The impact of corporate governance mechanisms on earnings management in Islamic banks in the Middle East region

Abstract

Purpose The purpose of this paper is to examine whether corporate governance mechanisms affect the reporting of loan loss provisions by managers in Islamic banks in the Middle East region. Design/methodology/approach This empirical study uses balanced panel data from 20 Islamic banks, from seven Middle East countries for the period 2007 to 2011. The regression model is estimated using random effects specifications. Findings The empirical results show that discretionary loan loss provisions (DLLP) are negatively related to board size and the existence of an audit committee. Results also report a positive relationship between sharia board size and DLLP. This indicates that small sharia supervisory boards are more effective than larger ones, which could be due to the higher costs and negative effects of large groups on decision-making. Results also highlight that the existence of scholars with accounting knowledge sitting on the sharia board reduces discretionary behavior. Additional results provide evidence that an external sharia audit committee is also found to reduce discretion in Islamic banks. The conclusions are found to be robust to endogeneity issues and potentially omitted variables. Practical implications The findings are potentially useful for regulators and shareholders. Regulators could use the findings to focus on corporate governance mechanisms that restrain earnings management practices in Islamic banks and implement regulations to strengthen them. Additionally, this study gives shareholders further insight which enables them to better monitor the actions of managers and thus increase their control over their investments. Originality/value This study provides two contributions to the literature on Islamic banking. First, to the authors’ knowledge, this study is only the second piece of research focused on the impact of corporate governance on earnings management in Islamic banks. Second, the authors have examined the effect of some new corporate governance mechanisms that have not been studied previously in the research literature.

The role of the Sharia Supervisory Board and corporate governance mechanisms in enhancing Islamic performance – evidence from Indonesia

“…The SSB has a controlling function, supervising its bank's transactions, including controlling the revenue that comes from illicit activities or what is commonly called non-halal revenue. The SSB has a supervising and controlling function over the management's performance (Mersni & Othman, 2016), so that the greater the number of SSB members, and the higher their education levels are, the more effectively the SSB will carry out its control functions, including controlling the non-halal revenue. For an Islamic bank, non-halal revenue should not be recognized as revenue in the comprehensive revenue statement, but it is recognized as an ent ry in the benevolent fund (Indonesian Institute of Accountants, 2017).…”

“…Islamic banks use Islamic law as the main source for their management and operations. The motive for developing Islamic banks is because of the practice of interest, gharar and maysir maysir (Mersni & Othman, 2016) that are commonly used by conventional banks. Interest, gharar and maysir are transactions that are not suitable with Islamic law, so they must be replaced by other transactions which are allowed.…”

Financial Performance Determinant of Islamic Banking in Indonesia

“…SSB ensures that bank has complied with Islamic principles in accordance with what customer's desire. Thus, SSB is like an internal audit within a bank (Mersni & Othman, 2016). Besides, AAOFI wishes that Islamic bank has SSB proficient in sharia finance and sharia law (Mersni & Othman, 2016).…”

“…Thus, SSB is like an internal audit within a bank (Mersni & Othman, 2016). Besides, AAOFI wishes that Islamic bank has SSB proficient in sharia finance and sharia law (Mersni & Othman, 2016). Marwan et al (2016) considered SSB as one that controls and is influential in the performance and performance stability of Islamic bank.…”

Good Corpotare Governance dan Manajemen Laba di Perbankan Syariah

“…Sedangkan hasil penelitian Farida, Yusriati Nur;Prasetyo, Yuli ;& Eliada (2010); Bukit & Nasution (2015); serta Mersni & Ben Othman (2016) tidak menemukan adanya pengaruh ukuran dewan komisaris dan komposisi komisaris independen terhadap manajemen laba. Komite audit sebagai bagian dari sistem pengendalian manajemen memiliki peran dalam menurunkan manajemen laba.…”