Compliance and Determinants of the AAOIFI Financial Standards: Evidence From the MENA Region

Transcription

1. COMPLIANCE AND DETERMINANTS OF THE AAOIFI FINANCIAL STANDARDS : EVIDENCE FROM THE MENA REGION Oumayma Bechihi1*, Salem Lotfi Boumediene2 and Olfa Nafti3 2 1 ISCAE, University of Manouba, Tunisia. CBM, University of Illinois Springfield, USA. 3 ISCAE, University of Manouba, Tunisia. ABSTRACT This paper analyses the level of compliance of financial disclosure with accounting standards of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and its determinants in Middle Eastern and North African (MENA) Islamic banks. Based on 40 Islamic banks in seven MENA countries over the period 2010-2016, the authors used a disclosure index to measure the compliance level and the effect of governance characteristics and the Sharia Board on the extent of compliance with the AAOIFI accounting standards. Results show a high level of compliance (67%). Using the Feasible General Least Square Regression, we found that the presence of women on the board of directors, the reputation of the Sharia Board, and the cross membership of Sharia Board members are key determinants of compliance. While independence of board of directors is significantly associated to reduced financial disclosure. The research contributes to the literature on accounting and the Islamic banking sector. These findings will be useful for regulatory authorities to better- understand the accounting disclosure practices of Islamic banks. Although findings are encouraging, the sample is limited only to banks. Future researches could deal with a larger sample and review other disclosure items to ensure compliance with the AAOIFI standards. Few empirical studies have explored the determinants of compliance with the AAOIFI standards for Islamic banks in MENA countries. Therefore, this work complements and enriches the research in the field in the MENA region. Keywords: financial disclosure, AAOIFI compliance, Islamic banks, governance characteristics, Sharia board ARTICLE INFO Article History: Received: 4 February 2021 Accepted: 16 March 2021 Published: 30 April 2021 ♣ Corresponding Author: Oumayma Bechihi. E-mail: bechihioumaima@yahoo.fr
2. Asia-Pacific Management Accounting Journal , Volume 16 Issue 1 INTRODUCTION Islamic banks, in their emergence as financial institutions are different from conventional banks, and have experienced rapid development and significant growth in numbers and turnover in recent years. Islamic banks are widespread and universally accepted and are becoming the destination of non-Muslim customers. Sufian (2010) and Zaini (2007) argue that the development of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) standards was preceded by the adoption of local or the International Financial Reporting Standards (IFRS) standards by Islamic financial institutions in the preparation of their financial reports and are, therefore, faced with problems in applying standards that are not adapted to their Sharia principles. In this sense, Abdul Rahman and Bukair (2013) gave the example of the prohibition of interest (Riba), one of the important principles of Islamic law. The AAOIFI standards, although not exhaustive, are considered the appropriate standards to overcome this inadequacy. For its part, the AAOIFI and its universal network have succeeded in convincing regulatory authorities to adopt its standards on a mandatory or voluntary basis in some regions of the world, fully, partially, or as guidance (Sarea & Haneefa, 2013). Furthermore, to maintain the trust and loyalty of their clients, Islamic banks must disclose transparent financial information, which complies with Sharia rules. Several studies such as those of El-Halaby et al. (2018); Grassa et al. (2019); El-Halaby and Hussainey (2016); El-Halaby (2015); Ahmed and Khatun (2013); Vinnicombe (2012); and Farook et al. (2011) have studied disclosure in Islamic banks and have attempted to measure the level of compliance by these banks with the rules of Sharia and its various determinants. Nevertheless, the compliance of Islamic banks in these studies is measured according to Sharia standards only, and limited research has addressed the level of compliance with the AAOIFI financial standards. Through results arising from our study, we intend to bring empirical proofs/insights into compliance of Islamic banks in the MENA region within the AAOIFI financial accounting standards. The closest to this research focuses either on a single country (Vinnicombe, 2012; Sarea, 2012; Nadzri, 208
