Why Do Foreign Firms Have Less Idiosyncratic Risk than U.S. Firms?

Abstract

Using a large panel of firms across the world from 1991-2006, we show that the median foreign firm has lower idiosyncratic risk than a comparable U.S. firm. Country characteristics help explain variation in idiosyncratic risk across countries in both level and change regressions, but less so than firm characteristics. There exists a strong negative relation between idiosyncratic risk and an index of government stability and quality. Further, idiosyncratic risk is positively related to financial development. Surprisingly, there is evidence that firms have less idiosyncratic risk in countries with greater transparency. Finally, idiosyncratic risk does not appear to be related to investor protection laws. Our results support theories predicting that better financial development leads firms to undertake riskier investments, but they are inconsistent with theories predicting that more firm-specific information increases idiosyncratic stock return volatility.