Influence of adoption AAOIFI accounting standards on earning management: evidence from Islamic banks

The economic consequence for adopting accounting standards is one of the growing and valuable topics in accounting research. The purpose of this paper is to address the question whether the adoption of Islamic standards that are issued by Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFIs) has a positive effect on the level of earnings management (EM) in the Islamic banks (IBs) setting. The authors measure, in general, the impact of AAOIFI for adopter and non-adopter banks. This paper furthermore investigates whether IBs adopting AAOIFI as compulsory or as voluntary adopters, in general, are being less engaged in earnings manipulation.

Using empirical data from 143 IBs across 26 different countries from 2014 to 2018, the paper uses a linear regression model and probit regression analysis that group the banks investigated in this paper into adopters and non-adopters. Additional probit regressions were performed to test to what extent the status of AAOIFI adoption (compulsory or voluntary adopters) has an impact of EM.

The adoption of AAOIFI generally is associated with a reduction in the EM level. Furthermore, adopter IBs for AAOIFI is least involved in EM as compared to non-adopter IBs. In addition, the findings of this paper indicate that IBs across countries that mandate AAOIFI standards are less engaged in earnings manipulation as compared to other IBs in countries that adopt AAOIFI as voluntary standards.

The results reported in this paper provide insights to central banks and regulators regarding the prominence of mandates of AAOIFI standards for IBs to enhance the trust level of stakeholders by reducing the unethical behavior (EM). In addition, this paper supports the applicability of AAOIFI standards for IBs rather than the conventional standards such as IFRS or local GAAP.

To the best of the authors’ knowledge, the findings are unique at two levels. First, the paper provides evidence on the economic consequences of using AAOIFI in the context of IBs which was not explored by previous research. Second, the paper extends the investigation of the impact of AAOIFI adoption for adopters verses non-adopters, as well as for mandatory verses voluntary adoption of AAOIFI.