3. Compliance and Determinants of the AAOIFI Financial Standards 2006 ), a single year (El-Halaby & Hussainey, 2016), a single bank or a limited number of banks (Al Sulaiti et al., 2018). This study aims to address this shortcoming by examining the characteristics of financial reporting as an index for most Islamic banks in the MENA countries. According to González et al. (2017), the majority of Islamic financial institutions around the world are located in the MENA region. Hence, the Islamic banking sector in this area has now become an important part of the development of their economies and is also growing in the financial landscape of the regions as well as in the countries. It is also a growing activity, as it meets people’s financial needs without conflicting with their social and religious values (Anagnostopoulos et al., 2020). A number of papers reviewed factors influencing financial information disclosure (Farook et al., 2011; Mallin et al., 2014). The closest studies either limited their analyses to social disclosure (Haniffa & Hudaib, 2007) or missed most of the corporate governance factors particularly related to the Sharia Supervisory Board (Ajili & Bouri, 2017). The purpose of our research was to address the gap in the literature through the examination of the incidence of several governance features related to the Directors and Supervisory Board of the Sharia and other firm characteristics. The foregoing analyses would determine whether financial information is derived from these factors and explore the effect of the Board of Directors and the Supervisory Board of Sharia as governance mechanisms in Islamic banks. Through that research, we will address issues related to two main components of disclosure literature: the measurement of disclosure and the exploration of its determinants. The new insight would be useful to policymakers in increasing the level of disclosure in Islamic banks. Indeed, compared to the AAOIFI compliance studies, our paper presents four contributions. First of all, we introduce new variables such as the presence of women on the board of directors and joint audit. Second, we covered more banks comparing to other studies like Ullah (2013) (7 banks), Hassan et al. (2012) (13 banks), Al Sulaiti et al. (2018) (24 banks), Ajili and Bouri (2017) (39 banks), while this research constitutes a sample of 40 banks. Third, we cover more recent years (from 2010 to 2016), while other researches are focused on earlier periods such as Ajili and Bouri 209
4. Asia-Pacific Management Accounting Journal , Volume 16 Issue 1 (2017) (from 2010 to 2014), Al-Sulaiti et al. (2018) (from 2012 to 2015), and El-Halaby and Hussainey (2016) (only 2013). Those research did not find a positive association between the compliance level and presence of women on the board of directors (Allini et al., 2014). We are providing evidence regarding the impact of corporate governance characteristics and Sharia board members on the AAOIFI compliance level. Besides, this study covers Islamic banks located in the MENA region, while previous studies focused on a single country (Vinnicombe, 2012). The current study varies considerably with preceding research exploring disclosure drivers that contain firm attributes, the mechanism of corporate governance as well as Sharia supervisory board characteristics. The research design contained five governance variables such as board size, its independence, and presence of women as members. Two variables were related to the Sharia Supervisory Board, which are board reputation as well as cross-membership, and four firm characteristics as control variables which are financial performance, adopted standards, audit quality, and joint audit, to see to what degree it affects disclosure levels. Previous researchers covered a limited range of features (Ajili & Bouri, 2017; Vinnicombe, 2012). Therefore, our study analyses the compliance level to the AAOIFI standards and financial disclosure in Islamic banks and its determinants. The aims of our research can be summarized as follows: 1. 2. Measure the level of financial disclosure. Determine to what extent the level of financial disclosure is related to governance characteristics, and Sharia supervisory boards. The paper is structured as follows. The first section presents the introduction. While the second section shows the literature review as well as develops our hypothesis. Section 3 presents the methodology adopted for this work and data collection. Section 4 outlines the descriptive analysis. Section 5 presents and discusses the main findings. The last section presents the main conclusions. 210
5. Compliance and Determinants of the AAOIFI Financial Standards LITERATURE REVIEW Corporate Governance of Islamic Banks Corporate governance in Islamic banks has not been well defined in previous research studies . However, Standard 3 of the IFSB gives the following definition: “a set of relationships between a company’s management, its board of directors, its shareholders and other stakeholders which provide the structure through which: the objectives of the company are set; and the means of attaining those objectives and monitoring performance are determined” (IFSB, 2006). According to Grassa and Matoussi (2014), Islamic banking governance practices are different from those of conventional banks as they have investment accounts that make their system of governance more complicated. Hence, Islamic banks have to conduct their activities based on Sharia law. Consequently, the risk of non-compliance with Sharia rules