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Corporate
Foreign directors and corporate governance
governance in Islamic banks
Ali R. Almutairi
Department of Accounting, Kuwait University, Kuwait City, Kuwait, and
765
Majdi Anwar Quttainah
Department of Management and Marketing, Kuwait University, Kuwait City, Kuwait Received 22 July 2017
Revised 22 December 2017
Accepted 6 February 2018

Abstract
Purpose – The purpose of this paper is to examine whether foreign directors’ influence on opportunistic
behavior among managers varies between Islamic banks (IBs) and conventional banks (CBs). It also examines
how religious ethics and morals guide foreign directors to be better monitors.
Design/methodology/approach – A panel fixed effects regression is used to analyze the effect of
foreign directors on opportunistic behavior among managers in IBs and CBs. The authors use different
proxies such as loss avoidance, discretionary loan loss provision and expense preference behavior to measure
management opportunistic behavior.
Findings – Based on sample of 3,758 bank-year observations for 164 banks over the period 1993-2015, the
authors show that the presence of foreign directors in IBs increases boards’ effectiveness in impeding
management opportunistic behavior, whereas the presence of foreign directors in CBs reduces boards’
effectiveness in curbing management’s unethical acts. The authors also document that IBs (CBs) with foreign
directors demonstrate less (more) earnings management and expense-preference behavior among managers.
In addition, the authors’ evidence indicates that the existence of the Shari’ah supervisory boards helps foreign
directors be more effective monitors.
Research limitations/implications – The current study focuses on banks only which makes its results
subject to sample bias; there are many other forms of financial institutions (e.g. investments, real-estates and
mutual funds) complying to the Shari’ah law. Second, owing to the lack of foreign board directors
characteristics, the authors cannot investigate the intensity of the specific characteristics that could have
specific directions in affecting managerial behavior.
Practical implications – The findings in this paper may help standards-setters, auditors, investors and
regulators take appropriate measures and create better policies that reduce managers’ discretion. This could
in turn improve information transparency decision-making, monitoring, advising and accounting quality.
Originality/value – The authors’ theoretical framework combines the agency, contingency, resource-
dependence, stewardship and stakeholders’ theories and applies them to Shari’ah as an alternative ethical and
internal governance mechanism. The authors find that the impact of foreign directors on management
opportunistic behavior depends on the corporate religious norms within boards of directors, in particular,
suggesting that religious values affect how foreign directors influence bank managers’ behavior.
Keywords Foreign Board Directors, Shari’ah, Shari’ah supervisory board, Agency theory,
Resource dependence theory, Stakeholders theory, Stewardship theory, Earnings management,
Expense preference behavior
Paper type Research paper

Introduction
The link between corporate governance and management opportunistic behavior is a Journal of Islamic Accounting and
Business Research
popular topic for many researchers (Cornetta et al., 2008; Dechow et al., 1996; Klein, 2002; Vol. 11 No. 4, 2020
pp. 765-791
Marra et al., 2011; Park and Shin, 2004; Peasnell et al., 2005; Wang and Campbell, 2012; Xiea © Emerald Publishing Limited
1759-0817
et al., 2003). Evidence from these studies is mixed; however, in this study, we focus on DOI 10.1108/JIABR-07-2017-0104
JIABR whether the presence of foreign directors in mitigating unethical behaviors among
11,4 managers varies between Islamic banks (IBs) and commercial banks (CBs). Specifically, we
hypothesize that the presence of foreign directors in IBs (CBs) may potentially reduce
(increase) managers’ self-interests. We also hypothesize that foreign directors in IBs with
Shari’ah supervisory boards (SSBs) can inversely influence management opportunistic
behavior more than their counterparts in IBs with no SSBs.
766 Although prior studies report mixed findings on whether foreign directors are effective
monitors (Bremholm, 2015; Firoozi et al., 2016; Hooghiemstra et al., 2016; King, 2007;
Miletkov et al., 2013; Oxelheim and Randoy, 2003; Ramaswamy and Li, 2001; Zhang and
Uchida, 2012), we argue that embedding foreign directors in an ethical business
environment helps boards of directors (BODs) mitigate opportunistic behavior among
managers, as proxied by earnings management and expense-preference behavior.
Unlike that of CBs, corporate governance of IBs is mainly based on ethical principles and
moral values derived from Islamic law (Shari’ah). These principles and values complement
the economic behavior of individuals, communities and corporations. The most influential
agent of those principles and values in IBs is the SSB, which is an additional, internal layer
of corporate governance. Similar to BODs, SSBs have two main roles: monitoring and
advising. They verify whether all IB transactions and activities are Shari’ah compliant (ex-
ante and ex-post), and they advise management and BODs on decisions.
Based on sample of 3,758 bank-year observations for 164 banks over the period 1993-
2015, our findings indicate that the presence of foreign directors in IBs increases boards’
effectiveness in impeding management opportunistic behavior, whereas the presence of
foreign directors in CBs reduces boards’ effectiveness in curbing management’s unethical
acts. We split our sample into IBs and CBs and find that IBs with foreign directors
demonstrate less earnings management and expense-preference behavior among managers.
CBs with foreign directors demonstrate the opposite. We also document that the existence of
the SSB helps foreign directors be more effective monitors. Specifically, after splitting the IB
group into IBs with SSBs and IBs without SSBs, we show that foreign directors have a
greater impact on opportunistic behavior among managers in IBs with SSBs. Our results
hold after controlling for BOD characteristics and other variables are known to affect
opportunistic behavior.
This paper makes several contributions. First, it contributes to the literature regarding
the effect of foreign directors on opportunistic behavior among managers (Hooghiemstra
et al., 2016; Ramaswamy and Li, 2001; Zhang and Uchida, 2012). Second, our study is the
first to examine whether and how religious ethics and morals help foreign directors be better
monitors. In spite of Western ethical standards and codes of business ethics, we find that
foreign directors in CBs do not add value to the monitoring and advising roles that ensure
sound governance. Further, we contribute to the SSB literature by showing the essential role
of the SSB in promoting and enforcing Islamic principles and values. Last, this paper
extends the board diversity literature by presenting evidence that foreign directors help
BODs mitigate opportunistic behavior among managers.
The rest of the paper is structured as follows. First, relevant literature is reviewed and
hypotheses are developed. Second, research design and data collection are discussed. Third,
empirical results are presented. Finally, discussion and concluding remarks are presented.

Literature review and hypotheses development

Corporate governance of Islamic banks
Many prior studies extensively rely on agency theory to explain how BODs mitigate agency
costs (Berle and Means, 1932; Fama and Jensen, 1983; Jensen and Meckling, 1976). Agency
theory argues that the BOD is one important monitoring tool to ensure a company operates Corporate
in the best interests of shareholders (Jensen and Meckling, 1976); it is responsible for governance
protecting shareholder rights through overseeing financial disclosures and improving
corporate performance.
However, other theories present new insights into the role of boards. For instance,
contingency theory suggests that a firm can create strategic opportunities and improve its
interaction with the external environment by inviting or appointing outside directors.
Outside directors may also provide and safeguard the resources necessary for the survival 767
of the firm. Similarly, stewardship theory views directors as stewards who can improve firm
performance (Donaldson and Davis, 1991; Muth and Donaldson, 1998). Resource-
dependency theory considers boards a resource of social and business networks that can
influence firm environments (Carpenter and Westphal, 2001; Johnson et al., 1996; Pearce and
Zahra, 1992). In addition, stakeholder theory asserts that boards should serve the needs of a
wider group of stakeholders and ensure that companies do not violate ethical standards or
stakeholders’ rights and interests when making decisions (Donaldson and Preston, 1995;
Freeman, 1984; Freeman et al., 2004).
Though these theories present solutions to agency problems, they are relatively
unsuccessful in considering ethics as a significant element of the corporate governance
framework (Hasan, 2012). Following major financial scandals and corporate failures;
however, there have been many calls for integrating ethics into corporate governance
(Arjoon, 2005; Caldwell and Karri, 2005; Drennan, 2004; Sullivan and Shkolniov, 2007).
Notably, the corporate governance characteristics of IBs are quite different from those of
CBs. This difference is mainly based on the role of ethics in IBs’ business activities and
operating environments (Grassa and Matoussi, 2014). In IBs, a primary objective of
corporate governance is to ensure fairness to all stakeholders through greater transparency
and accountability based on a set of Islamic rules and laws, collectively referred to as
Shari’ah. Shari’ah originates from the rules dictated in the Qur’an (the Muslim holy book)
and Sunnah (the living example of Prophet Muhamad). It governs multiple aspects of
Islamic societies. In particular, all business activities of IBs must comply with Shari’ah.
Besides substance, Shari’ah is also concerned with business form (Ibrahim, 2006).
Another difference in corporate governance between IBs and CBs is the relatively large
amounts of investment deposits in IBs, which could increase agency problems and create
conflicts of interests among depositors, shareholders and managers (Grassa and Matoussi,
2014). In addition, the institutional environment in which IBs operate tends to be less
transparent, involves weaker market forces and sometimes struggles with inefficient
government oversight (Claessens, 2006)[1].
Most Islamic countries require additional layers of governance (i.e. SSBs) before they will
allow banks to call themselves Shari’ah compliant. Thus, BODs and SSBs are two internal
governing bodies complementing each other in many IBs. The BOD is responsible for
protecting the interests of shareholders and maximizing bank value by monitoring and
advising managers. The SSB monitors many other aspects of management behavior (e.g.
religious, moral and ethical); it also oversees and approves ex-ante and ex-post banking
products, services and transactions (Quttainah and Almutairi, 2016). It ensures both
depositors and stakeholders that all bank activities comply with Shari’ah principles.
Further, the SSB requires CEOs and other top managers to provide all necessary and
relevant information that helps SSB members apply Shari’ah to a transaction or product
regardless of outcome. The SSB also controls resources, provides advice and counsel to
external and internal users of financial information, answers questions from different
parties (e.g. depositors, customers, and investors) and clarifies ambiguity in any transaction
JIABR (Quttainah et al., 2013). Nevertheless, it continuously guides and trains management to
11,4 apply Islamic rules in daily transactions to avoid religious conflicts in business deals with
others. In-house SSBs also provide religious guidelines to BODs to ensure adherence to
Shari’ah. They offer additional support to BODs to cultivate positive managerial behavior
and higher financial performance (Abu Ghudda, 2001; Shaffaii, 2008; Suleiman, 1999).

