen because the standard error of the mean is a functionof the square root of n.

5. Results

Our first attempt to explain IPO underpricing uses all six cultural dimensions in a weighted leastsquares multi-factor regression model. Table 3 contains the full regression results. The model is sig-nificant at better than the 1% level with an adjusted R2 of 38.0%. In this first pass using all six culturaldimensions, the results indicate the overall model does a good job in predicting the magnitude of IPOunderpricing from country to country.

We next examine the signs of the coefficients for each cultural dimension relative to the expectedsigns based on our six hypotheses. The coefficient for PDI is positive. This is consistent with our hypoth-esis that IPO underpricing benefits the wealthiest individuals with the most power. The coefficientfor UAI is negative and consistent with the idea that firms within cultures with a large aversion touncertainty would be less likely to underprice and investors at the same time within those countrieswould expect an unambiguous price before trading in the secondary market commences. The coeffi-cient for IDV is negative. This is consistent with our hypothesis that lower IDV scores imply a groupmentality that would increase IPO underpricing, since the investment banking group would be moreinclined to give special treatment to their most valued clientele. The observed sign on IDV suggeststhat a stronger group mentality leads to higher underpricing.

2 Details regarding dimensions of national culture can be found on Geert and Gert Jan Hofstede’s webpage.www.geerthofstede.nl/culture/dimensions-of-national-cultures.aspx.

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Table 1IPO returns and cultural dimension for 39 countries.

Country Sample size IPO return PDI UAI IDV MAS LTO IVR

Argentina 20 4.4 49 86 46 56 20.40 61.83Australia 1103 19.8 36 51 90 61 21.16 71.43Austria 96 6.5 11 70 55 79 60.45 62.72Belgium 114 13.5 65 94 75 54 81.86 56.70Brazil 253 35.8 69 76 38 49 43.83 59.15Bulgaria 9 36.5 70 85 30 40 69.02 15.85Canada 635 7.1 39 48 80 52 36.02 68.30Chile 65 8.4 63 86 23 28 30.98 68.00China 1762 156.1 80 30 20 66 87.41 23.66Denmark 145 8.1 18 23 74 16 34.76 69.64Finland 162 17.2 33 59 63 26 38.29 57.37France 686 10.6 68 86 71 43 63.48 47.77Germany 704 25.2 35 65 67 66 82.87 40.40Great Britain 4205 16.3 35 35 89 66 51.13 69.42Greece 373 50.8 60 112 35 57 45.34 49.55Hong Kong 1008 15.9 68 29 25 57 60.96 16.96India 2811 92.7 77 40 48 56 50.88 26.12Indonesia 361 26.3 78 48 14 46 61.96 37.72Ireland 31 23.7 28 35 70 68 24.43 64.96Italy 273 16.4 50 75 76 70 61.46 29.69Japan 3078 40.5 54 92 46 95 87.91 41.74Korea South 1521 63.5 60 85 18 39 100.00 29.46Malaysia 350 69.6 104 36 26 50 40.81 57.14Mexico 88 15.9 81 82 30 69 24.18 97.32Netherlands 181 10.2 38 53 80 14 67.00 68.30New Zealand 214 20.3 22 49 79 58 32.75 74.55Norway 153 9.6 31 50 69 8 34.51 55.13Philippines 123 21.2 94 44 32 64 27.46 41.96Poland 224 22.9 68 93 60 64 37.78 29.24Portugal 28 11.6 63 104 27 31 28.21 33.26Russia 40 4.2 93 95 39 36 81.36 19.87Singapore 519 27.4 74 8 20 48 71.54 45.54Spain 128 10.9 57 86 51 42 47.61 43.53Sweden 406 27.3 31 29 71 5 52.90 77.68Switzerland 159 28.0 34 58 68 70 73.55 66.07Taiwan 1312 37.2 58 69 17 45 92.95 49.11Thailand 459 36.6 64 64 20 34 31.74 45.09Turkey 315 10.6 66 85 37 45 45.59 49.11U.S.A. 4205 16.9 40 46 91 62 25.69 68.08

Hofstede defines six dimensions of culture; power distance index (PDI), uncertainty avoidance index (UAI), individualism (IDV),masculinity (MAS), long term orientation (LTO), and indulgence versus restraint (IVR).