can cause considerable financial difficulties (Claessens, 2006). The IFSB 3 supposes that effective corporate governance in the Islamic banking industry requires a system of organizational mechanisms to ensure that the actions of management are aligned with the interests of stakeholders. Thus, the establishment of incentives for the board of directors and the Sharia Board is relevant to reach the targets that are in the stakeholders’ interest in order to enhance their effective accountability, therefore strengthening the incentives for Islamic banks to allocate their resources more efficiently and hence to comply with Islamic Sharia rules and standards (IFSB, 2006). Examining Sharia practices and the system of Sharia governance in Islamic banks in different countries confirms existence of important divergences and various practices of Sharia across those banks, recognizing in current governance practices in Islamic banking and that it still needs to be improved to meet the specific standards of these institutions (Hasan, 2011). Similarly, Mollah and Karim (2011) argue that the corporate governance system that Islamic banks adopt, offers better vulnerability to financial crises compared to other institutions. 211
6. Asia-Pacific Management Accounting Journal , Volume 16 Issue 1 Financial Disclosure and AAOIFI Standards’ Compliance The AAOIFI was established in Bahrain in 1991 as an international nonprofit organization. Its main responsibility is the development and publication of standards related to the Islamic finance sector. It issued 111 standards in areas of Sharia, accounting, auditing, ethics and governance in global Islamic finance of which 34 Financial Accounting Standards, 6 auditing standards, 57 Sharia standards, 12 governance standards and 2 codes of ethics standards. It is committed to the standardization and harmonization of International Islamic Financial Practices and Shariacompliant financial reporting AAOIFI (2020)1. According to the AAOIFI (2020)1, AAOIFI standards are established to orient the Islamic financial market on the Sharia guidelines supporting the industry’s growth. A number of institutional members such as central banks and regulatory authorities, financial institutions, audit and law firms, from more than 45 countries around the world support the AAOIFI. These standards as adopted by leading Islamic financial institutions worldwide have brought gradual levels in international standardization of the Islamic financing practices. In the first Standard relative to the presentation and disclosure of financial statements of Islamic financial institutions, Islamic banks’ annual reports contain basic information followed by 7 financial statements and other various information (AAOIFI, 2020). In this context, we define compliance by “the degree to which Islamic banks comply with the multitude of issues in the accounting and governance standards issued by the AAOIFI” (AAOIFI, 2020). Ehsan et al. (2019) studied voluntary financial disclosure as suggested by the AAOIFI and compliance in Pakistani Islamic banks and found a level of compliance of more than 50%. El-Halaby et al. (2018) analyzed 117 Islamic banks in 2016 covering 23 countries and used three indexes: one for Corporate Social Responsibility Report, one for Sharia Supervisory Board report and one for the financial statements. Their results show a positive and meaningful relationship between disclosure levels and the Sharia audit department and bank size. 212
7. Compliance and Determinants of the AAOIFI Financial Standards Al Sulaiti et al . (2018) measured compliance using disclosure indices, which included three financial accounting standards: Murabaha, Mudaraba and Musharaka. Data was collected using annual reports of 24 Islamic banks in Bahrain and Qatar covering the years 2012-2015, and they concluded that studied sample is compliant with the AAOIFI related to these standards and the degree of compliance has improved during this period. The Murabaha Standard and Islamic banks in Qatar had the highest mean of compliance so far. They suggest that “in respect of the Murabaha, the more this product is used, the less unstable it is in complying with Islamic banks”. Ajili and Bouri (2017) investigated 39 Islamic banks in GCC countries between 2010 and 2014. They measured and compared compliance level requirements of disclosure set by the AAOIFI and the IFRS and factors related thereto. They reported a higher level of compliance with the IFRS than with then AAOIFI. Moreover, bank age and size are key determinants of compliance as well. Ahmed and Khatun (2013) examined compliance levels of 17 Islamic banks in Bangladesh with the AAOIFI Sharia governance system for understanding the status of Sharia compliance with risk management. The results revealed that none of the Bangladeshi Islamic banks fully complied with the AAOIFI Sharia system of governance as there was no audit committee in the board of directors for any of the banks in the country. Ullah (2013) analyzed 7 Islamic banks’ annual reports in Bangladesh. Results