768 Reasons for nominating foreign directors

Firms appoint foreign directors for many reasons. First, foreign directors can be useful for
companies in the foreign directors’ home country (Masulis et al., 2012), and they can provide
effective strategic advice on cross-border mergers (Alabdullah and Farris, 2014). Second,
firms with foreign operations and firms that wish to expand their foreign operations or
attract foreign investors tend to appoint foreign directors (Miletkov et al., 2013). In addition,
foreign sales, foreign ownership and cross-listing all motivate firms to nominate foreign
directors (Oxelheim et al., 2013). Historical ties between countries, as well as cultural,
institutional, and geographical proximity are other reasons firms have foreign directors
(Van Veen et al., 2014).
The presence of foreign directors could also signal diligent managerial monitoring (Chiu
et al., 2013). Forbes and Milliken (1999), for instance, argue that foreign directors are more
likely to reduce board cohesiveness because they may express independent opinions and feel
less hesitant to discuss controversial subjects, thereby encouraging other directors to
participate and contribute to more effective governance (Srinidhi et al., 2011). Because of
their different cultural backgrounds and experiences, foreign directors are also more likely
to enrich boardroom discussions (Hooghiemstra et al., 2016).

Foreign directors and corporate governance

Prior literature presents two competing arguments and mixed results about the value
foreign directors contribute to corporate governance. One view claims foreign directors
enhance the BOD’s ability to increase the quality of financial statements, possibly because of
the greater knowledge and unique experience foreign directors enjoy (Choi and Hasan, 2005),
as well as the social capital or network connections they have with key stakeholders
(Ramaswamy and Li, 2001).
Prior studies generally support the first view. For instance, Oxelheim and Randoy (2003)
use a sample of 253 Swedish and Norwegian public firms over a three-year period to
investigate how foreign directors from the USA, Canada and UK affect firm performance.
The results of their study show a positive relationship between the presence of foreign
directors and firm performance. Sugai et al. (2008) report similar findings using a sample of
about 60 Japanese public firms from 2006 to 2008. Their results indicate higher performance
for Japanese firms with foreign directors. King (2007) shows that foreign directors are better
at coordinating company resources, resulting in greater productivity and higher
performance. In addition, Bremholm (2015) studies 250 firms listed on the Tokyo stock
exchange between 2010 and 2013 and finds higher Tobin’s Q for firms nominating foreign
directors. Ramaswamy and Li (2001) suggest that the presence of foreign directors in Indian
manufacturing companies mitigates utility-maximization managerial behavior. Along those
lines, Zhang and Uchida (2012) also find that firms with foreign directors show less earnings
management. Peck-Ling et al. (2016) find a positive association between an increase in the
proportion of foreign directors and return on equity (ROE). In addition, based on a sample of
348 Malaysian public firms over the period 1999-2010, Peck-Ling et al. (2016) show that the
presence of foreign directors with more than 50 per cent voting rights has a positive impact
on firm value. Aside from that, firms with foreign directors engaging in cross-border
mergers enjoy higher announcement returns and pay less for their cross-border targets Corporate
(Alabdullah and Farris, 2014). In sum, these studies suggest that foreign directors are more governance
effective monitors and add value to corporate governance.
The other view, however, suggests that foreign directors reduce the board’s ability to
enhance the quality of financial reporting. Several explanations are possible, such as
language barriers; unfamiliarity with local legal systems and regulations, including
standards of corporate governance and accounting, geographical distance and the cost of
travel (Hooghiemstra et al., 2016; Masulis et al., 2012)[2]. Prior studies support this view as
769
well.
For example, Firoozi et al. (2016) test how the presence of foreign directors on audit
committees affects financial reporting quality for a sample of Canadian firms between 2008
and 2012. They show that having one or more foreign directors on the audit committee is
associated with lower financial reporting quality. In another study, Miletkov et al. (2013)
examine the association between the presence of foreign directors in non-US firms and firm
performance over the period 2001-2011 and report a negative association. Further, Masulis
et al. (2012) use a sample of S&P 1,500 firms over the period 1998-2003 to investigate the link
between foreign directors and firm performance. Their evidence shows lower Tobin’s Q for
firms with foreign directors. They also report that firms are more likely to restate their
financials after they nominate foreign directors, especially those serving on the audit
committee. Hooghiemstra et al. (2016) examine the impact of the presence of foreign
directors on earnings management for a sample of 586 nonfinancial public traded-Nordic
firms during the period 2001-2008. Their findings show greater earnings management for
firms with foreign directors. Collectively, these studies suggest that foreign directors tend to
be ineffective monitors and contribute to lax corporate governance.

Foreign directors and opportunistic behavior among managers

The BODs is an important internal mechanism to curb opportunistic behavior among
managers, and board composition affects how effective that mechanism is (Ahmed and
Duellman, 2007; Dechow et al., 2010). More specifically, researchers find that companies with
mainly independent directors are less likely to behave unethically than those with no or
fewer independent directors (Bruynseels and Cardinaels, 2014; Hwang and Kim, 2009; Klein,
2002). Although corporate governance literature shows independent directors are the most
effective management monitors, it also shows that not all independent directors are equally
effective (Fich and Shivdasani, 2005; Masulis et al., 2012) or have the same moral
integrity[3]. Directors, like managers, are agents who have interests that may be different
from the interests of shareholders. Like inside directors, outside directors may have their
own private interests (Masulis et al., 2012).
The Islamic view of corporate governance, however, is more comprehensive and mainly
related to the ethical identity that rests in Shari’ah. In IBs, employees’ daily transactions and
activities should be based on Shari’ah, which focuses on the relationship between man
and his creator (Beekun, 1996). This is in contrast to the Western or secular ethical systems
and moral codes CBs adopt; those systems and codes are based on the values of their human
founders and generally segregate ethics from religion. Of course, there have been many legal
reforms around the world to enforce ethical standards (e.g. USA’s SOX, Canadian’s C-SOX
and Japan’s J-SOX) (Drennan, 2004). However, companies find adherence to these reforms
costly. In addition, researchers find that enforcement costs associated with manmade rules
are much higher than enforcement costs associated with divine rules, and external legal
reforms are often less accepted than internal legal reforms (Kayode and Ishola, 2012;
JIABR Quttainah, 2012). Nonetheless, legal reforms may not be as effective if directors have no
11,4 strong moral conscience (Chapra and Ahmed, 2002).
Islamic institutions gained notoriety in recent years for remaining stable during the
global financial crises of 2008. This happened largely because they set an example of how to
gain clients’ trust and confidence. Chapra (2009) attributes this stability to the strong
emphasis on ethics enforced by Shari’ah.
770 In turn, evidence does show that IBs are less likely than CBs to engage in unethical
business practices (Quttainah, 2012; Quttainah and Almutairi, 2016; Quttainah et al., 2013).
In addition, the Islamic banking system is growing 50 per cent faster than the CB system[4].
Although both have foreign directors in their boardrooms, IBs tend to nominate more
foreign directors than CBs do, however. In a comparison of IBs and CBs, Grassa and
Matoussi (2014) show, for example, that the percentage of foreign directors in IBs rose from
10 per cent in 2000 to 35 per cent in 2009. They also report that the proportion of foreign
directors on IBs boards is significantly higher than that of CB boards[5].
In spite of prior studies’ mixed results regarding foreign directors’ monitoring
effectiveness, we argue that international expertise is a valuable asset to firms (Giannetti
et al., 2015) under the right circumstances. Foreign directors are outsiders, and outsiders can
bring favorable insights that improve decision-making. Besides their competencies and
skills, foreign directors are also likely to be effective monitors in ethical business
environments. Because Islam stresses ethics and moral integrity, foreign directors in firms
that embrace Islam may be more likely to be effective monitors. We argue that foreign
directors may be more likely to constrain unethical management behavior in IBs but less
likely to do the same in CBs. We therefore expect that the presence of foreign directors in IBs
(CBs) negatively (positively) affects management opportunistic behavior. Put formally, we
offer the following directional hypothesis:

H1. The presence of foreign directors in IBs (CBs) has a negative (positive) association
with opportunistic behavior among managers.
In IBs, the SSB and Shari’ah principles both influence directors[6]. As part of the IBs
internal governance framework, the SSB functions as an internal control body, increasing
the IB’s credibility in the business community (Rammal, 2006). The SSB is a gatekeeper
ensuring that all financial transactions and activities are Shari’ah compliant. It also
provides religious guidelines to directors to ensure compliance with Shari’ah and ensures
directors, among others, behave in line with the Islamic moral code to avoid religious
conflicts during decision-making. In addition, the SSB works with the board to enhance
positive managerial behavior (Abu Ghudda, 2001; Shaffaii, 2008; Suleiman, 1999). Besides
their scholarship in Islamic finance, members of the Shari’ah board have qualifications in
accounting and finance. This is necessary to ensure better consultation and supervision.
Foreign directors are likely to be better advisors and monitors in the presence of SSBs,
possibly because SSBs allow foreign directors to exercise their advising and monitoring
responsibilities more effectively. Quttainah and Almutairi (2016) suggest, for example, that
managers of IBs with SSBs exhibit greater ethical behavior than those in IBs with no SSBs.
Nonetheless, the essential role of the SSB is even more pronounced in conventional
institutions that offer Islamic financial services (Dar, 2011; Quttainah, 2012). Without the
SSB’s emphasis on Islamic ethics, foreign directors may thus fall behind on their
responsibilities. Hence, we expect that the negative influence foreign directors exert on
opportunistic behavior will be more pronounced in IBs with SSBs than in IBs with no SSBs.
We, therefore, state our second hypothesis in alternative form as follows:
 H2. The negative association between the presence of foreign directors and Corporate
opportunistic behavior among managers is more pronounced in IBs with SSBs. governance

Research design and data collection

Model specifications and measuring variables
To test H1, we use Model (1a) and Model (1 b), which reflect management opportunistic
behavior in CBs and IBs, respectively (see Appendix for variable definitions): 771
Management Opportunistic BehaviorCBs ¼ f ð FBD; BOD Characteristics;
Bank Characteristics; Control VariablesÞ
(1a)

Management Opportunistic BehaviorIBs ¼ f ð FBD; BOD Characteristics;

SSB; Bank Characteristics; Control VariablesÞ
(1b)

We use loss avoidance and discretionary loan loss provision to measure opportunistic
behavior among managers in two ways. Loss avoidance indicates how bank managers
maximize their utility by managing earnings to suit their own interests (Altamuro and
Beatty, 2010; Beatty et al., 2002). Empirical evidence (Burgstahler and Dichev, 1997;
Degeorge et al., 1999) shows how important earnings management is to managers.
Following Kanagaretnam et al. (2010), we define loss avoidance (LD) as an indicator variable
that equals 1 if a bank has a small ROA (income before taxes scaled by total assets) between
0 and 0.01 and 0 otherwise[7].
The second dependent variable, discretionary loan loss provision (Abnormal), defined as
the absolute value of the residual from Model (2). We use the absolute value of Abnormal
because earnings management could go in both directions (i.e. income increasing and
income decreasing):

LLP ¼ f ð BLLA; CTLO; NPLsMNPLs; CEs; YRsÞ (2)

where:
LLP = The normal or nondiscretionary component of loan loss provision;
BLLA = Beginning balance of loan loss allowance;
CTLO = Change in total loans outstanding;
NPLs = Nonperforming loans;
MNPLs =An indicator variable that equals 1 if the value for NPLs is missing, and 0
otherwise;
CEs = Indicator variables for country effects; and
YRs = Indicator variables for year effects.
We define a foreign director as any board member who is not a citizen of the domicile
country. Masulis et al. (2012) defines foreign board directors (FBD) as those living in another
country, while Oxelheim and Randoy (2003) define foreign directors as those born “Anglo-
American.” In addition, Hooghiemstra et al. (2016) defines a foreign director as “non-Nordic
foreigners.” To proxy for FBD, we use continuous and discontinuous indicators. That is,
JIABR FBD is the ratio of foreign directors to the total number of directors on each board, and as an
11,4 indicator variable, it equals 1 if the BOD has foreign directors; it equals 0 otherwise.
For the first proxy of earnings management (LD), several BOD variables are controlled
based on previous literature. Board size, BODSize, is the total number of board members.
We also control for the positive association between monitoring outcome and the number of
outside directors (Jensen and Meckling, 1976; Peng, 2004; Shleifer and Vishny, 1997).
772 OutSider is the ratio of directors exogenous to the IB to the sum of directors setting on
board. We further include board interlocks (BODInks) to control for members with
interlocking directorate and information outcomes. BODInks is the ratio of board members
with interlocks to the total number of BODs. We also deploy (CEOInks) to control for outside
directorships on boards that are more active and hold many meetings. CEOInks is the ratio
of CEO directorates to the total number of directors on each board. Interlocking enables
firms to monitor one another (Mizruchi and Stearns, 1994) and provides firms with
information about business practices (Davis et al., 1997). Conversely, interlocking may
decrease firm efficiency because of the excessive burden on the members of the BOD (Ferris
et al., 2003; Fich, 2005; Quttainah, 2014).
To ensure that there is no variation in earnings management, we also include several
bank characteristics indicated by Kanagaretnam et al. (2010). First, we use bank size (LgAs),
measured as the natural logarithm of total assets at the end of year t. We use it to test for
external validity and for the purposes of control. Second, we include the loan ratio (LR),
which is the total loans scaled by total assets at the beginning of year t. Further, we include
change in cash flow (CCF) and loan loss allowance (ALL), calculated as the change in total
loans outstanding deflated by beginning total assets, and the allowance for loan losses at the
end of year t scaled by total assets at beginning of year t, respectively. We control for
potential risky assets (RAs), which is the total risky assets (i.e. assets that are equity-type
contracts) scaled by total assets at the beginning of year t.
Nonetheless, European Intelligence Unit country Risk (EIUCR) is used as a control
variable to proxy for the quality of regulation and the legal environment, as well as
economic, political, and business-trend developments that are likely to affect bank
creditworthiness measured by the European Intelligence Unit country risk. Also, a region
indicator variable (ME) is included as a control variable to account for differences between
countries (Grigorian and Manole, 2002).
Further, since IBs and CBs hold different loans and other asset portfolios, managers may
have different incentives to manage earnings. In model (1a), therefore, we control for
institutional differences among different countries using a country-level governance index
(GI) (see, Kaufmann et al., 2010). In addition, we control for SSB in model (1 b) (Quttainah,
2014, 2012; Quttainah and Almutairi, 2016; Quttainah et al., 2013). SSB is an indicator
variable that equals 1 if the IB has an in-house SSB and 0 otherwise. Last, we control for
growth in assets when management opportunistic behavior is prxied by Abnormal. Growth
(GH) is defined as the change in total assets from the beginning to the end of year t.
As for testing H2, we divide our IB sample into IBs with SSBs and IBs with no SSBs and
employ the following regressison models:
Management Opportunistic BehaviorIBs with SSBs
¼ f ð FBD; BOD Characteristics; SSB Characteristics; Bank Characteristics;
Control VariablesÞ (3a)
 Management Opportunistic BehaviorIBs withoutSSBs Corporate
¼ f ð FBD; BOD Characteristics; Bank Characteristics; Control VariablesÞ (3b) governance

In model (3a), we control for SSB traits (Quttainah, 2014, 2012; Quttainah and
Almutairi, 2016; Quttainah et al., 2013) in addition to the control variables mentioned
above. SSB Size is the total number of SSB members. In addition, we control for the
positive association between monitoring outcome and the number of outside directors 773
(Jensen and Meckling, 1976; Peng, 2004; Shleifer and Vishny, 1997). Outside SSB is the
ratio of SSB members exogenous to the IB to the total members of the SSB. Next, we
include SSB interlocks (SSBInks) to control for SSB members with interlocking
directorate and information outcomes, defined as the ratio of board members with
interlocks to the total number of board directors. In addition, we add SSB Education to
control for SSB members with higher education directorate and educational outcome
and it is an indicator variable that is equal to 1 if a member of the SSB holds a
postgraduate degree and 0 otherwise.

