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CORPORATE GOVERNANCE, RISK-TAKING AND FIRM PERFORMANCE OF

ISLAMIC BANKS DURING GLOBAL FINANCIAL CRISIS

M. Kabir Hassan, Ph.D.

Professor of Finance and

Hibernia Professor of Economics and Finance

Department of Economics and Finance

University of New Orleans

New Orleans, LA 70148

Office Email: mhassan@uno.edu

Alternate Email: KabirHassan63@gmail.com

Office Phone: 504-280-6163

Cell Phone: 610-529-1247

Sabur Mollah, Ph.D.

School of Business

Stockholm University

SE-106 91, Stockholm

Sweden

Phone: +468163034

E-mail: sabur.mollah@fek.su.se

http://goog_516793021/mailto:KabirHassan63@gmail.comtel:504-280-6163tel:610-529-1247mailto:sabur.mollah@fek.su.se

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CORPORATE GOVERNANCE, RISK-TAKING AND FIRM PERFORMANCE OF

ISLAMIC BANKS DURING GLOBAL FINANCIAL CRISIS

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: The global banking system virtually halted during the recent

global financial crisis, but Islamic Banks were not as exposed as much. We examine if a

multi-layer governance structure laced with Islamic ethical banking principles was

responsible for preventing Islamic banks to fail during the 2007-2009 financial crisis.

Research Findings/Insights: Using a paired-sample of 84 Islamic and conventional banks

from Bangladesh, Bahrain, Malaysia Pakistan, Saudi Arabia, the United Arab Emirates, and

the United Kingdom over the period of 2006-2009, we find that the corporate governance and

financial disclosure indices emerged as the key driving forces for risk-taking for Islamic

banks.

Theoretical/Academic Implications: This research contributes to the multi-layer corporate

governance model that is based on moral values as practiced in Islamic banks can be an

effective governance mechanism in minimizing future financial crises.

Practitioner/Policy Implications: Our findings cast doubt on the independence of Shari’ah Boards. Multiple board positions limit their ability to function as effective monitors as well as Islamic value proposition quality controllers. Keywords: Corporate Governance, Islamic Banks, Financial Crisis

JEL Classification Codes: G34, Y90, G01

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CORPORATE GOVERNANCE, RISK-TAKING AND FIRM PERFORMANCE OF

ISLAMIC BANKS DURING GLOBAL FINANCIAL CRISIS

INTRODUCTION

The Financial Crisis Inquiry Report (FCIC, 2011) concludes, inter alia, that dramatic

failures of corporate governance and risk management of financial institutions coupled with a

systematic breakdown in accountability and ethics were responsible for the recent financial

crisis. The global banking system halted during the crisis, but Islamic Banks (hereafter IBs)

were not exposed1. However, some of the world’s largest financial institutions e.g., Lehman

Brothers and Merrill Lynch were bailed out during crisis. While the causes of the crisis will

be debated for years to come, at least two questions have drawn considerable attention among

academics, investors, and policy makers. First, how did the IBs tackle the global financial

crisis? Second, what were the strengths in the governance system of IBs?

IBs can be distinguished from their conventional counterparts (hereafter CBs) in, at

least, two significant ways. Firstly, at the top of its governance structure, IBs must institute a

supervisory board called the ‘Shari’ah Supervisory Board (hereafter SSB)’, which acts as an

additional layer of governance2. SSB acts as an independent control mechanism in restraining

the board of directors and other governance agents from engaging in risk taking activities;

therefore, IBs board structure should be prevented from aggressive risk taking during

financial turbulence like the crises. However, the SSB in IBs board structure are morality and

ethics driven rather than greed; therefore, IBs boards mitigate shareholders incentives since it

is achieved at the cost of tax payers or moral hazard or deposit insurance, especially the IBs

board focuses on ensuring social justice. Thus, IBs board will take fewer risks during the

financial turbulence and eventually IBs survive from financial crisis. The same argument is

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also valid in case of the powerful CEOs in IBs. The powerful CEO has the incentive to be

engaged in less risky investments (e.g., Hermalin and Weisbach, 1998; and Pathan, 2009) and

hence, the CEOs help mitigate financial fragility for the IBs during crisis. However, due to

the Shari’ah restriction, the financial and risk disclosure, and transparency levels are high in

IBs; therefore, higher level of disclosure and transparency help IBs less risk-taking and

hence, IBs maximize shareholder value and performance. Based on these arguments, we have

proposed a theoretical model for the IBs governance structure as below (Figure 1).

Figure 1: Theoretical Model of the Governance Model for the Islamic Banking

These distinctions between CBs and IBs are utilized in this study to examine, firstly,

whether the multi-layer governance provided via the SSB acts as an independent control

mechanism in restraining the board of directors or other governance agents from engaging in

excessive risk taking. Secondly, the distinction between the two-types of banking systems is

utilized to test whether IBs supposed adherence to ethical conduct resulted in shielding them

from the devastating effects of the financial crisis and create shareholder value and hence,

perform better during crisis. By analyzing the regression results and survey responses, we

conclude that the corporate governance index (CGI) and financial disclosure and

Shari'ah Supervisory

Board

• SUPRA AUTHORITY:

• Shari’ah Supervisoty Board (SSB) helps Islamic Banks adhere to the morality and ethics rather than greed

• Shari'ah Supervisory Board (SSB) ensures social justice

Board of Directors

• ETHICS AND MORALITY DRIVEN BOARD:

• Refrain from Aggressive Risk Taking

• Eventually protect Islamic banks against fallibility during unusual financial circumstances and help create shareholder value and perform better

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transparency index (FDTI) emerged as the key driving force for risk-taking behavior of IBs

during financial turbulence. However, the board structure of the IBs is driven by the short-

term profitability during financial crisis. The current state of the Shari’ah supervision (SSB)

pronounced as the weak indicator of the IBs governance mechanism, which is blamed to be

the cause of poor performance of IBs governance mechanism. Since, Shari’ah plays a vital

role in governance mechanism of IBs (Lewis, 2005), there was a need in researching Shari’ah

governance and corporate governance together. In this respect, this is the first study, which

captures both Shari’ah governance and corporate governance together in determining the role

of SSB in the governance system of IBs. However, the pair sample comparison in this study

help interprets the role of SSB more precisely.

