Essays on Religiosity and Finance: Evidence from Saudi Arabia

Abstract

This thesis examines the relatively underexplored influences of informal institutions, particularly religiosity, on corporate outcomes. Drawing on the theory of social norms, it investigates how Islamic religiosity, as a form of religious social norms, shapes firm behaviour in Saudi Arabia. The study focuses on three key areas: corporate investment efficiency, corporate risk-taking behaviour and corporate environmental, social, and governance (ESG) practices. The research employs panel data analysis to evaluate these relationships among companies listed in Saudi Arabia from 2012 to 2020. In the first essay, the primary finding is that the firm’s headquarters, located in a community with a higher Islamic religiosity level, positively influences corporate investment efficiency. Furthermore, our findings indicate that the beneficial link between religiosity and investment efficiency is more pronounced in firms that are not financially constrained and those without significant institutional ownership. In companies that do not face significant financial limitations, the principles guided by Islamic religiosity appear to facilitate more effective investment decisions and better allocations. Similarly, the absence of significant institutional ownership suggests that without strong external governance mechanisms, internal cultural norms such as religiosity can be critical in enhancing monitoring functions, guiding corporate behaviour, and improving investment efficiency. Finally, our study finds a negative correlation between Islamic religiosity and agency costs. This finding implies that the advantageous effect of Islamic religiosity may largely stem from its role in diminishing agency conflicts. Reducing these conflicts plays a key role in the beneficial outcomes associated with implementing these norms. In the second essay, empirical evidence demonstrates that firms headquartered in communities with higher Islamic religiosity tend to engage in lower levels of corporate risk-taking. This effect is more pronounced in firms with lower institutional and foreign ownership, where external monitoring is weaker. The results suggest that Islamic religiosity plays a monitoring role, helping to curb excessive risk-taking. They support the proposed mechanism that religiosity constrains corporate risk-taking, especially in settings with limited institutional oversight. Moreover, the influence of Islamic religiosity appears to be offset in firms with foreign ownership, likely due to the introduction of different cultural norms and governance practices. Conversely, firms without foreign ownership appear more aligned with local religious norms, reinforcing the inverse relationship between religiosity and risk-taking. Furthermore, the study identifies a positive relationship between Islamic religiosity and corporate performance. Firms headquartered in communities with higher levels of religiosity are more likely to experience exceptional positive performance and are less susceptible to extreme negative outcomes. This balance contributes to their superior average performance and highlights the value-enhancing effects of religiosity. Path analysis further shows that Islamic religiosity reduces risk-taking, which, in turn, contributes to higher firm performance. In the third essay, findings reveal that firms operating in communities with higher levels of Islamic religiosity tend to exhibit lower ESG activities. This effect is particularly pronounced among financially constrained firms, where the added costs and potential inefficiencies of ESG initiatives may shrink profit margins and thus weaken managerial incentives to invest in them, especially when firms align with prevailing religious norms and enjoy the confidence of market participants. Moreover, higher levels of Islamic religiosity are associated with reduced agency costs, indicating that Islamic religiosity promotes ethical behaviour and limits managerial self-interest, thereby diminishing the need for ESG as a governance mechanism. These findings suggest that Islamic social norms can serve as a substitute for corporate ESG. In highly religious environments, where ethical conduct is expected and stakeholder trust is strong, ESG activities may offer limited signalling value and appear less necessary. These results provide important implications for policymakers and investors, offering insights into decision-making processes in emerging markets. By addressing the previously unexplored relationship between Islamic religiosity and corporate outcomes, this thesis enriches the existing literature and sheds light on the unique characteristics of the Saudi financial market as an emerging economy.