Elghuweel, M. I., Ntim, C. G., Opong, K. K. and Avison, L. (2017)
Corporate governance, Islamic governance and earnings management in
Oman: a new empirical insights from a behavioural theoretical framework.
Journal of Accounting in Emerging Economies, 7(2), pp. 190-224.
(doi:10.1108/JAEE-09-2015-0064)
This is the author’s final accepted version.
There may be differences between this version and the published version.
You are advised to consult the publisher’s version if you wish to cite from
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http://eprints.gla.ac.uk/118238/
Deposited on: 11 April 2016
Enlighten – Research publications by members of the University of Glasgow
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Corporate governance, Islamic governance and earnings management in Oman: A new empirical
insights from a behavioural theoretical framework
Abstract
Purpose: This paper examines the impact of corporate (CG) and Islamic (IG) governance mechanisms on
corporate earnings management (EM) behaviour in Oman.
Design/Methodology/Approch: We employ one of the largest and extensive datasets to-date on CG, IG
and EM in any developing country, consisting of a sample of 116 unique Omani listed corporations from
2001 to 2011 (i.e.,1,152 firm-year observations) and a broad CG index containing 72 CG provisions. We
also employ a number of robust econometric models that sufficiently account for alternative CG/EM
proxies and potential endogeneities.
Findings: First, we find that, on average, better-governed corporations tend to engage significantly less in
EM than their poorly-governed counterparts. Second, our evidence suggests that corporations that depict
greater commitment towards incorporating Islamic religious beliefs and values into their operations
through the establishment of an IG committee tend to engage significantly less in EM than their
counterparts without such a committee. Finally and by contrast, we do not find any evidence that board
size, audit firm size, the presence of a CG committee and board gender diversity have any significant
relationship with the extent of EM.
Originality: To the best of our knowledge, this is a first empirical attempt at examining the extent to
which CG and IG structures may drive EM practices that explicitly seeks to draw new insights from a
behavioural theoretical framework (i.e., behavioural theory of corporate boards and governance).
Keywords: Corporate governance, Islamic governance, earnings management, behavioural theory,
endogeneity, Oman.
Paper type: Research paper
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1. Introduction
In this paper, we seek to contribute to the extant corporate governance (CG) and earnings
management (EM) literature by distinctively examining how and why a firm’s CG and Islamic governance
(IG) mechanisms may influence its EM practices. Specifically, we investigate the extent to which a broad
composite CG index, IG committee and other CG variables can explain observable changes in firm-level
EM in Oman.
Although a number of previous studies have examined the association between CG and corporate EM
practices (Chung et al., 2002; Klein, 2002; Xie et al., 2003; Chen & Zhang, 2012; Leventis &
Dimitropoulos, 2012; Anglin et al., 2013; Albu & Girbin, 2015), a careful evaluation of this literature
reveals a number of weaknesses. First, despite increasing evidence that CG mechanisms underpinned by
agency driven rational/opportunistic economic motives and formal structures alone may not be able to
fully explain underlying managerial motivations for engaging in EM (Daily et al., 2003; Hambrick et al.,
2008) and thus new theoretical perspectives, such as behavioural theory, may need to be considered
(Gabrielsson & Huse, 2004; van Ees et al., 2009; Huse et al., 2011), existing studies are still overhemingly
informed by the ubiquitous agency theoretical perspective (Davidson et al., 2005; Mitra & Cready, 2005;
Lin et al., 2006; Rahman & Ali, 2006; Jaggi & Tsui, 2007; Jiraporn & Gleason, 2007).
