Board of directors and earnings management: conventional and Islamic banks

ABSTRACT

This study examines how the board of directors (BOD) of Islamic banks (IBs) might affect earnings management differently, compared to BOD of conventional banks (CBs). Our results indicate that banks in the MENA region that promote BOD independence incur less earnings management. Distinguishing between CBs and IBs, we document higher loan quality and credit policy at IBs. Moreover, smaller BOD size and board independence decrease earnings management at IBs. Findings suggest that agency theory might not accommodate the agency conflicts at IBs, since it neglects stakeholders’ behavioural patterns. Thus, these results suggest the need to shape directors’ financial acumen at IBs.

KEYWORDS:

• Board of directors
• board independence
• board size
• earnings management
• Islamic and conventional banks

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. Earnings management refers to the use of managers’ judgment in financial reporting and in structuring transactions to alter financial reports with the objective of either misleading stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on the reported accounting numbers (Healy and Wahlen 1999).

2. ‘Sharia is the legal framework within which the public and private aspects of life are regulated for those living in a legal system based on fiqh (Islamic principles of jurisprudence) and for Muslims living outside the domain’ (Beck, Demirgüç-Kunt, and Merrouche 2013; photnote 5, p 434).

3. Depositors in Islamic parlance are called investment accounts holders (IAHs). These accounts are fully under the control of IB managers.

4. Displaced commercial risk (DCR): ‘refers to the risk arising from assets managed on behalf of IAH which is effectively transferred to the IBs own capital because the IBs follows the practice of foregoing part or all of its Mudarib share of profit on such funds, when it considers this necessary as a result of commercial pressure in order to increase the return that would otherwise be payable to the IAH’ (Islamic Financial Services Board, 2005 p19).

5. Due to few duality observations in IBs, we base our conjecture in the whole sample (H3).

6. http://www.worldbank.org/en/region/mena

7. The boxplot and normality tests of the main variables show 9 outliers. However, we winsorize all variables at the top and bottom 1% of observations and results are robust to these changes.

8. Regression results are not included, but are available from the authors upon request.

9. Our descriptive statistics and related discussions are based on the t-test results.

10. These results contradict our results in the correlation matrix, table (4), since these results represent the multivariate regression where each variable affects partially the dependent variable, while the correlation matrix gives a univariate relationship.

11. Regression results are not included, but are available from the authors upon request.