The studies by Akhigbe and Martin (2008) and Pathan (2009) highlight the disclosure

and governance practices and risk-taking behavior of US Banks around Sarbanes-Oxley Act

2002, but nothing is done on the IBs governance and risk-taking. Thus, none of these studies

is enough to understand the risk-taking behavior of IBs during global crisis. Therefore, this

study brings new thoughts in the Islamic banking research. However, the studies by Sierra et

al. (2006), Adams and Mehran (2012), Anders and Valledado (2008), Wintoki et al. (2012),

Francis et al. (2012) and Pathan and Faff (2013) investigate the governance mechanism and

firm performance/value, but nothing in this kind is conducted on the IBs. Even though there

are some contradictions of results with the existing studies, this study adds value in the

existing literature by producing empirical evidence between governance and firm

performance/value for the IBs during financial crisis. Nevertheless, this study develops four

distinct governance indices having thirty-two parameters, which is extensive in terms of the

available literature either in traditional banking governance literature or in Islamic banking

literature.

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The rest of the paper is organized as follows: section 2 presents the literature review

and hypotheses development; the data and methodology is described in section 3; section 4

elaborates the empirical results; and concluding remarks are reported in section 5.

REVIEW OF RELATED LITERATURE AND HYPOTHESES DEVELOPMENT

Corporate governance and bank risk-taking literature emphasizes shareholder incentives and

managers’ incentives. Similar to the usual corporations, bank shareholders have a preference

for excessive risk-taking due to the moral hazard problem and limited liability, and convex

pay-off systems (Galai and Masulis, 1976; Jensen and Meckling, 1976; and John et al., 1991).

However, due to the higher level of information asymmetry in the banking companies, the

dispersed and unsophisticated debt holders can not prevent the shareholders from more risk

taking by initiating complete debt contracts on an ex-ante basis (Dewatripont and Tirole,

1994). Therefore, bank shareholders have strong incentives for excessive risky investments

so that they can maximize their potential benefits at the cost of deposit insurance and tax-

payers money. Nevertheless, John et al. (1991) have concluded that risk-adjusted deposit

insurance premium and risk-adjusted capital fail to mitigate the moral hazard problem and

control banks’ risk taking incentives fully. Thus, bank managers’ opportunistic behaviour

depends on the board structure.

Furthermore, agency conflict between shareholder-manager is a central issue for the bank

governance because managers may not serve for the best interest of the shareholders.

Therefore, a clear understanding about managers’ incentives regarding bank risk-taking

should be elaborated. Managers’ wealth consists of a portfolio of tangible and financial

assets, and human capital. Since managers’ wealth is concentrated in the firms the managers

manage, managers protect their wealth internally by selecting excessively safe assets or

diversification at the firm level (Smith and Srulz, 1985; and May, 1995). Furthermore, tax

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shield and bankruptcy costs in the highly levered firms like banks contribute management

incentives towards selecting overly safe projects rather than excessively risky project (Parrino

et al., 2005). Managers’ risk-taking incentives differ depending on their compensation

packages. In addition, bank managers are risk averse while their compensation is based on

fixed salaries rather than through shares and option programs because managers have little to

gain if banks do very well, but they have a chance to lose the job when the bank fails

(Saunders and Cornett, 2006). Thus, shareholders and managers incentives conflict since

shareholders want managers to invest in all positive net present value projects, irrespective of

their level of risk (Guay, 1999) but bank managers accept some safe, value-reducing projects,

and reject some risky, value increasing projects (May, 1995).

However, CEO power measured by CEO duality (Hermalin and Weisbach, 2003; and Pathan,

2009) influences boards monitoring ability (Fama and Jensen, 1983; and Jensen, 1993), and

since CEOs has incentives to take less risk; therefore, CEO power negatively affects bank

risk-taking. Board size negatively affect firm performance (Hermalin and Weisbach, 2003)

due to coordination cost and free-riding problems and individual directors incentives to

acquire information and monitor managers is low in large boards; thus, CEOs find the large

boards control better (Jensen, 1993). Strong boards measured by board size and board

independence (Pathan, 2009) are expected to be better monitor bank managers for the

shareholders interest and hence, high risk-taking.

In addition, a sizeable literature investigates the relationship between governance

mechanisms and firms’ performance and shareholder value for the non-financial firms (see

Weir et al., 2002 and Stanwick and Stanwick, 2010), but the empirical studies generate

inconclusive results (see Gani and Jermias, 2006; Larcker et al., 2007; Stannwick and

Stanwick, 2010; and Bauer et al., 2008). Some studies provide evidence showing a positive

effect of corporate governance on non-financial firm value (e.g. Lee et al., 1992). However,

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some studies report a negative association between corporate governance and firm value (e.g.

Hutchinson, 2002), while other studies find no impact of corporate governance on firm value

(e.g. Gupta et al., 2009). But the empirical literature on governance and performance or value

is limited on the banking sector except a few (for example Sierra et al. 2006; Anders and

Valledado, 2008; Adams and Mehran, 2012; Francis et al. 2012; Wintoki et al. 2012 and

Pathan and Faff, 2013). Sierra et al. (2006) suggest that strong board improve bank

performance. Adams and Mehran (2012) also produce similar results for board size, but they

fail to identify any relation between performance and independent directors. Anders and

Valledado (2008), on the other hand, show a positive but concave effect of both bank board

and independent directors on bank performance. Furthermore, Wintoki et al. (2012) report no

relation between board size or board independence and firm performance, but Francis et al.

(2012) show that better governed firms perform well during financial crisis. In addition, the

financial stability and risk taking is a serious research issue during global financial problem.

Akhigbe and Martin (2008) and Pathan (2009) study the board structure and bank risk-taking,

especially capital regulations, charter value, market discipline and ownership structure as the

controlling mechanisms were captured in their studies.