Sample and data description

Information is retrieved for all banks available in the BankScope database between 1993 and
2015. We construct a balanced panel sample and delete banks with incomplete twenty-year
bank information. We also exclude banks established after 1993. Bank specialization, asset,
liabilities, earnings, expenses, ratings and country- and risk-rating information are mainly
from the BankScope database, supplemented with information from several country-level
and bank-level websites. Table I reports the distribution of observations by country. It
shows that Bahrain has the highest number of observations (499) and Bangladesh has the
lowest number of observations (92). Such an analysis indicates that Bahrain is a well-
established financial and banking hub in the Middle East, specifically in the Arabian
Peninsula. Our sample includes 82 IBs in 15 countries. We match IBs with CBs based on size
and geographic location. The matched sample includes 82 CBs from 15 countries. In
addition, we manually collect SSB traits, regular board characteristics including foreign
directors and the number of directors in each SSB from banks’ websites. The final sample

Country name Freq. (%) Cum.

Bahrain 499 13.28 13.28

Bangladesh 92 2.45 15.73
Egypt 253 6.73 22.46
Indonesia 115 3.06 25.52
Iran 230 6.12 31.64
Jordan 207 5.51 37.15
KSA 207 5.51 42.66
Kuwait 276 7.34 50.00
Lebanon 253 6.73 56.73
Malaysia 276 7.34 64.08
Pakistan 414 11.02 75.09
Qatar 138 3.67 78.77
Sudan 276 7.34 86.11 Table I.
Turkey 154 4.1 90.21 Sample distribution
UAE 368 9.79 100 of observations by
Total 3,758 100 country
JIABR consists of 3,758 observations for 164 banks, of which 1,879 observations are for 82 IBs.
11,4 Figure 1 depicts the market share of IBs in each country in terms of total bank assets. We
find that IBs in Iran have the highest market share (80.12 per cent) and IBs in Malaysia have
the lowest (1.79 per cent)[8]. Furthermore, as a robustness check, the sample of IBs and CBs
is used in a frontier analysis that uses CBs’ efficiency levels as a benchmark for IBs.
Table II presents the summary statistics for the dependent, independent and control
774 variables. The mean (median) LD and Abnormal values of the bank-year observations in our
sample are 0.20 (0.00) and 0.008 (0.00), respectively. For the IBs included in our sample, the
mean (median) LD and Abnormal are 0.30 (0.00) and 0.003 (0.00). In general, these values
suggest that management opportunistic behavior tends to be lower in IBs. The average
proportion of foreign directors setting on the BODs in bank-year observations is about 20
per cent. On average, about half of bank-year observations have foreign board directors. In
IBs, the mean ratio of foreign directors to the total number of directors setting on the board
is 50 per cent. In addition, 51 per cent of the IB-year observations have foreign directors.
Notably, IBs may represent a welcoming and attractive business environment for foreign
directors. On average, about 46 per cent of the IB-year observations have SSB, and each SSB
consists of five directors. Further, IBs with SSBs, approximately, have 10 per cent of
directors with interlocks, 16 per cent of outside directors and 99 per cent of directors with
postgraduate degrees.

Empirical results
Main results
Table III depicts univariate tests between CBs and IBs, and within the IB sample. In Panel A
of Table III, the mean LD values of CBs and IBs are 46 and 30 per cent, respectively[9], with
a statistically significant difference at the 1 per cent level. Furthermore, the mean Abnormal
value is 0.5 per cent for CBs compared to 0.3 per cent for IBs, with mean difference
significant at the 1 per cent level. These preliminary findings, albeit initially, support H1
and H2.
Additionally, Panels B and C of the same table show a t-test mean comparison in the
presence of foreign directors between IBs and counterparts, and between IBs with SSBs and
IBs with no SSBs, respectively. Results show that the presence of foreign directors in IBs is
significantly pronounced, with more concentration in those with SSBs. IBs may have

90.00%
80.00%
70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
Figure 1.
Market share for IBs
in each country in
terms of total bank
assets
Source: Bank Scope
Variable N Mean SD Minimum Median Maximum
Corporate
governance
Earnings-management measures
LD 3,758 0.20 0.40 0.00 0.00 1.00
LD IBs 1,879 0.30 0.48 0.00 0.00 0.40
Abnormal 3,758 0.008 0.10 0.00 0.00 0.45
Abnormal IBs 1,879 0.003 0.007 0.00 0.00 0.01
Expense-preference behavior measures
775
NIE 3,758 0.06 0.06 0.05 0.06 0.10
NIE IBs 1,879 0.006 0.33 0.02 0.03 0.05
Bank characteristics
LgAs 3,758 9.03 4.24 7.16 8.21 20.50
GH 3,758 0.20 0.55 0.00 0.04 0.99
LR 3,758 0.42 0.50 0.00 0.50 0.88
CCF 3,758 0.03 0.28 1.00 3.00 6.00
ALL 3,758 0.05 0.42 0.00 0.030 0.55
RAs 3,758 0.62 0.36 0.52 0.61 0.99
SSB and BOD characteristics
Islamic 1,879 0.50 0.50 0.00 0.50 1.00
SSB 1,879 0.46 0.53 0.00 0.00 1.00
SSBSize 1,879 5.00 2.65 3.00 5.00 9.00
SSBInks 1,879 0.10 0.09 0.00 0.20 033
Outside SSB 1,879 0.16 0.50 0.00 0.07 0.62
SSB Education 1,879 0.99 0.40 0.02 0.05 0.99
BODSize 1,879 10.10 8.22 5.00 10.00 12.00
FBD 3,758 0.20 0.44 0.00 0.20 0.80
FBD (indicator) 3,758 0.50 0.50 0.00 1.00 1.00
FBD in IBs 1,879 0.50 0.48 0.00 0.40 0.80
FBD (indicator) in IBs 1,879 0.51 0.80 0.00 1.00 1.00
FBD in SSBs 805 0.93 0.48 0.00 0.10 0.71
FBD (indicator) in SSBs 805 0.52 0.55 0.00 1.00 1.00
BODInks 3,758 0.10 0.45 0.00 0.04 0.29
Outsider 3,758 0.60 0.25 0.00 0.07 0.88 Table II.
CEOInks 3,758 0.89 0.67 0.00 0.05 0.45 Descriptive statistics

corporate citizen cultures that stem from Shari’ah and the teachings of Prophet Mohammed,
creating a unique and attractive environment to foreign directors.
Before performing the regression analyses, we generate pairwise correlation tables to
ensure that the link between the dependent and independent variables is not highly
correlated. In addition, we examine variables for multicollinearity following the procedure in
Hair et al. (1998). The first model includes 164 IBs and CBs with 3,758 bank-year
observations, and the second model includes 82 IBs and 82 CBs, each with 1,879 bank-year
observations. The VIF values for both panels are lower than the threshold value of 10
suggested by Hair et al. (1998).
Panels A and B of Table IV report the Pearson correlation matrix for the dependent,
independent and some control variables for the CBs and IBs, respectively. Both Panels
provide great insights, albeit prior to fixed effects regression. In Panel A, FBD is positive
and significantly associated with LD and Abnormal. In Panel B, however, FBD is
statistically and negatively related to LD and Abnormal. The extent to which the negative
statistical significance suggests that the presence of foreign directors in IBs mitigates
JIABR Panel A: Univariate tests between CBs and IBs
11,4 CBs IBs
N Mean Std N Mean Std Diff. t value
LD 1,879 0.46 0.61 1,879 0.30 0.48 0.067*** 1.23
Abnormal 1,879 0.005 0.010 1,879 0.003 0.007 0.003*** 2.00
NIE 1,879 0.03 0.05 1,879 0.006 0.33 0.516*** 1.95
LgAs 1,879 9.09 3.07 1,879 8.19 4.33 0.99*** 3.33
776 GH 1,879 0.233 0.46 1,879 0.115 0.32 0.052** 2.00
LR 1,879 0.68 0.36 1,879 0.45 0.38 0.06*** 1.95
CCF 1,879 0.024 0.057 1,879 0.016 0.044 0.009 1.55
ALL 1,879 0.044 0.07 1,879 0.016 0.07 0.072*** 4.35
RA 1,879 0.664 0.133 1,879 0.210 0.101 0.077*** 2.00
Panel B: Mean comparison between foreign directors in CBs and IBs
IBs N Mean Diff in means t-value Two tailed p-value
FBD No 1879 0.18 0.011 0.48 0.093
Yes 1879 0.50
FBD (indicator) No 1879 0.20 0.020 0.29 0.088
Yes 1879 0.51
Panel C: Mean comparison between foreign directors in IBs with SSB and IBs no SSB
SSB N Mean Diff in means t-Value Two-tailed p-value
FBD No 1049 0.19 0.01 0.58 0.023
Yes 805 0.93
FBD (indicator) No 1049 0.5 0.04 0.16 0.045
Yes 805 0.52
Table III. Notes: The means of the differences between two subsamples and absolute value of t-statistics are also
Univariate tests reported. Significance at the 10, 5, and 1% levels are indicated by *, ** and ***, respectively

