Can Inclusion in Religious Index Membership Mitigate Earnings Management?

Journal of Business Ethics, 2019

Posted: 17 Sep 2019

See all articles by Abdullah Alsaadi

Abdullah Alsaadi

Umm Al-Qura University - College of Business

Date Written: September 6, 2019

Abstract

This paper investigates whether religious-based index membership is important in mitigating earnings management. Using a large sample of firms domiciled across 12 European countries, our empirical results show that firms included in the Shariah-compliant index, as a proxy for religious index, are more likely to engage in accruals manipulation vis-a-vis non-Shariah-compliant firms. Our results are robust using the Heckman two-stage treatment effect model, weighted least squares model, alternative earnings quality metrics and after controlling for the potential effects of home-country characteristics. Furthermore, our empirical results indicate that corporate governance of Shariah-compliant firms does not constrain managerial opportunistic behaviour in misreporting earnings, and firms that with low scores of board functions, shareholder rights and vision and strategy are more likely to engage in earnings management. Further, Shariah-compliant firms domiciled in Coordinated Market Economies are more likely to manipulate earnings than those in Liberal Market Economies. Taken together, our findings suggest that the Shariah index membership does not indicate good corporate governance that can mitigate earnings management, and it may serve as a legitimacy mechanism to conform to stakeholders’ expectations. Our findings support arguments that the religious-based index membership is plausibly used as a ‘label’ and an impression management tool to attract investment.

Keywords: Shariah-compliant investments; Earnings management; Financial reporting; Corporate governance

JEL Classification: G30; M41

Suggested Citation

Alsaadi, Abdullah, Can Inclusion in Religious Index Membership Mitigate Earnings Management? (September 6, 2019). Journal of Business Ethics, 2019 . Available at SSRN: https://ssrn.com/abstract=3450035

Abdullah Alsaadi (Contact Author)

Umm Al-Qura University - College of Business ( email )

Makkah Al-Mukarramah, 21955
Saudi Arabia

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