Foreign directors and corporate governance in Islamic banks

Abstract

Purpose The purpose of this paper is to examine whether foreign directors’ influence on opportunistic behavior among managers varies between Islamic banks (IBs) and conventional banks (CBs). It also examines how religious ethics and morals guide foreign directors to be better monitors. Design/methodology/approach A panel fixed effects regression is used to analyze the effect of foreign directors on opportunistic behavior among managers in IBs and CBs. The authors use different proxies such as loss avoidance, discretionary loan loss provision and expense preference behavior to measure management opportunistic behavior. Findings Based on sample of 3,758 bank-year observations for 164 banks over the period 1993-2015, the authors show that the presence of foreign directors in IBs increases boards’ effectiveness in impeding management opportunistic behavior, whereas the presence of foreign directors in CBs reduces boards’ effectiveness in curbing management’s unethical acts. The authors also document that IBs (CBs) with foreign directors demonstrate less (more) earnings management and expense-preference behavior among managers. In addition, the authors’ evidence indicates that the existence of the Shari’ah supervisory boards helps foreign directors be more effective monitors. Research limitations/implications The current study focuses on banks only which makes its results subject to sample bias; there are many other forms of financial institutions (e.g. investments, real-estates and mutual funds) complying to the Shari’ah law. Second, owing to the lack of foreign board directors characteristics, the authors cannot investigate the intensity of the specific characteristics that could have specific directions in affecting managerial behavior. Practical implications The findings in this paper may help standards-setters, auditors, investors and regulators take appropriate measures and create better policies that reduce managers’ discretion. This could in turn improve information transparency decision-making, monitoring, advising and accounting quality. Originality/value The authors’ theoretical framework combines the agency, contingency, resource-dependence, stewardship and stakeholders’ theories and applies them to Shari’ah as an alternative ethical and internal governance mechanism. The authors find that the impact of foreign directors on management opportunistic behavior depends on the corporate religious norms within boards of directors, in particular, suggesting that religious values affect how foreign directors influence bank managers’ behavior.

Financial soundness of Islamic banks: does the structure of the board of directors matter?

“…This finding implies that the proportion of foreign directors does not affect the financial soundness of Islamic banks. This result contradicts the agency theory and suggestions of previous research (Daly and Frikha, 2015; Ramly et al , 2018; Mansoor et al , 2019; Almutairi and Quttainah, 2020). A possible explanation that may justify this finding is that the governance standards (AAOIFI and IFSB) do not impose requirements on the presence of foreign directors and remain silent.…”

“…In this regard, directors must ensure compliance with Shari’ah rules and verify that the Shari’ah corporate governance framework is compatible with the size and the nature of activities of the banks (IFSB, 2006; AAOIFI, 2010; BNM, 2010). Hakimi et al (2018) and Almutairi and Quttainah (2020) say that the Board of Directors’ effectiveness depends on its composition, which can affect the corporate governance of Islamic banks. That’s why this study aims to empirically diagnose the impact of the Board of Directors’ characteristics on the financial soundness of Islamic banks.…”

The impact of the board of directors and the Shariah board on the financial soundness of Islamic banks

“…Almutairi and Quttainah (2017) conducted a study on a sample of 100 IBs from 1993 to 2014 and found that the number of outside directors on a SB is positively correlated with the IB's performance. Almutairi and Quttainah (2020) add that the SB works with the director during its meetings to improve positive managerial behavior. Ramly et al (2018) assert that together, the SB and the director prevent managers from taking excessive risks, thereby improving financial soundness.…”

“…As a result, Islamic financial institutions (IFIs) are subject to a dual governance structure with both the SB and the board of directors (BODs), which makes their governance framework more powerful than that of conventional financial institutions (Alam et al, 2020). Almutairi and Quttainah (2020) add that the SB approves banking transactions and services, whereas the BOD is responsible for the overall corporate governance. Thus, the BOD and the SB enhance the credibility and confidence level of stakeholders.…”

“…Almutairi and Quttainah (2017) add that the SB and the BOD complement each other and share responsibilities in corporate governance. As a result, IFIs are effectively controlled by both the BOD and the SB to ensure their compliance with the Shariah, reduce Shariah risk and improve their financial soundness (Almutairi and Quttainah, 2020). Therefore, the two governing bodies need to cooperate and collaborate.…”