Despite the fact that there are a few studies recently published on banking governance, risk-

taking and performance, the literature on Islamic banking governance is very limited.

Safieddine (2009) has stressed that the corporate governance mechanism in Islamic banking

is unique, which is adhere to Shari’ah governance (Abu-Tapanjeh, 2009; and Chowdhury and

Hoque, 2006) and hence, Shari’ah board plays a vital role in the governance mechanisms of

the Islamic banking (Lewis, 2005). Thus, corporate governance research should analyze

Shari’ah governance alongside to get a complete picture of the governance mechanism of

Islamic banking. The existing literature on corporate governance of Islamic banking (e.g.,

Abu-Tapanjeh, 2009; Chowdhury and Hoque, 2006; and Lewis, 2005) addressed the

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theoretical viewpoints of the governance mechanisms of Islamic banking. However,

Safieddin (2009) has studied the agency framework related to the cash flow and control rights

of investors based on a survey over Saudi Arabia, Kuwait, Qatar, Bahrain, and United Arab

Emirates. Furthermore, the research on the Shari’ah governance is also very limited. Grais

and Pellegrini (2006) and Hasan (2011) have studied the theoretical aspects of the Shari’ah

governance of Islamic banking. Therefore, the existing literature on corporate governance is

not only limited but also has failed to link Shari’ah governance and corporate governance

mechanisms of the Islamic banking. However, there is no study found on the risk taking,

governance mechanism and performance of IBs during the financial crisis; therefore, this area

urges a need for research.

We assume that the monitoring ability of the Shari’ah Supervisory Board (SSB) in restraining

IBs from Shari’ah incompliant products and hence, refraining from excessive risk taking and,

in turn, help perform better. This paper investigates the role of Shari’ah backed Islamic

banking governance mechanism and the role of SSB on risk-taking and firm performance of

IBs during the financial crisis implementing the following hypotheses:

Hypothesis 1: There is no relationship between governance structure of IBs and risk-taking.

Hypothesis 2: There is no relationship between governance structure of IBs and firm

performance.

Hypothesis 3: There is no relation between Shari’ah Supervisoty Board (SSB) and the risk-

taking of IBs.

Hypothesis 4: There is no relation between Shari’ah Supervisoty Board (SSB) and the firm

performance of IBs.

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DATA AND METHODOLOGY

We primarily looked into BankScope database for the banking data. There are 147 Islamic

Banks listed in the BankScope database, but a large number of IBs do not fully involve into

the Shari’ah compliant products. Moreover, there are plenty of missing data in the

BankScope database for the Islamic Bank. Therefore, we collected data by hand from the

Islamic Banks, which fully provide Shari’ah compliant products. We include 59 Islamic

Banks in the sample. In addition, we collected the corporate governance data from the annual

reports of these banks. We match the conventional banks from the same country comparing

the similar size, but were able to match only 25 conventional banks. The data consists of 84

banks (59 Islamic and 25 Conventional) from Bangladesh, Bahrain, Malaysia, Pakistan,

Saudi Arabia, The United Arab Emirates, and The United Kingdom over the period of 2006-

2009. In addition, we have conducted an extended questionnaire survey over the Shari’ah

board members from the sample Islamic banks. We sent 47 questionnaires to the Shari’ah

scholars during April-July, 2012 to Bangladesh, Bahrain, Malaysia, Pakistan and the UK. The

Shari’ah governance data from the survey has been included in the analysis to test hypotheses

3 and 4.

Measures of Dependent Variables:

This paper investigates risk-taking and firm performance/value by the IBs governance

structure. The risk-taking variable is defined as investment in risky assets and securities to

total loans. The firm performance is measured using return on equity (ROE) and return on

assets (ROA). The ROE is calculated as net income divided by total equity and ROA is

calculated as net income divided by total assets. The similar proxies are implemented by

Hutchinson and Gul (2004) and Gani and Jermias (2006). The paper uses Tobin’s Q as a

market-based measure of firm value. Tobin’s Q is calculated as the Market-to-Book-Value of

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the equity ratio. The similar proxy for firm value is also implemented by Yermack (1996),

Weir et al. (2002), and Haat et al. (2008).

Measures of Explanatory Variables:

To capture the corporate governance structure, we construct four indices. The indices are

board structure index (BSI), financial disclosure and transparency index (FDTI), risk

disclosure index (RDI) and corporate governance index (CGI). The BSI, FDTI, and RDI are

the sub-indices; therefore, CGI constitutes all the three indices. The BSI constitutes sixteen

different aspects of board and CEO structure. The FDTI, on the other hand, contents eleven

components of the audit firm/committee, risk committee, and Shari’ah committee. In

addition, the RDI contents the disclosure of the five key risk parameters. Furthermore, the

CGI consists of all thirty-two characteristics, which contents the BSI, FDTI, and RDI.

Finally, the SSB (Shari’ah Supervisory Board) is introduced as a dummy variable in the

model. The other explanatory variables including firm and country specific variables are

described in Table 1.

_____________________

Insert Table 1 about here

_____________________

To test the hypotheses (H1-H43), we use the following models (1)-(2):

Model 1

Yb,c,t=α0+α1*BSIb,c,t+α2*FDTIb,c,t+α3*RDIb,c,t+β1*SSBb,c,t+γ*Xb,c,t+δ*MEc,t+ εb,c,t…(1.1)

Yb,c,t=α0+α1*CGIb,c,t+ β1*SSBb,c,t+γ*Xb,c,t+δ*MEc,t +εb,c,t…(1.2)

Yb,c,t=α0+α1*CGb,c,t+ β1*SSBb,c,t+γ*Xb,c,t+δ*MEc,t +εb,c,t…(1.3)

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Where

Yb, c,t is the proxy for the Risk-taking for bank b in country c at time t,

BSIb,c,t is the Board Structure Index of bank b in country c at time t,

FDTIb,c,t is the Financial Disclosure and Transparency Index of bank b in country c at

time t,

RDIb,c,t is the Risk Disclosure Index of bank b in country c at time t,

CGIb,c,t is the Corporate Governance Index of bank b in country c at time t,

CGb,c,t is the Corporate Governance variables (Board and CEO related) of bank b in

country c at time t,

SSBb,c,t is the Shari’ah Supervisory Board variables for bank b in country c at time t,

Xb,,c,t is a matrix of firm level variables (asset size, tier1 capital, and leverage),

MEc is a matrix of country level macroeconomic variables, and

b,c,tis the error term. α0 is the constant and , , , and are the vectors of coefficient

estimate.