against managers’ indulgence in utility maximization behavior. The case, however, seems
opposite in CBs.
Since our sample is a balance panel, we can either use fixed or random effects methods
recommended by Baltagi and Chang(1994) and Wansbeek and Kapteyn (1989). The fixed
effects regression controls for omitted variables that vary across entities but do not change
over time. The random effects regression controls for omitted variables that maybe constant
over time, but vary between cases and others may be fixed between cases but vary over
time. As the random effects estimator is a weighted average of fixed and between effects, the
Hausman test helps in determining the method that best fits. A panel fixed effects regression
always provides consistent results, yet may not be the most efficient model to run (Baltagi
and Chang, 1994). A panel random effects regression provides better p-values, as it is a more
efficient estimator. The former and the latter methods require justifiable statistically
outcomes. To determine the appropriate statistical technique, a Hausman test is used. First,
we estimated the effects model followed by the random effects model. The initiated
comparison between both models resulted in rejecting the null hypothesis due to the
conditional mean of the disturbance given regressors is zero. This indicates that a panel
fixed effect estimator is to be implemented (Baltagi and Chang, 1994).
Columns 1 and 2 of Table V provide fixed effects regression of FBD in CBs [Model (1a)].
In Column 1, FBD, as a continuous variable, is positively and significantly associated with
LD at p-value less than 0.05. In Column 2, the coefficient on the indicator variable, FBD, has
a positive and significant sign at p-value less than 0.01. In addition, Columns 3 and 4 of the
same table report the fixed effects results for the presence of foreign directorship in IBs
Panel A: Correlation among dependent, explanatory and control variables in CBs
Corporate
1 2 3 4 5 6 7 8 governance
1. LD 1.00
2. Abnormal 0.34 1.00
3. NIE 0.27 0.23 1.00
4. FBD 0.02*** 0.01*** 0.01*** 1.00
5. FBD indicator 0.03 0.02 0.03 0.13 1.00
6. BODSize 0.002 0.10 0.01 0.01 0.01 1.00 777
7. BODInks 0.13 0.12 0.04 0.06 0.31 0.43 1.00
8. Outsider 0.07*** 0.08*** 0.01*** 0.04*** 0.18*** 0.18*** 0.23*** 1.00
9. CEOInks 0.01** 0.01** 0.002** 0.02** 0.04** 0.10** 0.06** 0.05**
Panel B: Correlation among dependent, explanatory and control variables in IBs
1 2 3 4 5 6 7 8 9
1. LD 1.00
2. Abnormal 0.21*** 1.00
3. NIE 0.17*** 0.12*** 1.000
4. SSB 0.28*** 0.25*** 0.28*** 1.00
5. FBD 0.01*** 0.08*** 0.01*** 0.03*** 1.00
6. FBD indicator 0.002*** 0.001*** 011 0.04*** 0.02*** 1.00
7. BODSize 0.03*** 0.01*** 0.01*** 0.02*** 0.02*** 0.02*** 1.00
8. BODInks 0.07*** 0.03*** 0.01*** 0.03*** 0.03*** 0.03*** 0.04*** 1.00
9. Outsider 0.05* 0.03* 0.02 0.024* 0.02* 0.03* 0.04* 0.07* 1.00
10. CEOInks 0.06*** 0.03*** 0.02*** 0.08*** 0.02*** 0.17*** 0.09*** 0.03*** 0.10***
Table IV.
Notes: *p < 0.05; **p < 0.01; ***p < 0.001 Pearson correlation

[Model (1 b)]. Column 3 shows that the coefficient on the continuous variable, FBD, is
significant and negative at p-value less than 0.05. Column 4 shows the same results by using
FBD as an indicator variable.
Table VI shows fixed effects estimation techniques results of FBD effects on earnings
management, proxied by Abnormal, in CBs and IBs. Columns 1 and 2 report these effects in
CBs [Model (1a)]. In Column 1, the coefficient on the indicator variable, FBD, is positive and
marginally statistically significant at p-value less than 0.10. In Column 2, FBD, as a
continuous variable, is also positive but highly statistically significant at p-value less than
0.01. Columns 3 and 4 of the same table show the results of FBD-Abnormal link in IBs
[Model (1 b)]. In Column 3, the continuous variable, FBD, has a negative and economically
significant p-value smaller than 0.05 relationship with Abnormal. Column 4 reports similar
results when FBD is presented by an indicator variable. As for control variables in Tables V
and VI, overall, they carry their correct sign.
In sum, findings reported in Table VI are similar to those reported in Table V. Both
confirm the theoretical models by Shaffaii (2008) that governance in IBs conforms to
contemporary and religious standards. The mechanism deals with micro and macro
regulations and extends by building and strengthening the ethical and moral aspects of
business. Therefore, any missing element of the Islamic governance structure leaves IBs
with “a limping infrastructure” (Shaffaii, 2008, p. 2). The full implementation of the religious
governance reinforces and strengthens the moral and ethical aspects that improve
organizational behavior via the genuine monitoring by FBD.
Therefore, results reported in Tables V and VI support H1. That is, the presence FBDs in
CBs (IBs) has a positive (negative) impact on management opportunistic behavior. They
suggest that foreign directors in CBs are not effective monitors as opposed to their
JIABR CBs IBs
11,4 (1) (2) (3) (4)
Variable LD LD LD LD

FBD 0.0201** (5.60) N 0.3520** (15.43) N

FBD Indicator N 0.0484*** (4.31) N 0.5470** (15.00)
BODSize 0.0197 (3.53) 0.0165 (0.73) 0.15443* (1.81) 0.4434** (3.44)
778 BODInks 0.0180* (4.94) 0.0425** (3.53) 0.06654* (1.55) 0.2215** (13.00)
Outsider 0.0939* (2.36) 0.1435 (1.54) 0.3444** (15.33) 0.5446** (11.00)
CEOInks 0.01 (0.93) 0.0399** (2.74) 0.3054* (3.00) 0.2729* (1.44)
SSB N N 0.0350*** (1.32) 0.1367*** (0.78)
LgAs 0.0352 (2.44) 0.0161* (2.05) 0.1944 (1.33) 0.0418 (1.00)
LR 0.0101 (1.43) 0.0345 (1.61) 0.0655 (0.12) 0.1802 (0.51)
CCF 0.0231 (1.12) 0.0044 (0.20) 0.332 (1.23) 0.3431 (1.48)
All 0.0346 (3.46) 0.0358* (2.57) 0.0022 (0.11) 0.0086 (0.33)
RAs 0.0049 (1.66) 0.0017 (0.08) 0.0252 (1.34) 0.0441 (1.33)
EIUCR 0.0020 (0.04) 0.0145 (0.24) 0.0243*** (3.12) 0.0034* (3.00)
ME 0.3497 (0.33) 0.1765 (0.92) 0.221*** (3.43) 0.0222*** (4.00)
GI 0.0005 (0.17) 0.0244 (0.93) N N
Observation 1879 1879 1879 1879

Notes: This table presents fixed effects robust estimation models of FBDs in CBs and IBs for earnings
management to avoid earnings losses. Columns 1 and 2 examine the effects of FBDs as a continuous and
discontinuous variable, respectively, on managerial behavior in CBs. Columns 3 and 4 examine the effects
of FBDs as a continuous and discontinuous variable, respectively, on managerial behavior in IBs. The
Table V. dependent variable is LD, and it is an indicator variable that equals 1 if a bank has a small ROA (income
before taxes scaled by total assets) between 0 and 0.01 and 0 otherwise. The rest of the variables are BODs
Effect of FBDs on characteristics, SSBs traits variables and other control variables. The t-values are adjusted using the
loss avoidance in IBs heteroscedasticity adjustment approach in White (1980). Standard errors are in parentheses. Significance at
and CBs the 10, 5 and 1% levels are indicated by *, ** and ***, respectively

counterparts in IBs. FBDs serving on IBs boards become accustomed to the values
envisaged by Shari’ah principles, thereby improving their monitoring capabilities to deter
earnings management.
Columns 1 and 2 of Table VII show the results of the impact of FBDs on LD in IBs
without SSBs. The coefficient on the continuous and discontinuous FBDs is negative and
statistically significant at a p-value less than 0.05. The same table also reports the results of
the effect of the presence of foreign directors on loss avoidance in IBs with SSBs. The
coefficient on the continuous FBDs and discontinuous FBDs is also negative but more
statistically significant (p-value less than 0.01) than that reported in Columns 1 and 2 of
Table VII.
Table VIII reports the results of the effect of FBDs on Abnormal for IBs with no SSBs
(Columns 1 and 2) and IBs with SSBs (Columns 3 and 4). Notably, the negative impact of
presence of foreign directors on management opportunistic behavior, proxied by Abnormal,
is more pronounced in IBs with SSBs than in counterparts with no SSBs. The results are
consistent using the continuous and discontinuous measure of the presence of foreign board
directors.
Control variables in Tables VII and VIII, in general, have their expected signs. Overall,
findings in Tables VII and VIII support H2. They suggest that foreign directors in IBs with
SSBs are more effective monitors than their counterparts in IBs with no SSBs. The ability of
foreign directors to curb or minimize management opportunistic behavior is likely to be
reinforced not only by the Shari’ah principles but also by the embeddedness of SSBs within
 CBs IBs
Corporate
(1) (2) (3) (4) governance
Variable Abnormal Abnormal Abnormal Abnormal

