Corporate Governance Practices and Earnings Management in Islamic Banking Institutions

Abstract

This paper examines corporate governance (CG) characteristics and relates them to earnings management (EM) behaviours in the context of a large emerging sector, Islamic banking industry. Empirical Investigation used multivariate probit analysis and relied on a sample of 90 Islamic Banks over the period of the years 2000-2009. Findings revealed that CG issues in Islamic banking differ significantly from those of the conventional system. Main differences are found with regard to philosophical aspects, including objectives of the bank, natures of contract involved, key players in the CG practice as well as the relationships between the players. We verified that these aspects provide strong justification for an additional layer in the CG of an Islamic bank being the Shari'ah Supervisory Board (SSB). The mechanism and tools for the effective implementation of CG are relatively the same as the conventional system. Results suggest also that audit committee plays a more significant role in moderating EM than the other aspects of CG.  Moreover, the estimated coefficients of SSB embeddedness suggest that an in-house SSB is effective in mitigating EM. The results, however, do not provide evidence that SSB characteristics, such as SSB size, SSB members objectivity and SSB members competence are significant in mitigating EM. By the same, results revealed no difference between Islamic banks with and without governance  committee in terms of EM intensity.

Keywords: Earnings Management, Corporate Governance, Islamic Banking Institutions.