show a compliance level equal to 44.68%. However, the compliance study on Libyan banks “Gumhouria” conducted by Ahmad and Daw (2015) showed a low level of compliance and this low rate is due to multiple reasons namely the lack of training and knowledge of the AAOIFI standards. In another study, Haniffa and Hudaib (2004) analyzed different Islamic financial institutions in the GCC. They found that only Bahraini Islamic banks adopted and applied the AAOIFI in the preparation of their financial statements. Nevertheless, there were missing disclosures. Along the same lines, Al-Abdulatif (2007), through a questionnaire on relationships between external audit and employees of Saudi Arabia’s Islamic banks, argued that there was less than expected opinions on the adoption of the AAOIFI accounting standards. 213
8. Asia-Pacific Management Accounting Journal , Volume 16 Issue 1 Nadzri (2006) analyzed annual reports from some Islamic financial institutions around the world, and the results indicate that disclosure in these banks did not meet the requirements of the AAOIFI standards. Also, Sarea (2012) whose study was based on a questionnaire addressed to accountants in Bahraini Islamic banks, showed that 85% of accountants claimed a high level of compliance, 10% claimed the opposite and 5% agreed with an average level of compliance. Mallin et al. (2014) analyzed various information on the social responsibility of 90 Islamic banks across 13 countries. Results show that the board of directors and the Sharia Board are positively associated with disclosure levels. In the same vein, Vinnicombe (2012) conducted a content analysis of Islamic banks in Baharin and found that compliance was higher in some banks than others. The study by Sarea and Haniffa (2013) showed that Islamic banks face challenges in preparing financial statements to different standards, resulting in puzzles about measuring the level of compliance and reliability. In addition, the obligation to adopt the AAOIFI standards throughout the Islamic world is recommended. Shatnawi and Al-bataineh (2013) found that the Sharia Supervisory Board checks the financial reporting of Islamic banks regularly and reports any non-compliance with the AAOIFI standards to show the extent to which these banks are compliant with the AAOIFI. In order to evaluate the compliance level with the guidelines of general presentation and disclosure of the AAOIFI, this study investigated whether Islamic banks in the MENA region disclose their financial information following the requirements of the AAOIFI accounting standards. Determinants of Financial Disclosure: Research Hypotheses Development We used the Agency Theory and the Signal Theory to determine the factors that could potentially contribute to the compliance with the AAOIFI standards. Safieddine (2009) predicted that agency problems in conventional banks arise when managers stop maximizing shareholder wealth, any discrepancy between Islamic bank managers to invest all funds provided in Sharia compliant investments creates further agency conflicts. This research is based on the Agency Theory for determining compliance factors of Islamic banks with the AAOIFI standards. Haniffa and Cooke (2005) 214
9. Compliance and Determinants of the AAOIFI Financial Standards argued that the Signal Theory is used to deal with managers ’ incentives to disclose more information in financial reports. In fact, managers need to disclose adequate information in financial statements to communicate positive signals to potential users. As far as our research is concerned, this theory helps to address the incentives of Islamic bank managers to improve their Sharia and financial reporting in order to send positive signals to different users. Indeed, accurate and relevant signals that Islamic banks emit, explain to the different stakeholders the levels of disclosure of information and their compliance with the AAOIFI standards. Characteristics Related to Governance in banks Size of the board of directors The size of the board of directors is seen to be a key determinant affecting efficiency. According to the Agency Theory, the characteristics of a boards of directors regarding their composition and diversity may affect their ability to accomplish their responsibilities and large boards are conducive to better control (Fama & Jensen, 1983). Previously, Fama (1980) argued that the board of directors is seen as the core control mechanism for managers. Recently, Grassa et al. (2019) analyzed the content of 78 annual reports of Islamic banks operating in 11 countries between 2004 and 2012 to identify the impact of the governance of banks on the disclosure of Islamic banking products and services. The result indicated a positive association between the size of the board of directors and the information disclosed about Islamic banking products and services. Hashim et al. (2015) reviewed 82 annual reports from Islamic banks in the Gulf Council Cooperation (GCC) and Non-GCC countries. The objective of the research was to identify the home country’s role in the relationship between corporate governance and disclosure in Islamic financial institutions. The authors noted a positive effect of size, meaning the bigger the board of Islamic banks the stronger it becomes and should inevitably influence the organization’s actions and the number of sustainability practices. Neifar and Jarboui (2018) found that the size of the board has a significant effect on the information disclosed, which implies that their 215