Table 2Descriptive statistics of IPO returns and cultural dimensions.

Sample size IPO return PDI UAI IDV MAS LTO IVR

Mean 726 27.6 55.5 63.1 50.5 49.6 52.1 51.0Max 4205 156.1 104 112 91 95 100.0 97.3

USA China Malaysia Greece USA Japan South Korea MexicoMin 9 4.2 11 8 14 5 20.4 15.8

Bulgaria Russia Austria Singapore Indonesia Sweden Argentina Bulgaria

Mean, maximum and minimum are reported for each variable in the 39 countries sample. The country associated with themaximum and minimum values for each variable are presented to give a perspective in the scale and direction of each variable.Hofstede defines six dimensions of culture; power distance index (PDI), uncertainty avoidance index (UAI), individualism (IDV),masculinity (MAS), long term orientation (LTO), and indulgence versus restraint (IVR).

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Table 3Regression of IPO returns on the six cultural dimensions.

Constant PDI UAI IDV MAS LTO IVR

Parameter estimate 24.11 0.529 −0.453 −0.117 0.262 0.347 −0.377T-value 0.783 1.471 −2.375 −0.391 1.013 1.339 −1.011Significance 0.633 0.166 0.024 0.698 0.319 0.190 0.320

Weighted least squares regression analysis with six cultural dimensions as the independent variables and IPO return as thedependent variable. The weight is defined as the square root of the number of observations for each country. There are 39countries in the sample. Hofstede defines six dimensions of culture; power distance index (PDI), uncertainty avoidance index(UAI), individualism (IDV), masculinity (MAS), long term orientation (LTO), and indulgence versus restraint (IVR).Model summaryF-test value: 4.879.F-test sig: 0.001.Adjusted R2 0.380.

The coefficient for MAS is positive. This is consistent with our hypothesis that the greater the degreeof masculinity within a society, the greater the competitive nature of the parties involved and themore a person or group would willingly take advantage of others. This suggests higher underpricingwith increased masculinity. The coefficient for LTO is positive. This is consistent with our predictionsbased on firm management and initial investors. Management will more likely accept higher levelsof underpricing as long as the company can raise the funds necessary for its long term goals, andinitial investors in the IPO will not be interested in flipping their shares for short term gains. The finalcultural dimension, IVR, has a negative coefficient. This is consistent with our hypothesis that in amore indulgent society, initial IPO investors are more likely to take profits by selling their shares inthe open market.

The goal of this study is to understand which of Hofstede’s cultural dimensions are importantexplanatory variables for IPO underpricing. Our first regression model, in Table 3, has strong explana-tory power; however, UAI is the only significant cultural variable. In this first model, we use all sixcultural variables because, other than our hypotheses, there is no formal theory on how culturalvariables should impact IPO underpricing. In general, in regression analysis, the significance of eachindependent variable’s coefficient suffers with an increased number of variables that are correlatedto one another. Table 4 presents the correlation matrix of the six cultural dimensions. It is evidentfrom the table that there are several factors that are correlated to one another. Next, we examine ifit is possible to improve the efficacy of our model and the significance of the cultural dimensions byeliminating one or more independent variables from our model. We use a backward stepwise regres-sion approach to eliminate variables from the original regression. Backward stepwise regression isthe semi-automated process of removing variables based solely on the t-statistics of their estimatedcoefficients. This method is generally used with a modest-sized set of potential variables from whichyou wish to eliminate a few to fine-tune a regression model, especially in the case of our model whereno theory yet exists in the literature on how cultural variables might impact IPO underpricing in thevarious global markets.

Table 4Correlation of 6 cultural dimensions.