Second, Judge (2010) shows that the extent to which formal and informal CG structures/rules are
used differ around the world. For example, equity markets tend to be the main CG mechanisms in Anglo-
Saxon economies (e.g., UK and US) compared with concentrated ownership structures in Continental
European (e.g., German and Italy), African (e.g., South Africa and Nigeria) and Asian (e.g., Malaysia and
Singapore) economies. Similarly, CG structures in Scandinavian economies (e.g., Norway and Sweden)
are dominated by social norms rooted in egalitarianism/utopianism cormpared with Shariah law in Isamic
(e.g., Oman and Saudi Arabia) countries. In transition economies (e.g., China and Russia), however, the
primary CG mechanism is often the state/informal networks, whilst in other countries (e.g., India, South
Korea and Japan), business groups tend to be the main CG mechanism. Despite these differences in CG
arrangements around the world, existing studies have focused disproportionately on evaluating the effect
of Anglo-American CG mechanisms on EM to the neglect of the others (Epps & Ismail, 2009; Ghosh et
al., 2010; Lo et al., 2010; Bekiris & Doukakis, 2011; Alves, 2012), and thereby arguably impairing current
understanding of the impact of CG on EM in different economies.
Third, although a number of studies have investigated the link between CG and EM (Schipper, 1989;
Healy & Wahlen, 1999; McNichols, 2000; Bowen et al., 2008; Jiang et al., 2008), they are observably
concentrated in a few developed countries, such as UK and US, which tend to have largely similar CG,
economic, legal and institutional contexts (Chia et al., 2007; Francis & Wang, 2008; Krishnan & Parsons,
2008; Gavious et al., 2012). However, it can be argued that in developing countries, such as Oman with
different CG, economic and legal environment, the extent to which formal CG mechanisms are able to
restrain managerial ability to engage in EM may differ, and thus the association between CG and EM can
be expected to vary from the findings of prior studies that were conducted in developed countries. In
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particular, behavioural theory suggests that managerial/corporate board decision-making may not only be
influenced by their expertise, knowledge and skills, but also their experiences, beliefs and values
(Gabrielsson & Huse, 2004; van Ees et al., 2009; Huse et al., 2011).
Indeed, there is an emerging behavioural literature, which shows that individual/corporate
religious/cultural beliefs can affect their: (i) decision-making (Hilary & Hui, 2009) and risk-taking
behaviour (Bartke & Schwarze, 2008); (ii) corporate social responsibility (CSR) (Brammer et al., 2007),
equity-pricing (El Ghoul et al., 2012), social norms, cohesion and CG (Boytsun et al., 2011) and corrupt
(Mensah 2014) practices; (iii) willingness to engage in tunnelling/expropriate shareholders’ wealth (Du,
2013, 2014), evade tax/commit tax fraud (Stack 2006; Richardson 2008), financial reporting irregularities
(Dyreng et al., 2012; McGuire et al., 2012), philanthropy (Du et al., 2014) and EM (Callen et al., 2011; Du
et al., 2015; Kanagaretnam et al., 2015). A major issue, however, is that these studies have mainly been
conducted within the Judo-Christian contexts to the neglect of others, such as Buddhism, Hinduism, Islam
and Sikhism. In the case of Islam, although there are extensive normative/critical reviews relating to the
distinctiveness of IG srtuctures (Lewis, 2005; Archer et al., 1998; Rahman, 1998; Choudhury & Hoque,
2006; Kamla et al., 2006; Abu-Tapanjeh, 2009; Williams & Zinkin, 2010), empirical evidence on how
such IG mechanisms may drive corporate outcomes and practices, such as disclosure, performance, CSR,
risk-taking and EM are rare (Safieddine, 2009; Farook et al., 2011; Rahman & Bukair, 2013; Ginena,
2014; Mollah & Zaman, 2015; Al-Bassam & Ntim, 2016). This also impairs current understanding of how
IG mechanisms may impact on EM practices.
Consequently, this paper seeks to contribute to the existing literature by addressing some of the
articulated limitations of prior studies. First, we offer new empirical insights on the CG-EM nexus by
grounding our study in the emerging behavioural theory of corporate boards and governance, in which
corporate decision-making is not only assumed to be underlined by formal incentives and CG
mechanisms, but also informal CG arrangements, bounded rationality, political bargaining, routinisation
and satisficing behaviour (van Ees et al., 2009; Huse et al., 2011). In this case, we distinctively depart
from the dominant agency theoretical framework that is underpinned mainly by formal CG structures,
rational economic motives, managerial opportunism and optimising behaviour.