Model 2

Yb,c,t=α0+α1*BSIb,c,t+α2*FDTIb,c,t+α3*RDIb,c,t+β1*SSBb,c,t+γ*Xb,c,t+δ*MEc,t+ εb,c,t…(2.1)

Yb,c,t=α0+α1*CGIb,c,t+ β1*SSBb,c,t+γ*Xb,c,t+δ*MEc,t +εb,c,t…(2.2)

Yb,c,t=α0+α1*CGb,c,t+ β1*SSBb,c,t+γ*Xb,c,t+δ*MEc,t +εb,c,t…(2.3)

Where

Yb, c,t is the proxy for the firm value (Tobin’s Q) and/or Firm Performance (ROE and

ROA) for bank b in country c at time t,

BSIb,c,t is the Board Structure Index of bank b in country c at time t,

FDTIb,c,t is the Financial Disclosure and Transparency Index of bank b in country c at

time t,

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RDIb,c,t is the Risk Disclosure Index of bank b in country c at time t,

CGIb,c,t is the Corporate Governance Index of bank b in country c at time t,

CGb,c,t is the Corporate Governance variables (Board and CEO related) of bank b in

country c at time t,

SSBb,c,t is the Shari’ah Supervisory Board variables for bank b in country c at time t,

Xb,,c,t is a matrix of firm level variables (asset size, tier1 capital, and leverage),

MEc is a matrix of country level macroeconomic variables, and

b,c,tis the error term. α0 is the constant and , , , and are the vectors of coefficient

estimate.

Estimation Method

In estimating the above equations we use OLS. We attempted to apply Random-effect

GLS (Baltagi and Wu, 1999) and fixed effect panel data analysis method, but neither of those

were appropriate with our data for several reasons: First, the time-invariant parameter like

religion cannot be estimated with fixed-effect. Second, the board structure variables

(BOARD and INDEP), CEO power (CEO_CHAIR, CEO_INTERNAL) etc. do not vary

much over time, where the fixed-effect estimation should be inappropriate (Wooldridge,

2002, p. 286). Hence applying fixed-effect estimations would lead to massive loss of the

degrees of freedom (Baltagi, 2005, p. 14).

Description of the Data:

Table 2 presents descriptive statistics of the variables. The mean value of Tobin’s Q is

19.09% for the Islamic sample and 0.01% for the Conventional pair, with standard deviations

of 22.61% and 0.02%. Return on assets (ROA) and return of equity (ROE) are 5.18% and

33.51% for the Islamic sample and ROA and ROE for the Conventional pair are 0.89% and

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14.79%. The market values of both the Islamic and Conventional pair are significantly

undervalued. This could be due to sample selection, because all but one belongs to emerging

economies. However, returns (ROA and ROE) are significantly higher in the Islamic banks,

compared to the Conventional pair. Previous studies prominently identify Islamic banks as

being highly profitable, compared to Conventional banks. This study supports the previous

evidence. BSI, FDTI, and RDI are the sub-indices for composite corporate governance index

‘CGI’. Islamic banks produce worse governance indicators (e.g., BSI = 0.2856, FDTI =

0.3105, RDI = 0.4851, and CGI = 0.3253), compared to the Conventional pair. These primary

results help in the interpretation that the governance system in Islamic banks is worse,

especially the governance indices, compared to that of their pairs. But, we see a different

picture while we consider the board and CEO specific variables. Despite the fact that board

size and CEO-chair variables are insignificant, the board independence and internal CEO

(CEO-exe) are significantly different in IBs compared to the CBs, which indicate that the

boards are strong and the CEOs are powerful in IBs. However, we select the Conventional

pair very carefully by considering approximately the same size and location; therefore, we

can see that the sizes for both the samples are approximately similar. Noticeably, we find that

Islamic banks’ exposures to risky securities are 27.15% whereas their Conventional pair

invests only 2.90%. Financial leverage is more or less similar for both banking practices.

Nevertheless, we can see that the capital adequacy ratio (Tier 1 Capital) in Islamic banks is

significantly different from their Conventional pair, which indicates excess liquidity in

Islamic Banks.

_____________________

Insert Table 2 about here

_____________________

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EMPIRICAL RESULTS

Correlation Analysis

Table 3 presents the correlation matrix for both the samples in the study. The market

based performance variable ‘Tobin’s Q’ is positively related to the board structure index

‘BSI’, the financial disclosure and transparency index ‘FDTI’, and the overall governance

index ‘CGI’ and board independence but negatively related to the risk disclosure index

‘RDI’, board size, CEO variables (CEO-Chair and CEO-EXE) for the Islamic banks sample.

On the other hand, Tobin’s Q is negatively related to all the corporate governance

indices/variables except RDI and board independence in the Conventional sample. These

correlation coefficients indicate that the corporate governance initiatives are value

accelerating for Islamic banks, but value destructing for Conventional banks. However, risk

disclosure is value depreciating for both samples.

The story is opposite when we view the accounting based performance or return

variables. The return variables are positively related to BSI, FDTI, and board structure

variables, but negatively related to RDI and CEO variables for the IBs. However, the results

are mixed in case of Conventional banks. These results create confusion. The Islamic banks

are more profitable than the Conventional pair and the governance mechanisms, especially

board structure is the key driving force for financial performance. However, financial

disclosure may have played a significant role for the performance of Islamic banks.