10. Asia-Pacific Management Accounting Journal , Volume 16 Issue 1 members provide high-quality decisions, thus, influencing corporate reports. Along the same line, Al-Bassam et al. (2018) studied governance disclosure in Saudi publicly listed companies and found that banks with extensive boards, disclose more significantly than others. However, Bukair and Abdul Rahman (2015) analyzed whether board characteristics affect corporate social responsibility disclosure in GCC Islamic banks and argued that the size of the board does not affect the level of disclosure. They ensure that disclosure is not guided by the bank’s governance structure. Hence our hypothesis: H1: There is an association between board size and the level of financial disclosure The independence of the board Fama (1980) claimed that a board of directors, which is elected by the shareholders, is their central mechanism of control to supervise managers. Abraham and Cox (2007) predict that independent directors are considered as a tool of effective corporate governance and that they act in a timely and efficient manner to reduce agency problems. Patelli and Prencipe (2007) considered that independent directors try to report on their activities credibly so as to keep them reputable in order to assume their responsibilities. Peasnell et al. (2005) argued that the independence of board members improves the quality of financial statements. Grassa and Chakroun (2016) studied the effects of ownership structure and board characteristics on corporate governance disclosure for Islamic banks operating in the Gulf Cooperation Council (GCC) countries from 2006-2011. They found an important level of disclosure to be significantly associated with the independence of the board of directors. The same results were found by Neifar and Jarboui (2018). Wan Abdullah et al. (2015) investigated the drivers behind voluntary corporate governance disclosure in 67 Islamic banks in the South-east Asian and GCC countries in 2009. Their findings undoubtedly proved that the association with the independence of the board of directors is positive as well as significant. While, Grassa et al. (2019) found a negative relationship between the independence of the board of directors and the disclosure of Sharia and corporate social responsibility and financial information of Islamic banks. So, we proposed the following hypothesis: 216
11. Compliance and Determinants of the AAOIFI Financial Standards H2 : There is an association between board independence and financial disclosure level. The duality of the CEO Jensen and Meckling (1976) predicted that the dual role creates individual power for a chief executive officer (CEO) that affects the control exercised by the board. Fama and Jensen (1983) argue that the duality of the CEO creates conflicts of interest. From another angle, Donaldson and Davis (1991) found that companies where the entrepreneur exercises duality can improve shareholder wealth as well as financial performance. Cheng and Courtenay (2006) found no significant correlation between CEO duality and disclosure. Laksmana (2008) also explored the effect of certain governance characteristics (board of directors and compensation committees) on the extent of disclosure by analyzing companies from different sectors in 1993 and other companies in 2002. He highlighted a negative relationship between the CEO’s position and disclosure. However, the study by Bukair and Abdul Rahman (2015) did not show a significant relationship between the CEO’s duality and the level of disclosure. As with Neifar and Jarboui (2018), disclosure and duality were negatively associated. Against the current, Grassa and Chakroun (2016) approved an association between the duality of the CEO and the high disclosure of governance. Therefore, we proposed the following hypothesis: H3: There is an association between CEO duality and financial disclosure level. The presence of women on the board The gender variable measures diversity. Indeed, historically, women have always been unfairly represented in corporate governance. From the perspective of the Agency Theory, diversity may not affect the efficiency of a board of directors (Fama & Jensen, 1983). In particular, the presence of women on the independent board of directors can help to reduce information asymmetry and improve the quality of financial information. Al-Maghzom (2016) argued that the presence of women on the board of directors may well be a source of interest. Ellwood and Gracia-Lacalle (2015) showed that women leaders are effective in attracting and retaining women (Hillman et al. (2007). Allini et al. (2016) contend that gender difference reveals variations in the behavior and skills of board members. 217
