Chapter 8: The Effect of Religion on Financial and Investing Decisions

1. Chapter 8: The Effect of Religion on Financial and Investing Decisions

2. Topic Covered • Religions and Economic Factors: Dependence or Bifurcation? • Does Religion Matter? • Interplay between Religion and Political Economy • Religion and Individual Investing Behavior • Personal Traits • Gender, Age and Education Level • Religion and Social Behavior • Trust, Cooperation, Loyalty, Risk Perception, Risk Aversion and Gambling • Religion and Investor Psychological Behavior • Religion and Social Investing • Religion and Corporate Investment Decisions • Cost of Funds and Financial Instruments • Managerial Behavior, Investment Decision and Corporate governance

3. Religions and Economic Factors: Dependence or Bifurcation? • The literature on the institutional impact on economic growth adds a supplementary dimension related to culture, religion, and social activities. • Despite limited empirical evidence, the role of religion is important when studying economic growth. • For example, some authors such as El Ghoul et al. (2012) study whether religion affects a firm’s financing and investment decisions.

4. Cont. Does Religion Matter? • According to McCleary and Barro (2006), two approaches are available for dealing with the interaction of religion and political economy. • The first considers religion as a dependent variable in which decisions by government and other entities affect religion. • The second approach views religion as an independent variable. Here, religion influences societal behavior related to work, ethics, and productivity, which, in turn, could influence economic performance.

5. Cont. • The seminal study of Weber (1905) spurred a large body of literature on the impact of religion on both macroeconomic aggregates and firm-level indicators. Weber contends that religion has a positive impact on economic growth. He concludes that Protestantism, not Catholicism, has a great impact on economic growth because of the Protestant work ethic. • Various studies examine the issue of dependence or bifurcation of religion and economic variables at the empirical level. For example, Kogut and Singh (1988) investigate the link between countries’ cultural distance (religious distance) and their foreign direct investment (FDI). Their results reveal that large cultural distances impede the growth of FDI. • Helble (2007) shows, a common religion may increase the FDI but the presence of different religions engenders severe competition and triggers favorable growth because a liberal society in which the religion is diversified attracts foreign investors

6. Cont. Interplay between Religion and Political Economy • McCleary and Barro (2006) use survey information, aggregated to the country level, on religious beliefs related to afterlife and on participation in formal religious services and personal prayer. Their evidence shows a close dependence of economic growth in gross domestic product (GDP) on religious beliefs and the attendance of religious services. • Rupasingha and Chilton (2009) use religious adherence data from the American Religious Data Archive to study the effect of church adherence rates on U.S. economic growth. The authors use three religious groups: evangelical Protestants, mainline Protestants, and Catholics. The results support the view that religious adherent rates affect U.S. economic growth.

7. Religion and Individual Investing Behavior • The traditional finance theory of capital markets asserts that fundamental variables such as stock prices, profitability, and volatility affect financial decisions. • Additionally, behavioral finance contends that human psychology and emotion influences investment choices.

8. Cont. Personal Traits • A recent economic perspective holds that cultural and religious norms as well as the environment in which people are raised help to shape personal traits and preferences. • Specifically, the literature advances the notion that religion is a determinant of The Effect of Religion on Financial and Investing Decisions • Religion affects individual differences related to gender, age,education level, and their implication involving economic behavior follows.

9. Cont. • Gender • For at least 30 years, the gender-religion link has been central to social and scientific debates • Previous studies about the gender-religion relationship reveal consistently strong agreement that women are more religious than men, which is partly due to the superiority of differential gender socialization (Miller and Hoffmann 1995; Miller and Stark 2002). Heelas and Woodhead (2005), who examine religion practice in the United • Ammon, and Bernasek (1998) report that women become more risk averse as they age.

10. Cont. • Age • Parents influence individuals’ behavior and choice because they seek to convey their preferences and personal traits to their children by attending particular religious education and church attendance. Therefore, parents help to define the children’s religious beliefs and behavior (Benhabib, Bisin, and Jackson 2011). • For instance, Heelas and Woodhead (2005) find that older individuals have a high tendency to attend church, which means they are more religious.

11. Cont. • Education • Basic financial knowledge is crucial in investment decision-making (Lusardi and Mitchell 2009). Heightened levels of education are relevant to increased economic income. • Religious affiliation in childhood and adulthood specifies particular education attainment, family processes, marriage behavior, work behavior, and other behaviors that influence wealth ownership and asset ownership (Keister 2003). • According to Iannaccone (1998), individuals with a higher educational level exhibit a lower degree of religiosity. • Fehr et al. (2003) find that professionals or highly educated individuals express lower social behavior (e.g., trust behavior).