Scholars broadly agree that Islamic banks follow the Basel accord strictly and, Islamic

banks have plenty of customers and hence deposits as a result of adherence to faith-based

investing. However, practitioners express the view that Islamic banks never fall below

minimum capital requirements and have excess liquidity. These are said to be the key success

indicators for the Islamic banks. This is reflected in the relationships between tier 1 capital

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and the financial leverage variables (Table 3, PANEL A).

_____________________

Insert Table 3 about here

_____________________

Results for Risk-Taking and Corporate Governance

We conduct panel data analysis to investigate the relationship between risk exposure

and the corporate governance indicators/variables for the 84 Islamic and conventional banks

over the 2006-2009. Corporate governance indices (BSI, FDTI, RDI, and CGI), board

structure and CEO variables are tested against firm risk taking in models 1.1-1.3. The results

of the model for both Islamic and conventional banks are presented in Table 4. All models

are fitted with pooled OLS method4. The F-statistics for all models are highly significant,

which indicate the OLS pooled regression is the right choice. The results show that the CGI

and FDTI are highly significant, which indicate that the corporate governance mechanism as

a whole and financial disclosure and transparency in particular emerged as the key driving

force for risk taking for Islamic banks. Similarly, the full-sample finds positive (significant)

results for CGI and FDTI. However, board size influences risk-taking for the full-sample

(Panel C). Scholars generally argue that the risk exposure of Islamic banks is not high, due to

Shari’ah prohibition, but the reality is little different. We argue that Shari’ah prohibition may

restrict Islamic banks in investing the products and services having ‘excessive uncertainty

(gharar)’, but short-term profitability may be the key motivation for the risk-taking.

Nevertheless, the board structure and CEO power variables seem to be ineffective in

controlling risky investment for Islamic banks. Conversely, board independence for the

conventional banks together with risk disclosure index appears as conservative instruments in

risk-taking. In addition, size and financial leverage play significant roles in protecting Islamic

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banks from high, but none of them matter for Conventional banks. Nevertheless, the SSB

appear as a significant parameter for the risk-taking for the IBs. This result contradicts the

basic arguments of the paper since we argue that the IBs Shari’ah Supervisory board restraint

IBs in taking excessive risks. This could be because of the weak supervision ability or

ineffective supervisory board in IBs, which should be analysed more detail based on the

survey reports.

_____________________

Insert Table 4 about here

_____________________

Results for Shareholders’ Value, Firm Performance and Corporate Governance

We conduct panel data analysis to investigate the relationship between shareholder

value and the corporate governance indicators on the 84 Islamic and Conventional pair

sample over the 2006-2009 period. Three different models (2.1-2.3) for both Islamic and

Conventional banks are presented in Table 5 (Panel A, B, and C). All the models are fitted

with Pooled OLS method4. In Panel A, we find that board structure variables (board size and

independence) are positively significant with ROA, which indicate that these variables are the

key driving forces for the Islamic banking profitability. Conversely, the coefficients of FDTI

and CGI indices are negatively significant with performance variables, which indicate that

these indices destruct Islamic banks profitability. The similar results are reported in the full-

sample (Panel C). However, risk-taking behaviour, religion and financial leverage help

Islamic banks making short-term profits (ROA and ROE). On the other hand, the risk

disclosure index (RDI) and FDTI play key roles in conventional banks profit and value

destruction (Panel B). Nevertheless, financial leverage positively influences conventional

banks profitability. Nevertheless, religion and SSB played a leading role in profit making

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mechanism for the full-sample (Panel C). These results indicate that governance mechanisms

provide a weak explanation to changes in shareholders’ value measured by Tobin’s Q for

Islamic banks.

However, Hutchinson and Gul (2004) and Gani and Jermias (2006) view accounting-

based performance measures as better reflections of managerial actions for the non-financial

firms, since they are under management control, but our results contradict these studies. Our

results, however, support Yermack, (1996), Eisenberg et al, (1998), Fuerst and Kang (2000),

Bahgat and Black, (2002), and El Mir and Seboul, (2008). The findings also support the

similar arguments of Mishra et al. (2001) that smaller boards make decisions more quickly

and play a controlling function, whereas large boards lack genuine interaction and are less

likely to become involved in strategic decision-making (Judge and Zeithaml, 1992 and

Lipton and Lorsh, 1992).

This result coincides with Chang and Leng (2004) and Rechner and Dalton (1991) in

that the dual role of a CEO can have a positive effect on firm performance. The results

coincide with Jackling and Johl (2009) and Hayes et al., (2004) who find no association

between board activities, measured in terms of the frequency of board meetings, and firm

performance. This result contradicts El Mir and Seboul (2008) who find a significant positive

relationship between firm performance and auditor’s quality. Larger firms are typically

associated with better firm performance, since they may benefit from economies of scale.

This argument is not supported in our study. The leverage-performance relationship result

indicates that there is a significant relationship with firm performance. The results disagree

with Ebaid (2009) that finds capital structure has a weak-to-no impact on firm performance

and agrees with Jackling and Johl (2009) who find a negative significant relationship between

leverage and firm performance. Finally, neither the risk disclosure index nor risk exposure is

significant.

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_____________________

Insert Table 5 about here

_____________________

Robustness Checks for the Board Variables:

We may have problems of simultaneity, given the fact that board size and board

independence might have been determined simultaneously with the dependent variable. To

solve this econometric problem, we have implemented two-step system GMM estimator5

with adjusted standard errors for potential heteroskedasticity by Arellano and Bond (1998)

and xtabond2 instructions for Stata by Roodman (2006). This method considers the

unobserved effect transforming the variables into first differences and uses the generalized

method of moments to deal with endogeneity problems. We have determined board size and

board independence as the instruments under the GMM system, which are potentially

endogenous. The second-order autocorrelations and Hansen J-statistics are insignificant for

all models. The number of instruments reduces for all the models too. Furthermore, there is a

variation of the significance levels for the board size and board independence while testing

against financial fragility or risk-taking variables, but the directions of relationship are still

negative. Thus, the interpretations of the results from the GMM are qualitatively same as

presented in Tables 4 & 5 and hence unreported.