12. Asia-Pacific Management Accounting Journal , Volume 16 Issue 1 They confirm that there is a positive relationship between gender diversity and risk disclosure. In the same vein, Al-Maghzom (2016) analyzed the content of the annual reports of Saudi listed banks between 2009 and 2013 to determine the factors affecting risk disclosure. They argued that the gender variable is a key determinant of risk disclosure practices in Saudi banks. Velte (2017) reviewed 51 empirical studies on variables affecting corporate social responsibility disclosure and found that gender diversity within the board is often used as an indicator of board effectiveness and has a positive impact on corporate social responsibility disclosure. Mohamed et al. (2014) studied the influence of board characteristics on the reporting of 148 listed companies in Sri Lanka in 2012. They argued that boards with female directors are necessarily and negatively associated with disclosure. Hence, our hypothesis: H4: There is an association between presence of women on the board of directors and financial disclosure. The presence of audit committee Forker (1992) argues that audit committees are an effective monitoring mechanism to enhance corporate disclosure quality and to reduce agency costs. According to Pincus et al. (1989), the key role of the audit committee is to assist the board of directors to oversee a company’s financial reporting policy. Mnif and Tahari (2020) studied the effect of corporate governance characteristics on compliance with the AAOIFI governance standards disclosure for 54 Islamic banks adopting the AAOIFI in Bahrain, Qatar, Jordan, Oman, Yemen, Syria, Sudan and Palestine from 2009 to 2017. They found a positive association between compliance with the AAOIFI governance disclosure guidelines and audit committee independence. Al-Maghzom (2016) demonstrated that the audit committee is one of the main determinants of risk disclosure practices in Saudi banks. Albitar (2015) discussed the link of governance features with disclosure level of Jordan’s listed firms between 2010 and 2012. He successfully established a meaningful and positive association between audit committee and voluntary disclosure level. Barako et al. (2006) also indicated that the audit committee monitors annual reports and improves the quality of information disclosed between the various stakeholders. Avison et al. (2012) were no exception. Indeed, they showed that the audit committee is an important determinant of good corporate governance. While Neri (2010) contradicted his research 218
13. Compliance and Determinants of the AAOIFI Financial Standards and proved that there is indeed a negative relationship between the audit committee and the level of risk disclosure . So, our hypothesis: H5: There is an association between audit committee and level of financial disclosure. Characteristics Related to the Sharia Supervisory Board (SSB) The reputation of the SSB Safieddine (2009) claimed that under the agency theory an efficacious Sharia supervisory board (SSB) may reduce inter-agency conflicts as well as reporting imbalances among managers and stockholders through effective and independent oversight of operations compliant with Shariah law. According to Singh et al. (2004), the agency theory suggests that large boards involve diverse skills, resulting in a more effective supervisory role of boards. Farook and Lanis (2007) argue that Sharia board members in Islamic banks are often well known in their community for their knowledge and expertise of the Islamic religion and the regulations that govern it. Their credibility and reliability guarantee it. Consequently, the reputation of the Sharia Council remains an essential criterion for a better understanding of disclosure issues in Islamic banks. Nomran et al. (2016) also examined in their research the influence of Sharia board performance on Malaysian Islamic banks between 2008 and 2015.They established a significant association between performance of Islamic banks and Sharia board reputation. Farook et al. (2011) also argued that the reputation of the Sharia board is a necessary factor in assessing the level of disclosure of Islamic banks. Indeed, its measurement is based on the composition of the board of directors and members of the AAOIFI committees. Similarly, Abdul Rahman and Bukair (2013) examined the effect of Sharia Council characteristics on the level of corporate social responsibility disclosure in 53 Islamic banks operating in GCC countries and indicated that Sharia Council characteristics, including reputation are significantly and positively associated with level of disclosure. This proves that reputation is an important determinant in measuring disclosure level within Islamic banks. Hence our hypothesis: 219