PDI UAI IDV MAS LTO IVR

PDI 1UAI 0.1895 1IDV −0.6932 −0.1737 1MAS 0.0726 0.0960 0.0390 1LTO 0.1564 0.0987 −0.2360 0.1179 1IVR −0.4952 −0.1927 0.4695 −0.0722 −0.4839 1

The table contains the correlation matrix for all six cultural dimensions for our 39 countries sample. Hofstede defines sixdimensions of culture; power distance index (PDI), uncertainty avoidance index (UAI), individualism (IDV), masculinity (MAS),long term orientation (LTO), and indulgence versus restraint (IVR).

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Table 5Regression of IPO returns on three cultural dimensions.

Constant PDI UAI LTO

Parameter estimate −14.786 0.808 −0.427 0.548T-value −.849 3.485 −2.290 2.759Significance 0.403 0.001 0.028 0.009

Weighted least squares regression analysis with three cultural dimensions as the independent variables and IPO return asthe dependent variable. The weight is defined as the square root of the number of observations for each country. There are39 countries in the sample. Hofstede defines six dimensions of culture; power distance index (PDI), uncertainty avoidanceindex (UAI), individualism (IDV), masculinity (MAS), long term orientation (LTO), and indulgence versus restraint (IVR). In thisregression PDI, UAI, and LTO are the independent variables. This is the final model based on backwards stepwise regression.Model summaryF-test value: 9.159.F-test sig: 0.000.Adjusted R2: 0.392.

Using the backward step-wise regression approach the process starts with all six cultural dimen-sions and eliminates the dimension with the least significance from the model. The iterative processcontinues until we find the model with the best fit (i.e., the highest F-test value). Our final modelcontains three cultural dimensions: PDI, UAI, and LTO. UAI is significant at the 5% level, and PDI andLTO are significant at better than the 1% level. Relative to the original regression with all six culturaldimensions the F-test, or the measure of the model’s significance, increases from 4.879 to 9.159. Also,the adjusted R2 of the model increases to 39.2%. The backward stepwise regression process eliminatesthree cultural dimensions: IDV, MAS, and IVR. With these three variables removed from the model,there are no significant correlations among the remaining three cultural dimensions. The final three-factor model regression results are presented in Table 5. The signs for all three cultural dimensioncoefficients remaining in the model are unchanged from the original regression. All three signs areconsistent with our original cultural dimension hypotheses (Hypotheses 3, 4 and 6).

One concern with our model is that culture may be simply capturing effects associated with othercommon variables that have been previously identified to explain IPO underpricing. To address thisconcern we perform additional tests with the three cultural variables along with legal, market basedand corporate governance factors. The data for these additional tests come from the data webpage ofAndrei Schleifer. The webpage includes the data cited in Boulton et al. (2010). Table 6 reports resultsfrom six additional models along with the results of the three factor cultural model.

In Table 6, Model 1 we add a dummy variable for the legal origin of the country. The model usesa dummy variable for an English based legal system. This legal variable is insignificant, and with theaddition of the legal variable the model’s explanatory power is lowered. All three cultural variablesremain significant with the same sign. We ran additional tests using dummy variables for French andGerman based legal systems. Each regression had similar results with no significant coefficients onthe legal based variables. Our results indicate that the legal origin does not add any explanatory valuewhen the three cultural variables are in the model.

Our next tests add two different corporate governance factors from Boulton et al. (2010); Anti-self-dealing and anti-director rights. The anti-self-dealing index focuses on enforcement mechanisms,including litigation and disclosure surrounding self-dealing transactions. The anti-director indexmeasures how strongly the legal system protects minority shareholders, particularly minority share-holders’ voting rights. In Model 2 we add the anti-self dealing index to our three factor model. Thefactor is insignificant. In Model 3 we add the anti-director rights index. The anti-director rights indexis significant at the 5% level, and the three cultural variables have the same sign and are all significantat better than the 1% level.

In Models 4 and 5 we add market based variables to the regression analyses. In Model 4 we addstock market capitalization as a percentage of country GDP, and in Model 5 we add the number oflisted firms per million population. Both of these variables are significant at the 1% level, and in bothmodels all three cultural variables have the same sign and remain significant at the 1% level.