FBD 0.0463* (1.73) N 0.0222** (1.05) N

FBD indicator N 0.0269*** (3.26) N 0.0022** (1.33)
BODSize 0.0145 (0.53) 0.0048 (0.17) 0.0013* (0.11) 0.0122* (0.33)
BODInks 0.0039 (0.14) 0.0688 (1.22) 0.0070** (2.33) 0.0067* (1.66) 779
Outsider 0.0892 (1.59) 0.0681 (1.18) 0.1622* (1.88) 0.155* (1.64)
CEOInks 0.38 3 (1.42) 0.7231 (1.55) 0.2155** (2.44) 0.0233* (0.66)
SSB N N 0.2201**(2.22) 0.2700*** (1.44)
LgAs 0.0062 (0.44) 0.0066 (1.55) 0.0033** (2.33) 0.0200*** (3.70)
LR 0.111 (0.78) 0.0327 (0.43) 0.1008 (1.53) 0.0077 (0.55)
CCF 0.0669 (0.54) 0.0467 (0.36) 0.0133* (1.21) 0.0051* (0.44)
All 0.008 (0.27) 0.0225 (1.32) 0.0131 (0.66) 0.0032 (0.22)
RAs 0.0087 (0.77) 0.0438 (1.53) 0.0158* (1.41) 0.0100** (0.55)
EIUCR 0.0018 (0.06) 0.0134 (0.44) 0.023*** (4.77) 0.0055* (1.34)
ME 0.3867 (0.43) 0.1657 (0.19) 0.122*** (2.72) 0.0222*** (4.44)
GI 0.0007 (0.11) 0.0222 (0.23) N N
GH 0.1561 (0.81) 0.1652 (0.80) 0.023*** (2.99) 0.1333*** (2.75)
_cons 0.1402 (0.61) 0.0155 (0.05) 0.0333* (1.33) 0.0222*** (4.77)
Observation 1,879 1,879 1,879 1,879

Notes: This table presents fixed effects robust estimation models of FBDs in CBs and IBs for earnings
management abnormal loan loss provisions between CBs and IBs. Columns 1 and 2 examine the effects of
FBDs as a continuous and discontinuous variable, respectively, on managerial behavior in CBs. Columns 3
and 4 examine the effects of FBDs as a continuous and discontinuous variable, respectively, on managerial Table VI.
behavior in IBs. The dependent variable is Abnormal (discretionary) loan loss provision, which is as the Effect of FBDs on
absolute value of the residual of LLP = f (BLLA, CTLO, NPLs, MNPLs, CEs, YRs). The rest of the variables
are BODs characteristics, SSBs traits and other control variables. The t-values are adjusted by using the abnormal loan loss
heteroscedasticity adjustment approach in White (1980). Standard errors are in parentheses. Significance at provision in IBs and
the 10, 5 and 1% levels are indicated by *, ** and ***, respectively CBs

IBs governance. This leads us to affirm that SSBs are important determinant that provide
precession in the internal mechanisms to IBs ensuring compliance with Shari’ah, as well as
enhancing moral and organizational behavioral integrity.

Robustness tests and results

This section provides additional analysis to ensure whether our results hold when
alternative regression specifications are examined. Expense preference behavior is an
alternative dependent variable that proxies for utility maximization behavior. It
suggests that bank managers act contrary to the best interest of their firms by pursuing
utility-maximization policies that favor excessive allocation of resources to salaries,
larger staffs, unnecessary benefits, more privileges, and costlier office settings. We use
the noninterest expense (NIE) to proxy for management expense preference behavior,
calculated as the sum of all noninterest expenses (e.g. salaries, wages, office and other
related expenses) divided by lagged assets (Johnson, 1993; Srinivasan, and Wall, 1992).
We use the same control variables as in the above regression models except for the LR,
CCF, ALL and RAs.
As Table II shows, the mean NIE values for bank-year observations included in our
sample is 6 per cent, while the mean NIE value for the IB-year observations is 0.6 per cent. In
Table III, Panel A, there is a significant mean difference in NIE (p-value smaller than 0.01
JIABR IBs without SSBs IBs with SSBs
11,4 (1) (2) (3) (4)
Variable LD LD LD LD

FBD 0.5486** (17.33) N 0.0167*** (4.88) N

FBD Indicator N 0.5488** (17.00) N 0.0129*** (4.03)
BODSize 0.17653* (1.98) 0.4444** (3.56) 0.0174*** (4.87) 0.0226*** (4.03)
780 BODInks 0.04454* (1.75) 0.2233** (12.00) 0.0235*** (4.24) 0.0308** (2.17)
Outsider 0.3874** (18.33) 0.5333** (10.00) 0.0213*** (3.91) 0.0163** (2.14)
CEOInks 0.8454* (5.00) 0.2444* (1.89) 0.0082** (2.11) 0.0067* (1.74)
SSB Size N N 0.0190*** (3.54) 0.0250*** (2.39)
SSBInks N N 0.0139*** (2.37) 0.0342*** (2.84)
Outside SSB N N 0.0061*** (1.72) 0.0069*** (2.32)
SSB Education N N 0.0322** (2.56) 0.0064*** (1.71)
LgAs 0.1336 (1.43) 0.0455 (1.56) 0.0052 (0.24) 0.0202* (0.60)
LR 0.0555 (0.16) 0.1882 (0.67) 0.0153 (1.51) 0.0164** (1.98)
CCF 0.222 (1.55) 0.34561 (1.56) 0.0059** (2.15) 0.0076** (2.52)
All 0.0037 (0.14) 0.0675 (0.345) 0.0071 (0.94) 0.0107 (0.53)
RAs 0.0442 (1.98) 0.0111 (1.11) 0.0205*** (3.69) 0.0228*** (4.00)
EIUCR 0.0553*** (2.44) 0.0457* (8.00) 0.0122 (0.69) 0.0117 (0.27)
ME 0.441*** (6.03) 0.0324*** (5.00) 0.288 (0.55) 0.0222*** (2.84)
GI N N N N
Observation 1074 1074 805 805

Notes: This table presents fixed effects robust estimation models of FBDs in IBs for earnings management
to avoid earnings losses. Columns 1 and 2 examine the effects of FBDs as a continuous and discontinuous
variable, respectively, on managerial behavior in IBs without SSBs. Columns 3 and 4 examine the effects of
Table VII. FBDs as a continuous and discontinuous variable, respectively, on managerial behavior in IBs with SSBs.
Effect of FBDs on The dependent variable is LD, and it is an indicator variable that equals 1 if a bank has a small ROA
(income before taxes scaled by total assets) between 0 and 0.01, and 0 otherwise. The rest of the variables
abnormal loan loss are BODs characteristics, SSBs traits variables and other control variables. The t-values are adjusted by
provision in IBs with using the heteroscedasticity adjustment approach in White (1980). Standard errors are in parentheses.
and without SSBs Significance at the 10, 5 and 1% levels are indicated by *, ** and ***, respectively

between CBs and IBs), suggesting a lower level of management expense preference behavior
in IBs. In Table IV, FBDs, measured in a continuous form, has positive association with NIE
in CBs, while it has a negative relationship with NIE in IBs.
Table IX shows the results of the association between FBD and NIE. We observe no
evidence that the estimates from the first regression techniques are biased or overstated.
Findings in Table IX are in line with those reported in Tables V and VI. Foreign directors in
CBs are ineffective monitors compared to foreign directors in IBs. CBs’ directors could be
considered as neglectful monitors that virtually encourage managers to engage in utility
maximization behavior whether measured by NIE, LD or Abnormal.
We also test whether the presence of foreign directors in IBs with SSBs has more
negative impact on management expense preference behavior than on the presence of
counterparts in IBs with no SSBs. Results reported in Table X show that the negative
association between FBD and NIE is more pronounced in IBs with SSBs. These results are
consistent with those reported in Tables VII and VIII. This also supports our claim that
Islamic business environments, which are embedded with additional layer of ethical and
internal monitoring mechanism (i.e. SSBs), motivate foreign directors to be effective
monitors.
Though BODs in economically significant countries prefer to nominate foreign
directors from the same significant economic background, owing to the similarity of
 IBs without SSBs IBs with SSBs
Corporate
(1) (2) (3) (4) governance
Variable Abnormal Abnormal Abnormal Abnormal

