Internal Governance Mechanisms and Financial Reporting Quality : Evidence from Alternative Banking Systems

Abstract

Anglo-American research has long documented the positive impact of effective corporate governance mechanisms in improving corporate financial reporting quality. However, examination of this causality across different bank types (e.g. conventional and Islamic banks) is still lacking. This thesis investigates the role of different internal governance mechanisms (i.e. boards of directors and audit committees) in enhancing the financial reporting quality in conventional and Islamic banks. It utilises the Islamic banking model operating on an extended governance structure (i.e. Shari’ah supervisory board) to gain new insights into the influence of bank institutional characteristics and additional monitoring mechanisms on managerial opportunism and on the information value of earnings. For a sample of listed conventional and Islamic banks from 16 countries, the results are twofold. First, the findings provide evidence that having a large and independent board of directors and audit committee is associated with reduced levels of earnings management for both conventional and Islamic banks. These findings demonstrate the absence of structural differences between the two bank types regarding the effectiveness of the traditional governance mechanisms in limiting opportunistic earnings management behaviour. Conditional on the bank type, the results show that the presence of an additional layer of governance through employing a large and financially qualified Shari’ah supervisory board, whose members serve on multiple boards, provides a significant deterrent against earnings management in Islamic banks. Second, the findings provide evidence for the role of effective boards of directors and audit committees in enhancing the information value of earnings. The results show that large and independent boards and audit committees are associated with more persistent earnings, predictable cash flows, and reliable loan loss provisions that are highly associated with future loan charge-offs. The findings of this thesis provide valuable insights for a better understanding of the role of traditional and additional monitoring mechanisms in promoting financial reporting quality in both banking types.