Corporate political activities, religiosity and corporate decision making

Motivated by the recent increase in corporate political spending and the Supreme Court’s decision in allowing firms to freely use their treasury funds for political purposes (Citizens United v Federal Election Commission, 2010), this study examines the impact of corporate political activity (CPA) on its decision making. CPA is defined as the firm’s total annual lobbying expenses arising from the engagement of internal and external lobbyists while corporate decision making is measured in terms of: (1) firm risk exposure, measured as the standard deviation of firm returns (SDROA), research and development (RD), capital expenditure (CAPEX) and growth (GROWTH); (2) firm profitability constructed as returns on assets (ROA). Given that prior studies have also shown local religiosity matters in various firm outcomes, this study considers whether the main association between lobbying and corporate decision making is conditional on religiosity. In other words, this study examines the joint effects of firm lobbying and local religiosity on corporate decision making. Consistent with agency theory, this study finds that CPA is positively associated with corporate risk exposure but negatively related with firm profitability, suggesting that politically active firms are more likely to engage in risky behavior, resulting in lower firm returns. However, when the joint effects of CPA and religiosity are considered, the positive association between CPA and risk exposure is weaker for firms headquartered in strong religious counties. These results are consistent with three main arguments put forward by prior studies. First, religiosity reduces the acceptance of unethical business practices given that the basic tenets of most major religions reject unethical behavior (McGuire, Omer and Sharp, 2012). Second, religiosity through social norms prompts managers to conform to the dominant local religious guidelines and beliefs which subsequently affect the firm’s tolerance towards risky investments (Dyreng, Mayew and Williams, 2012; Eun, Wang and Xiao, 2015; Hilary and Hui, 2009; Sunstein, 1996). Lastly, the attraction and selection of large proportion of employees from areas where a corporation is located affects the culture and behavior of the corporation (Schneider, 1987). In this case, a firm which is headquartered at a highly religious county would possibly employ a greater number of religious employees that may subsequently affect the firm’s risk acceptance levels and firm performance. In regards to firm profitability, the negative association between lobby expense and ROA is significantly more pronounced for firms headquartered at highly religious counties. This finding, however, does not support the hypothesis that the negative relationship between corporate lobbying and ROA should be weaker for firms headquartered at highly religious counties since strong religiosity should have mitigated the agency problem. Nevertheless, this study provides two alternative arguments for the counterintuitive findings. First, as discussed earlier, religiosity is shown to be positively correlated with individual risk-averse behavior and such individual behavior is also shown to have certain influence on corporate culture through local social norms (Hilary and Hui, 2009; Miller and Hoffmann, 1995). Hence, firms headquartered at highly religious counties are more likely to be risk-averse and thus only consider investments that are deemed to be profitable and certain in their payoffs (low risk). In other words, such firms would require higher internal rate of return before investing (i.e., higher than usual subjective discount rate for all projects) due to the risk-averse corporate culture. However, by doing so, these firms have to forgo a large number of investments that could have generated reasonable returns, which results in poorer firm performance (ROA). Second, it could be that local religious social norm having stronger effects on risk aversion than to reduce the agency problem per se. Specifically, local religious social norms may have reduced both agency issue and risk taking behavior simultaneously, but such norms are stronger in mitigating risk taking behavior than to control the agency problem. Hence, more “religious firms” are likely to experience a lower ROA. These results are also robust to a variety of robustness tests. The study contributes to the current literature in several important ways. First, this study integrates the ethical climate of a firm, i.e., CPA and religiosity in examining corporate decisions. By doing so, multi-disciplinary domain drawn from political science, strategic management, economics, finance, psychology and sociology literature can be examined and integrated. Second, this research extends prior CPA studies that are limited to either examining the direct impact of CPA on firm outcomes or the antecedents of CPA. For instance, Cooper, Gulen and Ovtchinnikov (2010) examine the direct impact of corporate political contributions on stock returns; Yu and Yu (2011) study the association between corporate lobbying and fraud detection while both Hillman (2003) and Masters and Keim (1985) examine firm size and firm product diversification as the possible determinants of a firm’s CPA. However, this is the first study, in the author’s knowledge, that has examined the joint effects of CPA and local community religion on firm decision making. Third, this study adds to prior CPA research that is heavily focused on only corporate political contributions although some studies have suggested that lobbying is more important in influencing a political decision making process (Ansolabehere, Snyder and Tripathi, 2002; Hansen and Mitchell, 2000; Kim, 2008). Fourth, while recent studies on religiosity tend to focus at macroeconomic level, there is limited empirical work on how religiosity would affect firm behavior specifically. This study complements the existing religiosity literature by examining the moderating effect of local religiosity on CPA-firm decision making relationship. In fact, examining and understanding how local religiosity affects firm outcomes have been described as “one of the great uncharted areas” in social science (Lagace, 2001, p.1). Last but not least, this research provides investors and regulators alike with some useful insights in evaluating a firm’s political strategy. Furthermore, the findings suggest that local religious social norms may act as alternative governance or monitoring mechanism for firms, to the extent that regulators and investors may use religious social norm as a proxy to evaluate the possible risks (and perhaps the future firm profitability) associated with the firm.