How do Islamic banks manage earnings? Application of various measurement models in the Iranian Islamic banking system

Abstract

PurposeThis study aimed to identify and compare the measurement models of earnings management (EM) appropriate to the Iranian Islamic banking system. The importance of reported profit figures has motivated business executives, who also perform financial reporting, to manipulate these figures. These measures are referred to as “earnings management,” which negatively influence the quality of reported earnings and financial statements' reliability. The number of resources available to banks and their specific operational sensitivities doubles the importance of EM in this industry.Design/methodology/approachIn this study, four methods, namely, Jones (1991), modified Jones (Dechow et al., 1995), Kasznik (1999) and Kothari et al. (2005), were used to measure the EM index in 25 Iranian Islamic banks (IBs) registered with the Tehran Stock Exchange and/or the Central Bank of Iran. The study covered the period 2005–2020. Following the aforementioned methods, this research implemented templates that were repeatedly tested in subsequent studies using accruals to discover EM.FindingsThe results show that the Kasznik (1999) model is the preferred and compatible model with the Iranian Islamic banking system's accrual behaviour due to the consistency of the measurement coefficients with theoretical and previous research findings. Therefore, total accruals, including discretionary accruals and non-discretionary accruals, have the most correspondence with (1) property, machinery and equipment; (2) the change in cash flow from operating activities; and (3) the difference of change in revenue (ΔREV) and change in net receivable accounts (ΔREC).Originality/valueThis is the first investigation in the Iranian Islamic banking system. The research contributes to the Iranian Islamic banking system literature on the implements of EM, which could be appealed to in the context of developing countries like Iran. Finally, this study highlights the different EM capabilities in Islamic banking systems similar to the Iranian banking arrangement.

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“…The methodology employed in this research, as detailed below, aligns with the prevalent approach for studies of this nature. Initially, accrual earnings management was calculated using the Dechow method (de Souza et al, 2022;Elshafie, 2023;Ghaemi Asl & Ghasemi Doudkanlou, 2022;Lassoued & Khanchel, 2021;Marais et al, 2023). Subsequently, panel data regression analysis was applied (da Silva Flores et al, 2023;Pinheiro de Sá et al, 2021;Sundkvist & Stenheim, 2022;Tran et al, 2023).…”

“…This method primarily focuses on revenue recognition, making it suitable for identifying earnings management practices aimed at manipulating earnings in order to show higher profits or lower losses. In addition, Dechow's method is widely accepted by the scientific community (Elshafie, 2023;Ghaemi Asl & Ghasemi Doudkanlou, 2022;Marais et al, 2023).…”