This paper empirically tests the competing hypotheses regarding the influence of local religion on managerial income smoothing decisions. On the one hand, managers of firms in more religious regions may be more inclined to engage in income smoothing, as it helps reduce uncertainty and perceived risk of the firm. Conversely, managers may be less likely to engage in income smoothing because it often involves earnings manipulation, which goes against the principles of most religions.
We employ four established measures of income smoothing and obtain data on local religiosity from the Association of Religion Data Archives modified by Bacon et al. (2018). We perform univariate and multivariate empirical tests on US public firms from 1993 to 2018.
We find robust evidence that firms headquartered in more religious counties have a higher level of income smoothing. Further analysis shows that income smoothing significantly enhances the informativeness of earnings in higher religious areas. Managers also resort to greater income smoothing when their firms face heightened volatility or risk.
Our findings suggest that managers are more likely to use income smoothing to reduce uncertainty and the perceived risks associated with the firm. Our study supports the growing awareness that social norms, such as religion, play an important role in financial decision-making. We acknowledge that the data on local religion comes with limitations related to coverage and accuracy, primarily stemming from the inherent nature of self-report surveys.
For investors and analysts, the awareness that managers in firms influenced by higher religiosity tend to engage in income smoothing can aid in evaluating earnings information and making more informed investment decisions.
We examine the influence of religious norms in counties where firms are headquartered on managers’ attitudes toward income smoothing within a single-country context. Our analysis focuses on two characteristics of religion and develops two distinct hypotheses. First, the ethical values promulgated by religion may deter managers from engaging in opportunistically motivated income smoothing aimed at concealing earnings volatility. Alternatively, the risk aversion originating from religious beliefs may encourage managers to adopt more income-smoothing practices. Our findings support the latter perspective.
