The quality of earnings in Shariah-compliant companies: evidence from Malaysia

Abstract

Purpose – The purpose of this study is to examine the quality of reported earnings in the corporate reports of Shariah-compliant companies listed on Bursa Malaysia. Design/methodology/approach – This study hypothesises that companies with Shariah compliance status have higher quality of earnings because of greater demand for and supply of high-quality financial reports. The quality of reported earnings is measured using the cross-sectional Dechow and Dichev (2002) accrual quality model. The study uses a balanced panel data of 3,048 observations from 508 companies during a six-year period of 2003-2008. Findings – This paper finds robust evidence that Shariah-compliant companies have significantly higher earnings quality compared to other firms. The results provide support for the arguments that Shariah-compliant companies supply a higher quality of reported earnings to attract foreign investment, have greater demand for high-quality financial reporting because of their Shariah status and are subject to greater scrutiny by regulators and institutional investors. Research limitations/implications – This study contributes to the existing literature on Islamic capital market, business ethics, firms’ governance and financial reporting quality. The study would give a better understanding on issues relating to earnings quality of Shariah-compliant companies and would be especially useful for financial statement users, including investment analysts. Originality/value – This paper provides evidence on the quality of earnings in Shariah-compliant companies and offers new arguments that explain why such companies possess higher quality of earnings compared to their counterparts.

Sustainability of Leverage Levels in Response to Shocks in Equity Prices: Islamic Finance as a Socially Responsible Investment

“…Columns 2 and 3 provide an interesting observation, i.e., that non-compliant firms tend to record a greater level of reduction relative to their compliant counterparts. The findings also suggest that compliant firms tend to be more sustainable in nature, as these firms tend to have a higher degree of earnings quality [48], and hence, are less susceptible to shocks in equity values, as evidenced by significantly lower levels of reduction in book leverage ratios. Thus, non-compliant firms are more focused on redeeming debt instruments to lower the book debt ratio.…”

Do Shariah-compliant Companies Engage Lesser Earnings Management Behaviour?

“…Such companies are expected to adhere to Islamic or Shariah values which are favoured by the society. Shariah-compliant companies are thus subjected to greater scrutiny by regulators and other stakeholders (Wan Ismail et al, 2015). Taking this as a possible way to gauge companies, this study aims to examine the effect a company's reputation may have in influencing the management into engaging with earnings management practices.…”

“…Ibrahim et al (2015), for example, found that companies offering Islamic products and services tend to practise sustainability reporting, which are also less involved in earnings management behaviour. Based on the robust evidence, Wan Ismail, Kamarudin and Sarman (2015) noted that Shariah-compliant companies have significantly higher earnings quality. Nonetheless, there are studies which claim that companies that are significantly influenced by religion, specifically Islam, also performed unethical conducts including earnings management behaviour (e.g., Dyreng, Mayew, & Williams, 2012;Alkdai & Hanefah, 2012;Hamdi & Zarai, 2012;Farooq & AbdelBari, 2015;Alsaadi, Ebrahim, & Jaafar, 2017).…”

“…A study conducted by Wan Ismail et al (2015) examined the practices of 508 Malaysian companies before the 2008 financial crisis and found that Shariah-compliant companies have high earnings quality. According to Wan Ismail et al (2015), Shariah-compliant companies have the tendency to report high earnings quality because they are subjected to greater scrutiny from their regulators. In other words, these companies have the duty of maintaining their reputation which promotes and practices Islamic ethical values.…”

Financial Risk Ratios and Earnings Management: Reducing Uncertainties in Shariah-compliant Companies

“…This journal is a member of and subscribes to the principles of the Committee on Publication Ethics (COPE) (Mohamed Adil & Mohd-Sanusi, 2013;Wan Ismail, Kamarudin, & Sarman, 2015).…”