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Other scholars highlight the role of religion in promoting ethical behaviour in business organisations (Conroy & Emerson, 2004; Kennedy & Lawton, 1998; Longenecker et al., 2004; Weaver & Agle, 2002). Indeed, the use of ethical precepts grounded on religious teachings, is certainly not new to business. Noreen (1988) explored the use of ethical and other frameworks in business and accounting. He examined the boundaries of human behaviour in agency settings and argues that agency contracts alone cannot restrain opportunistic behaviour. He identifies religion as one of the enforcement mechanisms for better ethical behaviour.

Researchers in sociology and business ethics have indicated that religion has a profound impact on managers’ values, behaviours and business ethics, either directly or by implication. In attempting to explain why religion may affect moral attitudes, Weaver and Agle (2002) discuss a theoretical framework for understanding the influence of religion on business ethics. They argue that religion offer role expectations which, when internalised through repeated social interaction, contribute to a person’s self-identity as an adherent of a specific religion. When religion is a central part of a person’s self-identity, departures from religious role-expectations might generate higher levels of cognitive and emotional discomfort, which motivates adherents to keep their behaviour in line with religious role-expectations. Thus,

91 Weaver and Angle (2002) assert that the more salient a person’s religious identity, the more likely an individual is to act in accordance with the role expectations of his or her religion.

Further, Hirschi and Stark (1969) assert that religion inhibits unethical behaviour through its sanctioning system that legitimises and reinforces social values. Conroy and Emerson (2004) also argue that believers in God are less likely to act unethically because of the fear of being “caught” by an omniscient God and being punished. Religion contributes to the formation of perceptions of the certainty and severity of punishment for deviance or unethical behaviour. Moreover, highly religious people are likely to experience psychological shame from unethical behaviour, and those involved in religious networks are more likely than others to experience embarrassment, when involved in unethical acts. These two negative psychological consequences are linked to a lower rate of unethical behaviour among religion adherents (Kennedy & Lawton, 1998).

Stack and Kposowa (2006) discuss the impact of religious moral codes on unethical conduct from the perspective of the theory of moral communities. They suggest that communities with strong moral values might reduce the deviant or unethical attitudes of individuals within them, regardless of any individual’s own level of religiosity. People with relatively low levels of personal religiosity may be influenced by the attitudes and behaviour of people with high levels of religiosity in the greater community. Hence, moral communities may strengthen religious attitudes and beliefs for everyone in them, even those who are irreligious.

92 Empirical research has linked religion and ethical values in managerial attitudes and decision making (Conroy & Emerson, 2004; Kennedy & Lawton, 1998; Longenecker et al., 2004; Parboteeah, Hoegl, & Cullen, 2008; Rashid & Ibrahim, 2008), and in business practices, including accounting (Dyreng et al., 2010; Grullon et al., 2010; Hillary & Hui, 2009; Omer et al., 2010). Longenecker et al. (2004) examined differences in ethical judgements among various religious groups: Catholic, Protestant, Jewish, other religions and no religion. They surveyed 1,234 business managers and professionals in the United States regarding the ethical acceptability of 16 business decisions. They found that respondents who have strong religious convictions tend to demonstrate a higher level of ethical judgement. In a similar vein, Conroy and Emerson (2004) examined whether the ethical attitudes of students were affected by religiosity, and/or courses in ethics, religion, or theology. Using 25 vignettes, their results show that religiosity is, statistically, a significant predictor of responses in a number of ethical business scenarios. However, they found that completing religion or ethics courses explained little variation in ethical attitudes.

Parboteeah et al. (2008) examined the relations between religiosity and the justification of ethically-suspect behaviours. The justification of ethically-suspect behaviour refers to the degree that respondents would be willing to justify behaviours that are generally considered unethical (e.g., bribing and cheating). They hypothesised that religious beliefs are negatively related to justifications of unethical behaviour. Using a sample of 63,087 individuals from 44 countries, they found that religion is negatively related to an individual’s willingness to justify ethically-suspect behaviours. This empirical evidence implies that religion is an important mechanism in shaping societal ethical values and norms.

93 Prior studies also indicate that religion affects business and accounting practices.

Grullon et al. (2010) attempted to investigate the effect of religion on unethical corporate behaviour. They examined federal class action lawsuits against corporate executives and corporations. Option back-dating, excessive executive compensation and earnings manipulation through accrual choices were selected as proxies for unethical corporate behaviour. They hypothesised that firms headquartered in more religious counties are less likely to be involved in unethical behaviours because such firms adopt the ethical values of their local communities as an important part of their own corporate culture. Consistent with their prediction, the results show that firms headquartered in more religious counties are less likely to be the target of class action securities lawsuits, to manipulate earnings through accrual accounting choices, to backdate options or to grant large compensation packages to their managers. The results suggest that managers bring their communities’ religious values to their workplace, mitigating unethical managerial behaviours.

Dyreng et al. (2010) examined whether religious social norms are associated with aggressive financial reporting.17 They contend that religious social norms might influence managerial reporting behaviour in two ways. First, religious individuals are generally characterised as risk averse (Hillary & Hui, 2009). Thus, if a firm is located in regions where religious social norms are more prevalent, managers of such firm become more risk averse and more sensitive to litigation risk when making a financial reporting decision. Second, religious social norms may invoke reminders of personal norms such

17 _{Dyreng et al. (2010) defined aggressive financial reporting as accounting that is manipulated either}

within or outside the confines of GAAP to reflect something other than the economic reality for the benefit of management.

94 as honesty and morality. These personal norms could drive ethical behaviour in business conduct because deviation from personal norms could damage an individual’s self- concept. Both aversion to litigation risk and costs of deviating from personal norms are increased when managers report aggressively. Thus, they hypothesised that firms located in areas with more religious adherence are less likely to engage in aggressive financial reporting than firms located in areas with less religious adherence. Consistent with their hypothesis, they found that firms operating in countries with higher levels of religious adherence exhibit low analyst-based, forecast-error distributions, have higher accrual quality, have a lower risk of fraudulent accounting and are less likely to restate their financial statements.

Similar to Dyreng et al. (2010) and Grullon et al. (2010), McGuire et al. (2010) found that firms headquartered in areas with strong religious social norms exhibit less aggressive financial reporting. In particular, they documented that a religious ethical code is negatively associated with accounting risk, unexplained audit fees, and likelihood of accounting-related shareholder lawsuits. This empirical evidence suggests that religious moral codes play a significant role in deterring unethical corporate behaviour.

Prior studies however, examined the affect of religious ethics on unethical corporate practices in a setting where there are no clear guidelines to make a selection between a religious mode of business and a non-religious mode of business. This study extends prior research by examining the effect of Islamic ethical values on unethical corporate behaviours, particularly earnings management practices in a setting where the firms

95 driven by religious ethics are distinctly classified through well-defined institutional arrangements.

The expectation of the association is stated in the research hypotheses that are developed and discussed in the next section.