FBD 0.0789** (1.45) N 0.5929*** (17.56) N

FBD Indicator N 0.0049** (1.55) N 0.5970*** (18.07)
BODSize 0.0083* (0.45) 0.0652* (0.78) 0.5438*** (5.49) 0.6115*** (19.60)
BODInks 0.0045** (2.58) 0.0077* (1.57) 0.6349*** (18.59) 0.5976*** (13.50) 781
Outsider 0.1444* (1.48) 0.187* (1.54) 0.5095*** (5.04) 0.3629** (1.94)
CEOInks 0.2111** (2.22) 0.0553* (0.67) 0.0199*** (0.06) 0.1622*** (1.80)
SSB Size N N 0.0514*** (11.73) 0.0510*** (10.07)
SSBInks N N 0.0565*** (3.72) 0.1478*** (1.11)
Outside SSB N N 0.0602*** (2.93) 0.0665*** (3.21)
SSB Education N N 0.0276*** (3.43) 0.0254*** (3.16)
LgAs 0.0056** (2.54) 0.0457*** (3.67) 0.0044 (1.07) 0.006 (1.39)
LR 0.1228 (1.59) 0.0497 (0.67) 0.1899* (1.81) 0.0375** (0.56)
CCF 0.0153* (1.51) 0.0231* (0.04) 0.0580*** (11.29) 0.0503*** (9.67)
All 0.0171 (0.33) 0.0062 (0.26) 0.0087 (0.78) 0.0141 (0.98)
RAs 0.0153* (1.11) 0.0144** (0.87) 0.0704** (1.22) 0.0488** (0.73)
EIUCR 0.024*** (4.37) 0.0345* (1.89) 0.0312 (0.96) 0.0199 (0.42)
ME 0.112*** (2.23) 0.0348*** (4.08) 0.8287 (0.81) 0.0236*** (2.92)
GI N N N N
GH 0.022*** (2.59) 0.1567*** (2.89) 0.0868** (1.72) 0.1405** (1.03)
_cons 0.0323* (1.25) 0.0097*** (3.17) 0.2497* (1.70) 0.0061 (0.03)
Observation 1074 1074 805 805

Notes: This table presents fixed effects robust estimation models of FBDs in IBs for earnings management
abnormal loan loss. Columns 1 and 2 examine the effects of FBDs as a continuous and discontinuous
variable, respectively, on managerial behavior in IBs without SSBs. Columns 3 and 4 examine the effects of
FBDs as a continuous and discontinuous variable, respectively, on managerial behavior in IBs with SSBs. Table VIII.
The dependent variable is Abnormal (discretionary) loan loss provision, which is as the absolute value of Effect of FBDs on
the residual of LLP = f (BLLA, CTLO, NPLsMNPLs, CEs, YRs). The rest of the variables are BODs
characteristics, SSBs traits and other control variables. The t-values are adjusted using the abnormal loan loss
heteroscedasticity adjustment approach in White (1980). Standard errors are in parentheses. Significance at provision in IBs with
the 10, 5 and 1% levels are indicated by *, ** and ***, respectively and without SSBs

legal institutions and cultural values (Barrios et al., 2015), our findings indicate
different explanations. Foreign directors in IBs are more viable monitoring directors
even though they are serving on different economic background; however, the
corporate cultural values stemmed from the Shari’ah values and Islamic business
environments do influence them to become effective monitors. Further,
notwithstanding that Barrios et al. (2015) argue that greater cultural values and the
same significant economic background enhance the propensity of foreign directors, our
findings negate their argument, specifically that the existence of foreign directors in
CBs encourages bank managers to maximize their own utility.

Discussion and conclusion

There could be differences in unethically opportunistic behavior, and thus far, such an
association between the governance structure of CBs and IBs and opportunistic
behaviors maybe expected to vary. For example, Tables V and VI show that earnings
management (i.e. LD and Abnormal) is lower (higher) in IBs (CBs) with foreign directors
setting on the BODs. The results indicate that the decision-making process of BODs
JIABR CBs IBs
11,4 (1) (2) (3) (4)
Variable NIE NIE NIE NIE

FBD 0.0262*(1.67) N 0.1555* (1.09) N

FBD Indicator N 0.0061 (0.79) N 0.0555** (1.67)
BODSize 0.4428 (0.62) 0.3406 (0.47) 0.4144** (2.99) 0.0111* (0.08)
782 BODInks 0.088 (0.14) 0.3353 (0.48) 0.2222* (0.33) 0.533** (1.89)
Outsider 0.1069 (1.12) 0.0113 (0.13) 1.1000** (2.99) 0.3222* (1.51)
CEOInks 0.0133 (0.24) 0.4867 (0.48) 0.2225** (2.33) 0.4444** (2.00)
SSB N N 0.0085** (2.00) 0.2555**(2.78)
LgAs 0.0097 (0.69) 0.0198 (1.41) 0.0010 (0.08) 0.0039 (0.76)
EIUCR 0.0534 (1.31) 0.4338 (1.28) 0.2.223 (0.77) 0.3343 (0.13)
ME 0.1443* (0.65) 0.2736** (1.09) 0.4777** (1.81) 0.2333* (1.11)
GI 0.0102 0.2141 N N
_cons 0.018*** (83.45) 0.25*** (19.35) 0.077*** (12.00) 0.099*** (10.00)
Observation 1879 1879 1879 1879

Notes: This table presents fixed effects robust estimation models of FBDs in CBs and IBs for expense-
preference behavior. Columns 1 and 2 examine the effects of FBDs as a continuous and discontinuous
variable, respectively, on managerial behavior in CBs. Columns 3 and 4 examine the effects of FBDs as a
continuous and discontinuous variable, respectively, on managerial behavior in IBs. The dependent
Table IX. variable is noninterest expense (NIE), which is the sum of all noninterest expenses (e.g., salaries, wages,
office and other related expenses) divided by lagged assets. The rest of the variables are BODs
Effect of FBDs on characteristics, SSBs traits, and other control variables. The t-values are adjusted using the
noninterest expense heteroscedasticity adjustment approach in White (1980). Standard errors are in parentheses. Significance at
in CBs and IBs the 10, 5 and 1% levels are indicated by *, ** and ***, respectively

with foreign directors is influenced by not only knowledge, expertise and skills but also
corporate beliefs and values (Gabrielsson and Huse, 2004; Huse et al., 2011; Van Ees
et al., 2009). Tables VII and VIII depict that the results reported in Tables V and VI are
robust and provide strong perspective that Shari’ah principles and the role of SSBs lead
IBs to focus more on ethical and moral values in their transactions rather than credit
value. Consequently, optimal formal internal governance structures are instituted,
which are aimed at resolving conflict of interests arising from rational economic
motives and unethical opportunistic behavior.
Investigating CBs and IBs from within the competing Western theories like the
agency theory, contingency, resources dependence theory, steward theory and
stakeholders’ theory provide controlling sound governance mechanisms. Such theories
evolve around maximizing shareholders’ wealth via appointing internal or external
members. Such Western or secular ethical and moral codes adopted by transient and
parochial, as they are based on the values of their human founders. In CBs, foreign
directors are less likely to provide sound monitoring capabilities that improve
behavioral and financial performance, whereas in IBs with and without SSBs, foreign
directors successfully monitor and advise. It appears that the Western or secular
system of segregating ethics from religion is prevalent in CBs, even the ones that
operate in Islamic countries because Shari’ah values are abandoned and becoming
nonexistent.
However, our results provide encouraging evidence that foreign directors in IBs have
greater influence and stronger monitoring roles related to eliminating self-enhancing
activities among managers. We find this because of the application of Shari’ah. Shari’ah-
 IBs without SSBs IBs with SSBs
Corporate
(1) (2) (3) (4) governance
Variable NIE NIE NIE NIE

FBD 0.1335* (1.09) N 0.0031*** (1.12) N

FBD Indicator N 0.0575 (1.67)
**
N 0.0051*** (v1.79)
BODSize 0.4333** (2.99) 0.0122* (0.08) 0.2898*** (2.98) 0.3831*** (3.48)
BODInks 0.5552* (0.39) 0.443** (1.89) 0.4569 (4.05)
***
0.3958*** (3.50) 783
Outsider 1.1330** (2.99) 0.3322* (1.51) 0.2986*** (0.78) 0.3105*** (0.28)
CEOInks 0.2555** (2.33) 0.3544** (2.00) 0.4692*** (2.45) 0.4054** (2.14)
SSB Size N N 0.9145** (2.45) 0.519** (1.62)
SSBInks N N 0.127** (1.99) 1.0146** (2.17)
Outside SSB N N 1.07** (1.74) 0.8627** (1.78)
SSB Education N N 0.0677*** (0.72) 0.0712*** (0.75)
LgAs 0.3310 (0.08) 0.1039 (0.76) 0.1068 (1.23) 0.0013 (0.06)
EIUCR 0.2.323 (0.77) 0.4343 (0.13) 1.15 (0.38) 1.1783 (0.39)
ME 0.4744** (1.81) 0.2533* (1.11) 0.4895** (0.65) 0.2216* (0.33)
GI N N N N
_cons 0.056*** (12.00) 0.069*** (10.00) 0.15*** (38.53) 0.090*** (65.97)
Observation 1074 1074 805 805