For the final model presented in Table 6 we again use the backward step-wise regression approach.In this analysis the process starts with the three cultural dimensions PDI, UAI, and LTO along with the

122 B.A. Costa et al. / J. of Multi. Fin. Manag. 23 (2013) 113– 123

Table 6Regression of IPO returns on three cultural dimensions, legal, corporate governance and market based variables.

3-Factor Model Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

Intercept −14.786 −6.048 −3.530 27.680 21.041 14.630 49.120**

PDI 0.808*** 0.813*** 0.823*** 0.832*** 0.712*** 0.717*** 0.745***

UAI −0.427** −0.485** −0.507** −0.519*** −0.660*** −0.636*** −0.698***

LTO 0.548*** 0.496** 0.549*** 0.532*** 0.576*** 0.566*** 0.560***

English legal dummy −6.142Anti-self dealing −12.785Anti-director rights −10.015** −7.859**

Stock Mkt Cap/GDP −0.194*** −0.165***

Listed firms/million pop. −0.461***

Model F-test 9.159*** 6.783*** 6.789*** 9.742*** 11.139*** 11.002*** 10.883***

Adjusted R2 0.392 0.378 0.379 0.479 0.516 0.513 0.565

Weighted least squares regression analysis with three cultural dimensions as the independent variables and IPO return asthe dependent variable. The weight is defined as the square root of the number of observations for each country. There are39 countries in the sample. Hofstede defines six dimensions of culture; power distance index (PDI), uncertainty avoidanceindex (UAI), individualism (IDV), masculinity (MAS), long term orientation (LTO), and indulgence versus restraint (IVR). In thisregression PDI, UAI, and LTO are the independent variables. Model 1 adds a dummy legal origin variable. Model 2 adds anti-self dealing. Model 3 adds anti-director rights. Model 4 adds Stock Market Capitalization relative to GDP. Model 5 adds listedfirms per million of population. Model 6 is the final model from a backwards stepwise regression including; PDI, UAI, LTO,Anti-Director rights, Stock Market Capitalization relative to GDP, and listed firms per million of population.*Significant at the 10% level.

** Significant at the 5% level.*** Significant at the 1% level.

significant corporate governance and market variables (anti-director rights, Stock Market Cap/GDPand Listed Firms/million population). The iterative process continues until we find the model with thebest fit (i.e., the highest F-test value). In this case the step-wise regression approach only drops onevariable. Our final model contains all three cultural dimensions: PDI, UAI, and LTO that are significantat better than the 1% level. The model also includes one significant corporate governance metric (anti-director rights) and one market based metric (Stock Market Cap/GDP). The model is highly significantwith an F-test value of 10.883, and the adjusted R2 of the model increases to its highest level of any ofour tests at 56.5%.

6. Conclusions

In this paper, we examine whether Hofstede’s six cultural dimensions influence the level of initialIPO returns from one country to the next. Hofstede defines six dimensions of culture: power distanceindex (PDI), uncertainty avoidance index (UAI), individualism (IDV), masculinity (MAS), long termorientation (LTO), and indulgence versus restraint (IVR). We combine Hofstede’s cultural dimensiondata with global IPO underpricing data and perform an initial standard regression analysis. Weuse a weighted backward stepwise multi-factor regression approach to determine which culturaldimensions impact IPO underpricing. In our final three-factor model, we report significant relationsbetween initial IPO underpricing and three of the cultural dimensions: PDI, UAI and LTO. Thisthree-factor model explains nearly 40% of global variation in IPO underpricing using only threecultural variables. When the cultural model is expanded to include legal origin, market based andcorporate governance variables, the cultural factors remain significant. Our optimal model includescultural, corporate governance, and market based variables, and explains over 56% of country tocountry variation in IPO underpricing. Our findings indicate that along with corporate governanceand market based variables, the cultural variables help to explain the level of return associatedwith this critical step, an IPO, in the international capital market system. The results suggest that asociety’s culture can actually influence the degree of underpricing and therefore the overall process ofobtaining funding for growing firms. Finally, our results also suggest that cultural dimensions shouldbe considered when analyzing country specific financial information.

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