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Does Religiosity Matter to Value Relevance? Evidence from U.S. Banking Firms

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Abstract

This study examines whether religiosity is associated with the valuation multiples investors assign to fair-valued assets that are susceptible to managerial bias. Using a sample of U.S. banking firms, I find that the value relevance of such assets is higher for firms located in more religious counties than it is for firms located in less religious counties. Moreover, I find that this result is more consistent with the ethicality trait than the risk aversion trait of more religious individuals. Additional tests show that the positive association between religiosity and value relevance of fair-valued assets is limited to firms with high fair value exposure, and it is stronger for firms with lower audit quality, lower institutional ownership, and lower analyst following. The results of this study suggest that investors perceive the role played by religiosity, in particular ethicality, in curbing managerial accounting biases and price accounting estimates accordingly.

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Notes

  1. As explained by Dyreng et al. (2012), the honesty trait of more religious individuals stems from the fact that they are more often reminded by moral codes of conduct.

  2. Anecdotal evidence shows how investors’ religiosity affects their investment decisions. Franklin Graham, president and CEO of the Billy Graham Evangelistic Association (BGEA) and of Samaritan’s Purse, moved the bank accounts for these two ministries out of Wells Fargo because of the company’s ad featuring a lesbian couple. He wrote on his Facebook account: “Let’s just stop doing business with those who promote sin and stand against Almighty God’s laws and His standards. Maybe if enough of us do this, it will get their attention (http://www.charlotteobserver.com/living/religion/article23496706.html#storylink=cpy). Other religious groups, including the anti-LGBT American Family Association, have joined Graham’s voice against Wells. Around the same time, Doug Case, an LGBT executive at Wells Fargo said in published reports that then-CEO John Stumpf “very frequently will talk about LGBT inclusiveness and, talk about walking the talk, you can often hear him speak to the value that our LGBT team members provide” (Wilson 2015).(https://www.bizjournals.com/charlotte/blog/bank_notes/2015/06/wells-fargo-were-not-pulling-lgbt-ad-over.html).

  3. While Level 3 inputs are harder for shareholders to verify, Level 2 inputs are economically more important in my sample, representing approximately 90% of the fair value estimates.

  4. Pevzner et al.’s (2015) argument relies on the home bias assumption. The current study does not make any assumption regarding the investor base.

  5. Kedia and Rajgopal (2011) for instance find that clients farther from SEC regional offices are more likely to misreport. If investors recognize this association, they would trust more firms that are closer to SEC offices. The degree of religiosity of managers and investors cannot however be affected by the distance of the firm to SEC offices.

  6. First, under Statement of Financial Accounting Standard (SFAS) 115, “Accounting for Certain Investments in Debt and Equity Securities,” investment securities and debt securities that are “held for trading” or “available for sale” must be measured and recognized at fair value. Second, SFAS 123R, “Share Based Payments,” mandates the use of the fair-value-based method of accounting to recognize share-based employee compensation expenses. Third, SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” requires the measurement of all freestanding derivatives at fair value; it also mandates the measurement of hedged items at fair value, except for items subject to cash flow hedges. Fourth, SFAS No. 125, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” requires firms securitizing their receivables to recognize the cash flow streams retained by the firm at fair value.

  7. First, SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” allows firms to irrevocably measure many financial instruments at fair value rather than amortized cost on an instrument-by-instrument basis. Second, SFAS 155, “Accounting for Certain Hybrid Financial Instruments—an Amendment of FASB Statements No. 133 and 140” allows firms to elect fair value measurement for any hybrid financial instrument that contains an embedded derivative in cases in which a derivative would otherwise have to be bifurcated. Third, SFAS 156, “Accounting for Servicing of Financial Assets: An Amendment of FASB Statement No. 140,” permits a choice between the amortization method and the fair value measurement method for subsequent measurement of separately recognized servicing assets and servicing liabilities.

  8. While there is evidence that earnings management can be beneficial (it improves management’s communication of private information to external stakeholders (Holthausen 1990) and increases the flexibility to react in a contracting context (Dye 1988)), this study takes the most widely held view that earnings management misleads financial statement users and thus it is unethical.