Analysis of Survey Responses:

This section helps interpret the role of SSB in restraining IBs from aggressive risk-taking and

hence, perform better and generate firm value during global crisis. The average size of the

Shari’ah board is 3 and all members are male. The Shari’ah boards consist of Shari’ah

20

scholars and economists, but no lawyers. Shari’ah board members do not work for the bank

as employees. 55% of the respondents have said that they are accountable to the Board, but

45% said, they are accountable to the shareholders. However, 91% of the respondents have

agreed that the shareholders have the power to appoint and dismiss the Shari’ah Board and

the Shari’ah board reports to the board of directors.

Despite the fact that all the respondents have agreed that banks review the qualifications and

expertise of Shari’ah members, the responses are mixed when asked about Shari’ah

members’ training and their understanding for the internal control and risk management

process. All respondents, however, have agreed that the bank never evaluated their

performance. However, 63% has said that they meet quarterly, and 34% said, they meet

monthly and they never experienced quorum problems. The decisions are made based on

consensus. Moreover, 45% has said that the internal Shari’ah officer, who are bank

employees, are responsible for Shari’ah board meeting, but 55% said that the company

secretary is responsible for it. Interestingly, all Shari’ah scholars serve the bank on a part-

time basis, and Shari’ah scholars sit in different boards but, in some cases, the Central bank

permits one to sit in max 2 boards.

There are a few issues raised in this section regarding disclosure and transparency. The

Shari’ah governance system is monitored either by national Shari’ah council or Shari’ah

authority of the central bank. 82% of respondents have agreed that the bank has an

independent Shari’ah board6. The internal Shari’ah review is conducted by internal Shari’ah

committee (73%)7. Fourth, the Shari’ah resolutions are publicly available (82%).

There are questions about role of Shari’ah board and Shari’ah ruling, 55%of the respondents

believe that Shari’ah board plays an advisory role, and they validate the documentation, but

45% of the respondents noted that the Shari’ah board plays a supervisory role, and the board

21

members perform Shari’ah audit. However, 73% of the respondents believe that the banks

consider Shari’ah board ruling as the binding but 27% thinks that it is simply advisory.

Finally, the survey results cast doubt on the independent role of Shari’ah board, which was

considered as the key driving force for the IBs governance system in restraining IBs in

excessive risk-taking and hence, perform better during crisis. The results fail to reject H3-H4,

which help identify SSB as the weak parameter in IBs governance system. In addition, the

regression results identify corporate governance index (CGI) and financial disclosure and

transparency index (FDTI) as the major variables for risk taking in IBs, but board structure of

the IBs has profit motive. In our opinion, the monitoring ability of the Shari’ah board is

minimum. The SSB performs Shari’ah audits and validate the products and services. The

Shari’ah board members, however, perform the advisory role, and they work as an additional

checkpoint, which adds some value to the bank, but Shari’ah board cannot play any

supervisory role.

CONCLUSION

The purpose of this study is to test whether a multi-layer corporate governance model,

like that instituted by the Islamic banking system, and the supposed adherence to ethical

behavior, which is theoretically the cornerstone of Islamic banking, offer protection against

the fallibility to financial crisis. We analyze data for 84 banks (59 Islamic banks and 25

Conventional Banks) from Bangladesh, Bahrain, Malaysia, Pakistan, Saudi Arabia, the

United Arab Emirates, and the United Kingdom over the 2006-2009 periods.

The results indicate that the CGI and FDTI emerged as the key driving force for risk

taking for Islamic banks, but board structure of the Islamic banks are driven by short-term

profitability. However, governance mechanisms provide a weak explanation for the changes

in shareholders’ value measured by Tobin’s Q for Islamic banks. The results fail to reject the

hypothesis that the governance mechanism for the Islamic Banks is the effectual authority in

22

protecting against fallibility during the global financial crisis. Our findings cast doubt on the

independence of Shari’ah Boards. As Shari’ah Board members hold multiple positions, it raises

further concern about their ability to diligently discharge the roles expected of them. In

addition, Shari’ah board member tend not to undertake a monitoring role, limiting their role to

giving opinions on Shari’ah compliance of the products and services offered by IBs.

We make several contributions in this paper. We create a unique database by hand

collection to study the issues in hand, and as such provide better hypothesis testing with

appropriate data. Moreover, the corporate governance research on Islamic banking is

underexplored due to absence of readily available commercial database. Examination of the

global crisis adds a new dimension to this area. Second, we construct several corporate

governance indices for this study, which are unique in their own right, and employ such

indices on the same sample of countries for which no such corporate governance indices

exist. These indices capture a wide range of governance parameters, which are new and

unique in the corporate governance literature in baking and specifically Islamic banking.

Third, we have conducted questionnaire survey of Shari’ah Board members, thus adding a new

dimension to the field by analyzing a panel data for the both IBs and conventional banks

simultaneously. Finally, we compare the Islamic banks with the conventional banks using a

matched pair. To our knowledge, there is no other study that conducts a matched-pair sample

study as we do.

The findings of this research will be a valuable source of knowledge for policy

makers and regulators, particularly in the financial services sectors, in devising strategies to

deal with future financial crises. This research contributes to the literature regarding whether

a multi-layer corporate governance model, like that of the Islamic banking system, based on

moral values rather than greed and fear, can be accepted as an effective governance

mechanism in minimizing future financial crises.

23

ENDNOTES

1. Scholars pronounce the view that Islamic Banks were not exposed for several reasons: first, Islamic Banks strictly comply with Basel II and follow the guidelines of the Islamic

Financial Services Board (IFSB). Second, Islamic Banks build up a profit equalization

reserve, which is used to finance pay-outs during difficult years. Third, Islamic Banks

were neither exposed to toxic securities nor offered products like CDOs or MBS, due to

Shari’ah prohibition (Ahmed, 2009). Nevertheless, derivative products like CDS are

prohibited under Islamic law due to the existence of risky or hazardous sale.