Notes: This table presents fixed effects robust estimation models of FBDs in IBs for expense-preference
behavior. Columns 1 and 2 examine the effects of FBDs as a continuous and discontinuous variable,
respectively, on managerial behavior in IBs without SSBs. Columns 3 and 4 examine the effects of FBDs as
a continuous and discontinuous variable, respectively, on managerial behavior in IBs with SSBs. The
Table X.
dependent variable is noninterest expense (NIE), which is the sum of all noninterest expenses (e.g., salaries,
wages, office and other related expenses) divided by lagged assets. The rest of the variables are BODs FBD effects on
characteristics, SSBs traits and other control variables. The t-values are adjusted by using the noninterest expense
heteroscedasticity adjustment approach in White (1980). Standard errors are in parentheses. Significance at in IBs with and
the 10, 5 and 1% levels are indicated by *, ** and ***, respectively without SSBs

based institutions enforce and reinforce moral and ethical principles, which are based on
religion. Hence, the corporate culture in organizations that follow Shari’ah tends to have
more self-discipline (Wilson, 2002).
Overall, our results are in line with Ramaswamy and Li (2001) and Zhang and Uchida
(2012). In addition to curbing or mitigating unethical behavior, our findings suggest that
religion favorably influences BODs, specifically foreign directors. In turn, this suggests
religion affects managerial decision-making. It also suggests that SSBs help foreign
directors be more effective monitors and curb unethical behavior among managers. Our
results are robust across a number of econometric models that sufficiently account for
alternative corporate governance, earnings management and expense-preference behavior
proxies, as well as potential endogeneity problems.
Like any other empirical research of this nature, this study is imperfect and has
limitations requiring the findings to be carefully interpreted. First, the current study focuses
on banks only which makes its results subject to sample bias; there are many other forms of
financial institutions (e.g. investments, real-estates and mutual funds) complying to the
Shari’ah law. Second, owing to the lack of FBD characteristics, we cannot investigate the
intensity of the specific characteristics that could have specific directions in affecting
managerial behavior. Future research may attempt to compare our results with FBD
characteristics. Last, we do not measure the activity of FBDs through the number of board
meetings they attend. It is possible that FBDs miss their board meetings due to traveling
JIABR delay or inability to travel. Future research may also extend the sample to all Islamic
11,4 institutions worldwide.
The findings in this paper may help standards-setters, auditors, investors, and regulators
take appropriate measures and create better policies that reduce managers’ discretion. This
could in turn improve information transparency decision-making, monitoring, advising and
accounting quality.
784
Notes
1. IBs have certain distinguishing features. First, IBs strictly prohibit riba (interest) due to beliefs
about equality, justice and property rights. Second, speculative behavior and gambling are not
allowed. IBs also embrace the concept of profit-loss sharing, where capital suppliers become
investors instead of creditors and entrepreneurs share business risks in return for a share of
earnings. The sanctity of contracts is another feature of IBs, which minimizes information
asymmetry and moral hazard. Further, all activities and transactions must be Shari’ah
compliant. Business dealings involving alcohol, pork, drugs and games of chance are not
allowed. Last, IBs embrace social justice; they avoid any deal or transaction that results in
exploitation and injustice (Bouheni and Ammi, 2015; Mejia et al., 2014).
2. Language barriers are increasingly lower, as many boardrooms run their meetings in English
(such as Nokia and Skandia). Also, in some countries (e.g., Germany) boardrooms use interpreters
(Smith, 2011). In addition, foreign directors residing in their home countries may miss board
meetings in the country’s home country because of the long distance, potential travel delays,
travel cancellations, or high costs of travel. Therefore, foreign directors have less time to monitor
activities (Oxelheim and Randoy, 2003).
3. This is clear for large boards. As board size increases, there is potential for free-riding
directorship. As a result, the value of highly contributing members becomes diluted, which
inversely affects firm value (Jensen, 1993; Tosi et al., 2003). Also, outside directors may become
less motivated to perform their tasks, because they have less access to information upon which to
base their opinions and decisions.
4. IBs have branches and operations in different countries. For example, Kuwait Finance House,
headquartered in Kuwait and with a market capitalization of $8.2bn as of May 2016, has
several banks in Bahrain, Turkey, Malaysia, Saudi Arabia, United Arab Emirates, Jordan
and Germany; it also has many investment activities in the USA, Europe, Southeast Asia and
the Middle East. There are several reasons Islamic banking is booming: (i) it has a green
financing platform; (ii) it offers Shari’ah-compliant products; (iii) it welcomes non-Muslim
investors; (iv) it uses global indexing; (v) the oil-wealthy Gulf Cooperation Council uses it; (vi)
it has streamlined, simpler rules; (vii) it exists in a no-crisis zone; (viii) it embraces thoughtful
decision-making; and (ix) it is active in Malaysia, which has the largest Muslim population
(Borneo Post Online, 2013).
5. Notably, many IBs seek cross-listing on foreign markets, which may require foreign directors to
emphasize the BOD’s monitoring activities or signal motivation for increased monitoring mechanisms.
6. IB BODs cannot sign contracts with outsiders and authorize new or modified products and
services without first getting SSB approval. As noted, the SSB has to verify the transactions
comply with Shari’ah principles.
7. The results are similar when we use 0.005 and 0.002 as the interval threshold.
8. Given Iran has a very high concentration of IBs compared to other countries, in a robustness
check, we rerun our tests excluding Iran from our sample and our results hold.
9. The explanation refers to the indicator variable and not the continuous variable.
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JIABR Appendix
11,4
Variable Definition

LD Loss avoidance is an indicator variable that equals 1 if a bank has a small ROA (income
before taxes scaled by total assets) between 0 and 0.01, and 0 otherwise
Abnormal Abnormal (discretionary) loan loss provision is as the absolute value of the residual of
790 LLP = f (BLLA, CTLO, NPLs, MNPLs, CEs, YRs)
NIE Noninterest expense is the sum of all noninterest expenses (e.g., salaries, wages, office
and other related expenses) divided by lagged assets
FBD Indicator The ratio of foreign directors to the total number of directors on each board.
FBD An indicator variable it equals 1 if the board of director has foreign directors; it equals 0
otherwise
LgAs Bank size is measured as the natural logarithm of total assets at the end of year t
LR Loan ratio is the total loans scaled by total assets at the beginning of year t.
GH Growth is the change in total assets from the beginning to the end of year t
CCF Change in cash flow and loan loss allowance, calculated as the change in total loans
outstanding deflated by beginning total assets at beginning of year t
ALL Allowance for loan losses at the end of year t scaled by total assets at beginning of year t
BODSize Total number of directors on the board
Outsider The ratio of outside directors to the total number of directors on each board
BODInks Board interlocks is the ratio of board members with interlocks to the number of directors
on each board
CEOInks CED interlocks is the ratio of CEO directorates to the total number of directors on each
board
SSB An indicator variable that is equal to 1 if SSB is within the governance structure of the
IB, and 0 otherwise
SSB Size The total number of SSB members on the board.
SSBInks The ratio of SSB members’ interlocks to the total number of SSB members on each
board
Outside SSB The ratio of SSB members exogenous to the IB to the total number of SSB members
SSB Education An indicator variable that is equal to 1 if a member of the SSB holds a postgraduate
degree, and 0 otherwise
ME A region indicator variable to account for differences between countries
RAs Potential risky assets is the total risky assets (i.e., assets that are equity-type contracts)
scaled by total assets at the beginning of year t
EIUCR A control variable used as a proxy for the quality of regulation and the legal
environment, as well as economic, political, and business-trend developments that are
likely to affect bank creditworthiness measured by the European Intelligence Unit
country risk
ME Middle East is an indicator variable to control for the fixed region effects
Table AI. GI Country level governance index is used to control for institutional differences among
Variables definition different countries

About the authors

Ali R. Almutairi is the editor of Arab Journal of Administrative Science (AJAS) and an Associate
Professor of Accounting at Kuwait University. He holds a BS degree in Accounting from Kuwait
University, a MS degree in Accounting from University of Colorado and a PhD in Accounting from
Florida Atlantic University. He has published articles in a variety of academic journals including
Managerial Auditing Journal, Journal of Management and Governance, Malaysian Accounting
Review, Thunderbird International Business Review and Social Responsibility Journal. His research
interests include corporate governance, audit quality, capital market and earnings quality. Dr
Almutairi was the director of the MBA program at Kuwait University and a Financial Consultant at
Kuwait Central Statistical Bureau.
 Majdi Anwar Quttainah holds PhD in Management from Rensselaer Polytechnic Institute, Lally Corporate
School of Management and Technology (USA). He obtained MBA degree with merits from the
Business School and Entrepreneurship at Newcastle University (UK), and Bachelor degree in governance
International Business from the American International University in London (UK). Dr Quttainah is
an Assistant Professor and soon will be an Associate Professor of Management in the College of
Business Administration at Kuwait University, and he works on consultation and training projects as
a freelancer. His research and teaching interests are corporate governance; the three levels of
strategies, specifically corporate strategy, international management, and business, entrepreneurship
and small business, and organizational change and development. Majdi Anwar Quttainah is the
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corresponding author and can be contacted at: [email protected]

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