Did corporate governance mechanisms affect earnings management? Further evidence from GCC Islamic banks

Abstract

Purpose

The aim of this paper is to examine the impact of corporate governance mechanisms on earnings management practice for a sample of Gulf Cooperation Council (GCC) Islamic banks (IBs) using a new model of earnings management.

Design/methodology/approach

First, the authors estimate discretionary accruals based on loan loss provisions discretionary loan loss provision (DLLP) using the procedure derived from Jones’ (1991) original model. Second, the authors run a multivariate regression model to check the linkage between corporate governance characteristics and discretionary loan loss provision. Finally, the authors use an additional sensitivity check analysis to assess whether the results are robust to the estimation procedure and to other exogenous factors.

Findings

Using as sample of 26 IBs pertaining to the GCC region with a total of 223 firm-year observations and a nine-year period (2004-2012), the results are conclusive and show that first, IBs with large Shariah Board size manage less DLLP. Secondly, Accounting and Auditing Organization for Islamic Financial Institutions membership positively impacts earnings management through DLLP in IBs. Third, there is a negative relationship between boards of director’s independence the extent to which IBs manage DLLP. Fourth, the existence of block holders positively affects earnings management by IBs. Fifth, there is a negative relationship between audit committee meetings and DLLP. Finally, institutional ownership and bank size have no effect on earnings management through DLLPs.

Research limitations/implications

In this research, the authors do not take into account all governance factors that are supposed to impact earnings management in IBs. Future research should explore the impact of additional IBs governance structures including chief executive officer bonus, experience, gender and the extent to which IBs use real earnings management with Murabaha, Mudaraba and Musharaka transactions.

Practical implications

The paper is a very useful source of information that may provide relevant guidelines in helping the future development of corporate governance of IBs. In addition, the findings could prove to be useful for regulators because they are responsible for the acceptable level of corporate governance standards. Thus, they must consider strengthening governance mechanisms either through new legislation or stronger enforcement where earnings management is of such magnitude to that serious impedes information transparency and financial reporting quality of IBs.

Originality/value

This study associates the corporate governance characteristics with earnings management by IBs. The study contributes to the growing body of literature on earnings management and corporate governance in IBs. It should be useful to researchers, regulators, investors, analysts and creditors as well as other players in the capital markets, as it presents a new and important aspect that needs to be accounted for when assessing the quality of IBs’ accounting information in GCC countries.

Citation

Kolsi, M.C. and Grassa, R. (2017), "Did corporate governance mechanisms affect earnings management? Further evidence from GCC Islamic banks", International Journal of Islamic and Middle Eastern Finance and Management, Vol. 10 No. 1, pp. 2-23. https://doi.org/10.1108/IMEFM-07-2015-0076