Second, existing studies have mostly examined how individual CG mechanisms (e.g., board size
and independent directors) can affect corporate EM practices. However, recent evidence suggests that CG
structures tend to interrelate (i.e., CG structures are used in bundles) in order to be effective (Ntim et al.,
2015a, b), and therefore examining direct associations between individual CG structures and EM may lead
to spurious correlations. We overcome this limitation by investigating the relationship between a
comprehensive CG index containing 72 distinct governance privisions and EM in addition to individual
CG mechanisms that have been used in prior studies. Third, drawing from behavioural theory, we
conjecture that in a predominantly Islamic context, such as Oman, corporate/managerial engagement in
EM may not only be influenced by formal CG arrangements, expertise and skills, but also by their
informal Islamic religious experiences, beliefs and values. We test this by examining the extent to which
the presence of a Shariah supervisory board/committee, as a unique IG mechanism, drives corporate EM
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practices. To the best of our knowledge, this is a first direct attempt at providing empirical evidence on
how and why IG mechanisms may influence corporate EM practices. Oman offers an interesting research
context to test these propositions for a number of reasons. First, in response to the 1997 Asian financial
crisis and international corporate developments, Oman was the first country in the Middle East and North
Africa (MENA) region to pursue CG reforms in the form of the UK-style 2002 voluntary CG Code issued
by the Capital Market Authority (CMA). Similarly, Oman is one of the few countries in the MENA
region, which has fully adopted international accounting and auditing standards for its listed firms. This,
thus, places Oman at the forefront when it comes to CG, accounting and auditing reforms in the MENA
region. The central objective of these reforms has been to restore investor confidence, enhance financial
reporting quality and protect stakeholders’ interests by improving board independence, accountability,
disclosure, transparency and responsibility among Omani listed firms.
Second, distinct from most developed countries, but similar to other MENA countries, the Omani
corporate context has a number of unique features. First, Omani corporate context is characterised by: (i)
hierarchical social structures; (ii) greater reliance on informal rules and relationships (e.g., loyalty and
trust based on kingship, nepotism and tribalism) rather than formal CG structures (e.g., boards and audit
committee); (iii) increased commitment to Islamic religious beliefs and values. As previously noted and
from a behavioural theoretical perspective, greater commitment to Islamic religious values is important
because previous studies suggest that Judo-Christian religious beliefs and values can impact on serveral
corporate practices, including EM (Bartke & Schwarze, 2008; Richardson, 2008; Hilary & Hui, 2009;
Callen et al., 2011; McGuire et al., 2012). A major way by which Islamic religious beliefs and values can
be incorporated into corporate operations and decision-making is through the establishment and operation
of the Shariah supervisory board (Mollah & Zaman, 2015), whose central role is to certify whether
corporate investments are Shariah compliant. Third and similar to most developing countries, Omani firms
are
characterised by high levels of concentrated ownership, primarily by families and government
(Najib,
2007; Omran et al., 2008; Bishara, 2011). This is important because concentrated ownership structures
can render the markets for corporate control, capital, services, executive talent and labour meant to
discipline underperforming managers and corporations ineffective (Shleifer and Vishny, 1997; Jaggi and
Tsui, 2007; Alves, 2012; Chen and Zhang, 2012), and thereby often leading to managerial entrenchment.
Whilst these contextual issues are interesting, they also raise the question of whether a UK-style voluntary
CG Code can be effective in improving CG standards and performance, including reducing EM. We, thus,
examine the extent to which CG and IG mechanisms may drive corporate EM practices in Oman.
The remainder of the paper is organised as follows. The next section provides an overview of the
institutional framework for Oman. The subsequent sections present the theoretical literature, review past
empirical studies and develop hypotheses, present data and research methodology and report the empirical
findings and discussion, whilst the final section summarises and concludes the paper.
2. Institutional framework for Oman
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