The Impact of Religion on Financial Reporting Irregularities

Abstract

This paper examines the impact of religion on financial reporting. We predict that firms in religious areas are less likely to engage in financial reporting irregularities because prior research links religiosity to reduced acceptance of unethical business practices and because managers in religious areas are likely to be more averse to litigation risk. Our results suggest that firms headquartered in areas with strong religious social norms generally experience lower incidences of financial reporting irregularities. We also examine whether religiosity influences managers’ methods of managing earnings. Although we find a negative association between religiosity and abnormal accruals, we find a positive association between religiosity and two measures of real earnings management, suggesting managers in religious areas may prefer real earnings management over accruals manipulation. We provide evidence that our results are not driven by firms headquartered in rural areas and conclude that religious social norms represent a mechanism for reducing costly agency conflicts, particularly when other external monitoring is low.

Keywords: religion, financial reporting irregularities, earnings management, monitoring, religious social norms

JEL Classification: M41, M14