Prophet and Loss: How the local strength of faith can impact a company’s ethical behaviour

Companies are less likely to engage in unethical accounting practices when their headquarters are in areas of high religious observance, new research by academics at the universities of Sussex and East London has revealed.

Using a sample of more than 23,000 US firm-year observations over a 15 year period, Dr Emmanuel Mamatzakis and Dr Eric Boahen found that managers working for companies based with strong religious observance were less likely to attempt classification shifting.

While the practice, which involves shifting revenue items and core expenses from or into special items in a bid to inflate a firm’s core earnings, is not illegal, it is considered highly questionable on ethical grounds.

The study showed that being based in an area of strong religious feeling was as effective in maintaining ethical management behaviour as strong corporate governance or the use of big four accountancy firms although not as effectively as the threat of legal action.

Dr Emmanuel Mamatzakis , Professor of Finance at the University of Sussex Business School, said: "Our study indicates that the strength of religious feeling locally at a business’s HQ can help shape that company’s ethical behaviour and help deter the likelihood of managers’ undertaking immoral accounting practices such as classification shifting.
"As authors we feel that regulators, auditors and investors should note how our findings show the influence of religion in subduing the risk of misreporting and strengthen monitoring mechanisms put in place by management to mitigate unethical behaviour.
"This is important because, although religion is scarcely discussed in secular organisations, understanding its role in shaping corporate financial reporting is valuable from an ethical point of view."

The authors, whose paper has been published in Accounting Forum , said deviations from widely accepted ethical behaviour at firm level are rarely given attention but they often lead to high debt levels or even to catastrophic business failure.

They said that that the high religious observance of the county a firm was headquartered could make a difference to corporate behaviour because individuals’ decisions are shaped and influenced by the moral values and social norms of the environment where they live or work.

The authors added that their evidence showed that managers have little incentive or opportunistic motivation to misclassify expense or revenue items in religious counties. This religious influence was particularly prevalent in rural areas.

Dr Eric Boahen, Senior Lecturer at the University of East London said: “Our study finds that the level of religiosity and religious social norms of a firm’s environment has the potential to mitigate the likelihood of expense misclassification and any associated agency costs that might arise from such conduct.
“We believe religiosity complements corporate governance and BIG 4 audit to shape corporate behaviour and decision-making as well as subdue expense misclassification because managers with the responsibility of making decisions are influenced by the moral values and religious social norms of a firm’s environment.”

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By: Neil Vowles
Last updated: Friday, 28 June 2019