  9. The authors find however a positive association between religiosity and real earnings management. This result is consistent with the argument that managers of firms in more religious areas perceive real earnings management as less unethical or less risky than accruals manipulation.

  10. This result is also consistent with the honesty norms of religious individuals.

  11. They find that the default rate on Islamic loans is less than half the default rate on conventional loans.

  12. Their results are also consistent with the ethicality trait of more religious individuals.

  13. Kreps (1997) provides different explanations for adherence to social norms: (1) it is less costly relative to violation, (2) it permits coordination, (3) it is costly but leads to better treatment by others than will violation, and (4) it is desirable, per se.

  14. An alternative approach used in the literature is the returns-relevance approach. For instance, Bhat and Ryan (2015) use such approach and find that market and credit risk modeling enhance the returns-relevance of estimated annual unrealized fair value gains and losses for financial instruments that are recorded in other comprehensive income and in note disclosures.

  15. Qi et al. (2000) investigate the time-series properties of the Ohlson (1995) model. They show that the null hypothesis that market value and book value are non-stationary cannot be rejected for most of the sample firms and that book value and residual income do not cointegrate with market value for 80% of the sample firms. They suggest that scaling the variables can alleviate the non-stationarity problem. Barth and Clinch (2005) provide evidence that share-deflated specifications perform better than do other deflators (equity book value-deflated, lagged price-deflated, returns, and equity market value-deflated) in reducing scale effects in the modified Ohlson model. Thus, I scale my variables by the number of shares outstanding.

  16. In accordance with this argument, Benston (2008, p. 104) states that “fair values other than those taken from quoted prices (Level 1) could be readily manipulated by opportunistic and overoptimistic managers, would be costly to make, and very difficult for auditors to verify and challenge.”

  17. Unreported regression results show that the market pricing of Level 2 and 3 net fair-valued assets is not different. My findings are consistent with those of Chung et al. (2017) who document a coefficient of 0.916, 0.828 and 0.826 for levels 1, 2, and 3 fair-valued assets respectively indicating that the market pricing of Level 2 and 3 is not different.

  18. The use of the number of shares outstanding as a deflator has some limitations. As robustness check, I scaled the variables by book value and found that my inferences remain the same.

  19. Descriptive statistics show that the median of fair value liabilities is equal to zero.

  20. According to this score, the ten most religious counties in the US are (1) Bolivar, MS, (2) Utah, UT, (3) Hancock, TN, (4) Neshoba, MS, (5) Clarke, AL, (6) Lee, MS, (7) Atkinson, GA, (8) Hempstead, AR, (9) Putnam, OH and (10) Anderson, SC.

  21. The reported results also indicate that the market assigns a higher valuation multiple to EPS for firms with high fair value exposure than for those with low fair value exposure. The difference in EPS pricing between the two subsamples can be explained by the fact that firms with low fair value exposure have more observations with negative earnings values (21.1%) than those with high fair value exposure (12.3%).

  22. I would like to thank Chung, S.G., B.W. Goh, J. Ng and K.O. Yong for accepting to share their valuable hand collected data with me.

  23. Unreported results show that the negative association between religiosity and risk-taking is validated in my sample.

  24. Hilary and Hui (2009) and Adhikari and Agrawal (2016) among others used lagged adherence rate and lagged population as instruments for religiosity.

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Acknowledgement

This paper is based on my Ph.D. dissertation, completed at Queen’s University. I am indebted to my dissertation committee members Daniel Thornton, Michael Welker, Serena Wu, Steve Fortin, and Frank Milne. I appreciate the constructive comments from Queen’s faculty, in particular Steven Salterio and Lynnette Purda. I also thank Edward Riedl, William Mayew, Phil Shane, Christine Weidman, Sati Bandyopadhyay, and Michel Magnan for valuable comments and suggestions. The paper also benefited from comments received at AAA Financial Accounting and Reporting Section Mid-Year Meetings, and seminars at Concordia University, University of Waterloo and University of Ottawa.

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    Lamia Chourou

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Chourou, L. Does Religiosity Matter to Value Relevance? Evidence from U.S. Banking Firms. J Bus Ethics 162, 675–697 (2020). https://doi.org/10.1007/s10551-018-3978-z

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