12. Cont. Religion and Social Behavior • A wave of psychologists and sociologists emerged who attempt to clarify the connection of religiosity with moral systems and social behavior. • However, only recently evolutionist economists document how people frame social and religious adherences, which affects their risk perceptions and decision process. • Religiosity is an important driver of individual investment decisions (e.g., cooperation), prosocial behavior (e.g., trust, honesty, loyalty, ethical attitude, and fairness), individual risk perception, and gambling attitude. Religious organizations promote more prosocial behavior than secular (agonistic) ones (Paciotti et al. 2011)

13. Cont. • Trust • Religiosity is the most important driver of personal trust (Altman 2012). • Both economists and sociologists agree that religiosity promotes trust among individuals (Arrunada 2010). Paciotti et al. (2011) find that religious individuals exhibit a higher trust level compared to secular (i.e., nonreligious) people. • Cook, Hardin, and Levi (2005), highlight the relevance of trust in maintaining financial organization contacts and managing employee relations.

14. Cont. • Cooperation • Folk sociology is a research route stating that religion influences much of the prosocial behavior. It suggests that religious beliefs favor cooperation and social morals (Iannaccone and Berman 2006; Ruffle and Sosis 2007). • However, Dawkins (2006) considers religion as a source of discrimination and conflict. • Sosis and Ruffle (2003) note, participation in collective religious prayers and rituals triggers a higher degree of cooperation.

15. Cont. • Loyalty • Game theorists point out that religiosity also stimulates trustworthiness (Paciotti et al. 2011) • Peifer (2013) finds that investors who invest in both socially responsible (SR) funds and in conventional funds are more loyal to SR funds than to conventional ones. He asserts that the religion stimulates investors’ loyalty by increasing the willingness to maintain a religious asset (e.g., religious mutual fund), irrespective of the asset’s past low performance

16. Cont. • Risk Perception • Although behavioral finance highlights the importance of risk perception to investment decision-making, few studies examine the relationship between investors’ religious beliefs and risk perception. • Some studies highlight that an individual’s risk perception is a function of additional social factors (Renn 2004). • According to Olsen (2011), groups with a higher degree of trust have a lower risk perception. • The financial literature broadly categorizes individual risk attitudes into two main types: pure risk and speculative risk. Pure risk, for example, may take the form of diseases and car accidents. Speculative risk corresponds to the case facing both positive and negative chances to realize gains or losses (Shu, Sulaeman, and Yeung 2012).

17. Cont. • Risk Aversion • Because individual religiosity fosters personal trust, the relationship between religion and perceived risk is expected to reverse. • Keister (2003) finds that Jews exhibit a higher degree of risk-taking behavior and earn a high return on financial assets in comparison to non Jews. • Hilary and Hui (2009) claim that firms headquartered in highly religious regions exhibit a higher degree of risk aversion and a lower investment rate. • Noussairet al. (2012) show that the risk aversion of individuals increases with their degree of religiosity.

18. Cont. • Gambling • Gambling activities exemplify the aforementioned speculative risk. Empirical research asserts that gambling is entangled in religious rituals (Grunfeld, Zangeneh, and Diakoloukas 2008). Economists contend that the involvement in lotteries in a region is dictated by the dominant local religion. • Shari’a (Islamic law) condemns gambling and considers it as a Haram (prohibited) activity, a highly risky activity, and an immoral behavior • Gambling is also forbidden in Judaism. Indeed, gambling is restricted by the rabbinic authorities. The Talmud considers gambling for money as a form of robbery because the loser will never make peace with the winner who took his money.

19. Cont. Religion and Investor Psychological Behavior • Prevailing models of financial theory have limited forms of social interaction and behavior contagion among investors. • Understanding the process of contagion among investors’ beliefs on investment decisions requires explaining the relevance of religion in conveying individuals’ beliefs and emotions. • As Kumar et al. (2011) note, the finance literature omits the salient factor of religion, which is responsibility for influencing and spreading the social behavior of individuals. • Religion is an important feature that underlies social communication (Bisin and Verdier 2011), which is known in behavioral finance as the social network process.