14. Asia-Pacific Management Accounting Journal , Volume 16 Issue 1 H6: There is an association between reputation of the Sharia Board and financial disclosure level. SSB cross membership Cross-membership is a situation where the Sharia board member sits on several boards. Lorsch and Maclver (1989) support cross-membership because of its credibility, knowledge, and transparency. Grais and Pelligrini (2006) suggest that Sharia council members have access to confidential information and argue that this cross-membership can have an impact on Islamic banks, especially with competing banks. Haat et al. (2008) prove that having members on different Sharia boards of different Islamic banks improves the transparency of information disclosure. Decisions made within one board may also be part of the information for decisions made by other boards. Abdul Rahman and Bukair (2013) argued that this is an important feature of the Sharia Council of Islamic banks. Grassa (2015) noted that the repetition of a few names of Sharia board members helps to attract new clients, which improves the productivity and efficiency of Islamic banks. Unlike Alman (2012) who confirms that the Sharia Council’s cross-membership has a negative impact on risk taking in Islamic banks. Hence, our hypothesis is: H7: There is an association between cross-membership of the Sharia board members and financial disclosure level. Control Variables To test our hypotheses, the study included some control variables which are financial performance, adopted standards, audit quality and joint audit. Many theoretical and empirical literature suggest that these can potentially affect compliance and disclosure level in Islamic banks. The first variable financial performance was examined by El-Halaby and Hussainey (2016); Dignah et al. (2012); Mallin et al. (2014) who found that profitability has a significant impact on disclosure. As the sample contained 40 Islamic banks from 7 different countries the study controlled the variable adopted standards to consider differences between countries in adopting the AAOIFI or other accounting standards. According to El-Halaby and Hussainey (2015), accounting standards such 220
15. Compliance and Determinants of the AAOIFI Financial Standards as the AAOIFI are used to provide reliable and comparable information for all stakeholders to make investment decisions . Thus, the AAOIFI is an important element for improving the disclosure level (Mohammed et al., 2015). Consequently, adoption of the AAOIFI standards would be a strategic choice to increase disclosure and reliability of these banks (Ariss & Sarieddine, 2007). Furthermore, we used the variable audit quality represented by the Big4 auditors. Audit quality is perceived by the financial market as an indicator of the reliability of financial information disclosure and becomes intimately linked to a better quality of financial reports (Peel & Makepeace, 2012; Hodgdon et al., 2009; Xiao et al., 2004). Moreover, we also used the joint audit (Zerni et al., 2010; Alanezi et al., 2012; Becker et al., 1998; Francis et al., 2008). It represents a prospective tool for improving relevance and reliability in published financial information. It reduces information asymmetry and leads to more effective decision making. Besides, companies that have greater information are more likely to reduce this asymmetry by using a high-quality joint auditing. RESEARCH METHODOLOGY Sample Selection Our research was based on 40 Islamic banks across seven countries from the MENA region (Bahrain, United Arab Emirates UAE, Qatar, Kuwait, Saudi Arabia (KSA), Tunisia and Turkey). The study period was spread over 7 years, from 2010 to 2016, which corresponds to 280 observations presented in the form of a panel with a double temporal and spatial dimension. The data sources were the annual reports of the banks studied during this period. The 2010-2016 period and the 40 banks were selected due to the availability of the required data. The choice of the MENA region can explained by the significant development of the Islamic banking sector in this region compared to other countries in the world and the large number of Islamic financial institutions over the past decades. In fact, The Islamic banking sector is also gaining importance in the financial landscape of the MENA region as well as individual countries (González et al., 2017). 221
16. Asia-Pacific Management Accounting Journal , Volume 16 Issue 1 In addition, the banks chosen for our research are located in countries, which share similarities, especially for the culture, and in which Islam is the religion of the majority of people. Moreover, the scores of the IFCI (Islamic Financial Country Index) of these countries are comparable and close to each other (IFCI, 2019). Additionally, these countries are among the leading countries that have experienced a significant growth in Islamic banking during these years. Besides, they have a high IFDI (Islamic Financial Development Index) and are ranked among the top countries in terms of Islamic financial assets (IFDI, 2019). Construction of The Financial Disclosure Index (The Dependent Variable) Since our study aimed to measure the level