2. Shari’ah Board is considered as the ‘Supra Authority’ in Islamic banking (Choudhury and Hoque, 2006). Together with the regular board of directors and routine executive and

other operational committees, the institution of a Sharia Board turns their governance

into what we call ‘multi-layer’ governance. The multi-layer governance mechanism was

in place from the very inception of the Islamic Banking, even before Cadbury Report

(1981). While their conventional peers (CBs) are likely to have a governance structure

that features a board of governance and routine executive and board committees. We call

this as ‘single-layer’ governance.

3. We used the SSB dummy in models 1 &2 and analyzed the survey responses to test hypothesis 4.

4. Table A1 presents the multicollinearity criterion and the test results for the variables in this study. Our models pass the multicollinearity criterion; therefore, the panel data models

are free from collinearity bias.

5. Andres and Vallelado (2008), Pathan (2009), and Pathan and Skully (2010) also solved the

econometric problem in their papers applying GMM system estimator.

6. But the others tackle the matter with the help of Shari’ah advisory firm or the internal

Shari’ah officer.

7. 27% thinks the internal Shari’ah review is the part of the internal audit committee’s job.

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28

Table 1: Description of the Variables

This table presents the description of the corporate governance and other firm and country specific variables applied in the study. The description includes the calculation procedure for each variable.

Corporate Governance Indices

Name Abbreviation Calculation Procedure Board

Structure

Index

bsi The Board Structure Index (bsi) is constructed based on sixteen boardroom elements, e.g., strong

board, board competence, CEO power, CEO competence, board committees etc. Each of the

sixteen characteristics of the Board Structure Index (BSI) gains 1 point; therefore, the index range

between 1.00 - 0.00. The BSI constitutes the following characteristics: (a) board Size: Is the board

size of this bank larger than the median board size of the sample? If yes then 1, otherwise 0, (b)

Board Independence: Does the firm have half or more independent? If yes then 1, otherwise 0, (c)

Board Meeting: Did the firm conduct more meetings than the median number of meeting of the

sample banks? If yes then 1, otherwise 0, (d) Board Attendance: Did the members attend more

than 75% of meetings? If yes then 1, otherwise 0, (e) Board Committees: If the firm has more

than the median number of board committees then 1, otherwise 0, (f) Chair/CEO split: Are the

roles of Chair/CEO split? If yes then 1, otherwise 0 (Chair/CEO duality), (g) Chair Independence:

Is the Chairperson independent? If independent then 1, otherwise 0, (h) CEO qualification: MA or

higher =1, less = 0, (i) CEO banking experience: If CEO has more than the median years of

experience in the sample then 1, otherwise 0, (j) CEO Tenure: If the CEO has more than the

median tenure in the sample=1, otherwise=0, (k) Chair executive or non-executive; if non-

executive =1, otherwise=0, (l) Is SMT listed? Yes=1, no=0, (m) If the non-executive members in

Senior Management Team (SMT) are more than half of the SMT =1, otherwise =0, (n) Separation

Theorem: Is the CEO a member of the SMT? No=1, yes=0, (o) No. of non-executive directors. If

more than half of the board size=1, otherwise=0, (p) Affiliated Directors. If less than half of the

board size=1, otherwise =0. Source: Hand Collected

Financial

Disclosure

and

Transparency

Index

fdti The Financial Disclosure and Transparency Index (FDTI) is constructed based on eleven

committee variables. The committees are audit committee, Shari’ah committee, and risk

committee. The major elements of these committees are included in the index. Each of the eleven

characteristics of the FDTI gains 1 point; therefore, the index range between 1.00 - 0.00. The

definitions of the FDTI are described below: (a) Audit Firm: Has the bank appointed a BIG 4

audit firm? Yes=1, no=0, (b) Audit Committee: Has the bank formed an audit committee? Yes=1,

no=0, (c) Audit Committee: At least 3 members on the committee=1, otherwise=0, (d) Audit

Committee: How many meeting in the year? 4 or more=1, otherwise=0, (e) Shari’ah Committee:

Has the bank formed a Shari’ah committee? Yes=1, no=0, (f) Shari’ah Committee: At least 3

members on the committee=1, otherwise=0, (g) Shari’ah Committee: How many meetings? 4

meetings or more=1, otherwise=0, (h) Risk Committee: Has the bank formed a risk committee?

Yes=1, no=0, (i) Risk Committee: At least 3 members on the committee=1, otherwise=0, (j) Risk

Committee: How many meetings? 4 meetings or more=1, otherwise=0, (k) Risk management

actions the bank normally takes or has been taken last year. Yes=1, no=0. Source: Hand

Collected.

Risk

Disclosure

Index

rdi The Risk Disclosure Index (RDI) is constructed based on the disclosure of five risk factors, e.g.,

credit risk, liquidity risk, fund management risk, market risk, and operational risk. Each of the

five risk factors gains 1 point; therefore, the index range between 1.00 - 0.00. The definitions of

the RDI are described below: (a) Did the bank disclose Credit risk (Yes/No)? yes=1, no=0, (b)

Did the bank disclose Liquidity risk (Yes/No)? yes=1, no=0, (c) Did the bank disclose Fund

management (Yes/No)? yes=1, no=0, (d) Did the bank disclose Market risk (Yes/No)? yes=1,

no=0, (e) Did the bank disclose Operational risk (Yes/No)? yes=1, no=0. Source: Hand Collected.

Corporate

Governance

Index

cgi This index comprises all the thirty-two corporate governance characteristics of BSI, FDTI, and

RDI.

Strong Board and CEO Power Variables

Board Size board Number of the members in the board. Source: Hand Collected.

Independent

Director

indep Proportion of independent non-executive directors in the board. Source: Hand Collected

CEO duality ceo_chair If the CEO and Chairperson is the same person, we give 1 otherwise 0. Source: Hand Collected

Internally

Recruited

CEO

ceo_exe If the CEO is internally recruited then 1, otherwise 0. Source: Hand Collection.