20. Cont. • Individuals choose to work and live in the region where the local culture and religious beliefs are most suitable for them (Cialdini and Goldstein 2004). • Individual beliefs tend to be aligned with the average collective local culture and religion trends (Schneider 1987). • The deviation from common social and religious norms brings on a cognitive and emotional discomfort bias (Sunstein 1996). • Others often influence investors in almost every activity, e.g., religious activities. Such an influence can occur through social networks based on neighbors’ conversation, observation of actions, sport activity, verbal communication, commentators, and media (Hirshleifer and Teoh 2009), as well as on religious practices (Benhabib et al. 2011).

21. Cont. • Norenzayan and Shariff (2008) suggest that religion, as a cultural by-product, induces in human psychology a high sensitivity toward the prosocial reputation within the community group. That is, individuals who venerate moral deities exhibit a high concern for their prosocial reputation. • Nofsinger (2005) recognizes the influence of social mood on financial decision makers. He contends that a high social mood triggers psychological pitfalls (e.g., overconfidence and optimism) that induce an abnormal increase in stock prices and disturb the investing decision.

22. Cont. Religion and Social Investing • The recent meltdown of the financial system highlights the consequences of neglecting ethical values, ignoring investors’ psychological biases, and allowing free rein of inadequate regulation. • Social investing corresponds to an investment process translating the investment decision from a pure classical structure, based on financial needs, to a framework linking this financial objective to take account of the social, moral, and environmental effects and governance issues (Eurosif 2010)

23. Cont. • During the past two decades, empirical studies show that religion and faith help to explain the correlation between SRI and the improvement of financial systems. • Forte and Miglietta (2007) report that institutional investors such as pension funds, charitable organizations, and churches hold more than 92 percent of social investments. • Kurtz (2008, p. 253) states that “religious belief was the first rationale for socially responsible investment, and remains an important force today.” • The main ethical condition for SRI stemming from religious norms maintains that individuals and institutions should apply ethical and moral values within the investment decision-making process. Such a condition indicates that investors should avoid “sin stocks,” which may potentially hinder them from maximizing their returns.

24. Cont. Religion and Corporate Investment Decisions • Cost of Funds and Financial Instruments • The cost of funds is a primary issue that is central to the interaction of the firm’s financial and investment decisions. • Schoon and Nuri (2012) show, religion interferes with the cost of financial instruments. The authors discuss the prohibition of interest by the three major monotheistic religions in the world—Judaism, Christianity, and Islam. • Shari’ah (the jurisprudence in Islam) does not only forbid interest, but also suggests alternative financial instruments. Those instruments should be compliant with Shari’ah. • The Moudaraba contract is a typical example of the financial instruments that do not encompass interest. It consists of a partnership in which an economic agent having an excess of capital develops a partnership with another one that has expertise in deploying capital into business activities, with an agreement to share profits (Iqbal and Mirakhor 2011).

25. Cont. • Managerial Behavior • Managers in areas with high religious adherence tend to be highly risk averse (Hilary and Hui 2009). • Managers manifesting a higher risk aversion tend to avoid violating the law (Lerner and Yahya 2007). • For example, managers are less likely to be the target of class action securities lawsuits and litigation (Lisowsky 2010; McGuire et al. 2012). • Grullon, Kanatas, and Weston (2010) study the impact of religious norms on corporate misbehavior. Specifically, they examine the role of religious adherence in mitigating unethical managerial behavior such as aggressive earnings manipulation. Their empirical results suggest that firms headquartered in a highly religious community exhibit a lower likelihood of such managerial misbehavior

26. Cont. • Investment Decisions • The effect of religion on firm’s investment decisions can be seen through various perspectives. • For instance, Hilary and Hui (2009) study how religious norms that affect investment decisions influence a firm’s risk exposure. The authors survey managers of U.S. firms located in highly religious regions and find that these managers exhibit low degrees of risk exposures, which indicate a low level of risky investments and hence lower long-term growth. • Kumar et al. (2011) focus on the corporate attitude toward excessive speculative risk based on gambling activities. They show that local religious beliefs influence corporate decisions. • Religion is a double-edged sword for firm performance. Following moral religious beliefs can increase firm performance and profitability (Forte and Miglietta 2007). • Incorporating ethical attributes in corporate policies can be very costly, especially when social management goes beyond stakeholders’ expectations (Baron 2009).

27. Cont. • Corporate Governance • Its a source of moral values and ethical attitudes, religion may present a key incentive to improve corporate governance. Welch, Tittle, and Petee (1991) maintain that the religion substantially decreases the individual tendency to avoid taxes. • Further, religion eliminates the managerial opportunism to realize personal gains. • Firms involving managers with strong religious beliefs tend to pay dividends more regularly.