of compliance of financial disclosures in Islamic Banks and to identify its main determinants, our dependent variable was the financial disclosure index. Based on the AAOIFI standards (Version 2015), we constructed our disclosure indices as follows: We adopted the disclosure requirements of Accounting Standard No 1, which focussed on the presentation, and disclosure of financial statements. Thus, reflecting the financial responsibility of Islamic banks for the construction of our financial disclosure index. Then, we reviewed previous research that used this standard to construct the disclosure index (El-Halaby & Hussainey, 2016; Vinnicombe, 2012; Vinnicombe, 2010; Haniffa & Hudaib, 2007). For ensuring the index’s validity, we tried selecting items according to their availability and close association with the financial statements as well as their similarity to the items chosen by other researchers. Finally, we obtained a financial disclosure index based on 8 items belonging to the AAOIFI N°1 accounting standards as shown in Table1. 222
17. Compliance and Determinants of the AAOIFI Financial Standards Table 1 : Items Corresponding to The Accounting Standard N°1 AAOIFI Financial Disclosure Index Items Sources 1. Comparative financial statements El-Halaby and Hussainey (2016), AAOIFI (2020) 2. Basic information about the bank AAOIFI (2020) 3. Disclosure of the currency used for the measurements AAOIFI (2020) 4. Disclosure of earnings and expenses prohibited AAOIFI (2020) by Sharia 5. Disclosures on products allowed by the Sharia El-Halaby and Hussainey (2016), AAOIFI (2020) 6. Disclosure in statements of use of zakat and sadakat funds AAOIFI (2020), Vinnicombe (2010) 7. Disclosure in statements of use of loan funds AAOIFI (2020), Haneefa and Hudaib (al qard al Hasan) (2007) 8. The report shows that the bank complies with AAOIFI (2020) AAOIFI standards Independent Variables In order to explain the AAOIFI compliance level of Islamic banks in the MENA region, governance and Sharia board characteristics of the bank were tested. Table 2 presents these variables, their measures, and the relevant literature. Table 2: Independent Variables Variables Taill_CA (size of the board of directors) Ind_CA (Independence of members of the Board of Directors) Dua_PDG (CEO Duality) Measurement Literature Independent variables Number of members of Grassa et al. (2019), Hashim et al. the board of directors (2015), Wan Abdullah et al. (2015), Bukair and Abdul Rahman (2015) Number of independent Neifar and Jarboui (2018), Grassa members of the Board of et al. (2019), Grassa and Chakroun Directors (2016), El-Halaby and Hussainey (2016), Hashim et al. (2015), Wan Abdullah et al. (2015) Binary variable: 1 if CEO Neifar and Jarboui (2018), Grassa is Chair and 0 otherwise et al. (2019), Grassa and Chakroun (2016), Bukair and Abdul Rahman (2015) 223
18. Asia-Pacific Management Accounting Journal , Volume 16 Issue 1 Fem (Presence of women on the board of directors) Com_Aud (Audit Committee) Rep_Sh (Reputation of Sharia board) Binary variable: 1 if there is one or more women on the board of directors and 0 otherwise Number of Audit Committee members Binary variable: 1 if one of the bank’s Sharia board members is a member in the AAOIFI Sharia board and 0 if not Binary variable: takes 1 if a Sharia council member belongs to Sharia council in another Islamic bank Adh_Sh (Sharia board cross membership) Al Maghzom (2016), Allini et al. (2016), Velte (2017), Mohamed et al. (2014) Sellami and Tahari (2017), Al Maghzom (2016) Norman et al. (2016), Abdul Rahman and Bukair (2013), Farook et al. (2011) Grassa (2015), Abdul Rahman and Bukair (2013), Grais and Pelligrini (2006) Control Variables Control variables considered in this research were financial performance, adopted standards, audit quality and joint audit. Table 3 presents these variables, their measures, and the relevant literature. Table 3: Control Variables Control variables Measurement Literature Ren_Fin (Financial performance) Ratio: ROA= net income/total assets El-Halaby and Hussainey (2016), Dignah et al. (2012), Mallin et al. (2014) Norm (Adopted standards) Binary variable 1 when adopting AAOIFI standards and 0 if not El-Halaby (2015), Mohammed et al. (2015) Q_Aud (External audit quality) Binary variable: 1 if bank’s external auditor is one of the BIG 4 audit firms and 0 otherwise. Grassa et al. (2019), El-Halaby and Hussainey (2016), Peel and Makepeace (2012) Co_Aud (Joint Audit) Binary variable: 1 if the bank is audited by two auditors and 0 otherwise Becker et al. (1998), Francis et al. (2008), Andre et al. (2011), Zerni et al. (2010), Alanezi et al. (2012) Econometric Model and Independent Variable Measurements Our model aims to explain the compliance of financial disclosure by different governance and Sharia board variables: 224
19. Compliance and Determinants of the AAOIFI Financial Standards Ic_Fini,t = α0 + α1Taill_Cai,t + α2Ind_CAi,t + α3Dua_PDGi,t + α4Femi,t + α5Com_Audi,t + α6Rep_Shi,t + α7Adh_Shi,t + α8Ren_Fini,t + α9Normi,t + α10Q_Audi,t + α11Co_ Audi,t +