Firm Specific Variables

Asset Size size Log of Total Assets

Tier 1

Capital

tier1 Tier 1 Capital

Leverage leverage Customers’ Term Deposit/Equity

Big 4 Audit

Firm

big4 If the banks appoints one of the big 4 audit firms as the auditor then 1, otherwise 0. Source: Hand

collection

Shari’ah

Supervisory

Board

ssb SSB is the dummy variable for the IBs in the full sample.

Country Specific Variables

Log_GDP log_gdp Log of GDP for the country. Source: World Bank

Religion religion Religion is a dummy variable. If Islam is the primary religion of the county then 1, otherwise 0.

29

Table 2: Descriptive Statistics

This table presents the descriptive statistics for the variables used in the paper for the period 2006-2009. Tobin’s

Q is the firm value parameter. roa and roe are the firm performance proxies. bsi is the board structure index. fdti

is the financial disclosure and transparency index and rdi is the risk-disclosure index. cgi is the corporate

governance index. board is the board size. indep is the ratio of independent board members. ceo_chair is the

dummy variable for CEO-chair role duality. ceo_exe is the dummy for internally recruited CEO. big4 is the

dummy for big four audit firms. tier1 is the regulatory capital. size the asset size of the bank. leverage is the leverage ratio of the bank. religion is the dummy for the major religion of the country. log-gdp is the log of

country GDP. ssb is the dummy for IBs Shari’ah Board.

PANEL A: Islamic Bank Sample PANEL B: Conventional Bank Sample Pair-wise

T-Test Variables Observations

Mean Std.

Dev.

Min Max Observatio

ns

Mean Std.

Dev.

Min Max

Tobin’s Q 173 0.19 0.23 0.00 0.92 98 0.00 0.00 0.00 0.00 8.36***

roa 214 0.05 0.06 -0.01 0.34 98 0.01 0.03 -0.11 0.10 6.86***

roe 214 0.34 0.37 -0.24 1.92 95 0.15 0.21 -0.65 0.52 4.56***

bsi 214 0.29 0.14 0.13 0.69 100 0.32 0.23 0.00 0.77 -1.55

fdti 214 0.31 0.28 0.00 1.00 100 0.38 0.33 0.00 1.00 -1.90*

rdi 214 0.49 0.36 0.00 1.00 100 0.64 0.36 0.00 1.00 -3.53***

cgi 214 0.33 0.17 0.06 0.75 100 0.40 0.26 0.00 0.86 -2.9289**

risk 201 0.27 0.33 0.00 1.69 100 0.03 0.07 0.00 0.39 7.3608***

size 214 14.56 1.89 9.49 21.13 98 14.89 1.61 11.81 17.72 1.51

tier1 200 1.64 1.75 -0.31 10.00 100 0.18 0.12 0.00 0.65 -20.07***

leverage 211 5.70 5.77 -4.44 27.94 84.00 5.29 3.70 0.01 19.47 0.61

board 210 9.10 2.39 0.00 18.00 95.00 9.19 2.36 5.00 19.00 -0.29

indep 198 0.44 0.28 0.00 0.89 97.00 0.23 0.29 0.00 0.83 6.14***

ceo_chair 209 0.04 0.19 0.00 1.00 93.00 0.02 0.15 0.00 1.00 0.75

ceo_exe 205 0.18 0.38 0.00 1.00 97.00 0.03 0.17 0.00 1.00 3.56***

big4 209 0.78 0.41 0.00 1.00 95.00 0.86 0.35 0.00 1.00 -1.62

log_gdp 214 24.93 1.36 23.09 28.23 100.00 25.18 1.35 23.16 28.23 -

religion 214 0.95 0.22 0.00 1.00 100.00 0.92 0.27 0.00 1.00 -

ssb

214 1.00 0.00 1.00 1.00 100.00 0.00 0.00 0.00 0.00 -

30

TABLE 3: Correlation Analysis

This table presents the correlation coefficients for the two panels (Islamic and Conventional) over the period

2006-2009. Tobin’s Q is the firm value parameter. roa and roe are the firm performance proxies. bsi is the board

structure index. fdti is the financial disclosure and transparency index and rdi is the risk-disclosure index. cgi is

the corporate governance index. board is the board size. indep is the ratio of independent board members.

ceo_chair is the dummy variable for CEO-chair role duality. ceo_exe is the dummy for internally recruited

CEO. big4 is the dummy for big four audit firms. tier1 is the regulatory capital. size the asset size of the bank. leverage is the leverage ratio of the bank. religion is the dummy for the major religion of the country. log-gdp is

the log of country GDP.

PANEL A: Islamic Sample Tobin’

s Q

roa roe bsi fdti rdi cgi board indep ceo_

chair

ceo-

exe

big4 risk size tier1 leverage religion log-gdp

Tobin’s

Q

1.00

roa 0.14 1.0

0

roe 0.38 0.69

1.00

bsi 0.10 0.1

6

-

0.15

1.0

0

fdti 0.17 0.15

0.10

0.57

1.00

rdi -0.20 -

0.15

-

0.27

0.2

0

0.33 1.00

cgi 0.06 -

0.05

-

0.12

0.8

0

0.87 0.60 1.00

board -0.05 0.1

3

0.1

1

-

0.20

-

0.05

0.11 -

0.07

1.00

indep 0.05 -

0.02

0.0

9

0.1

2

-

0.03

-

0.17

-

0.02

-0.16 1.00

ceo_chai

r

-0.07 -

0.11

-

0.09

-

0.09

0.06 0.16 0.04 0.03 -0.02 1.00

ceo_exe -0.15 -

0.21

-

0.19

-

0.06

-

0.15

0.10 -

0.06

0.01 -0.12 0.07 1.00

big4 -0.02 -

0.02

0.0

4

-

0.15

0.06 -

0.02

-

0.04

0.02 0.02 0.09 0.20 1.00

risk -0.08 0.1

0

-

0.12

0.2

0

0.16 -

0.04

0.15 0.17 -0.02 -

0.02

-

0.06

0.06 1.00

size 0.03 -

0.24

-

0.06

0.0

1

0.03 -

0.10

-

0.02

-0.08 0.09 0.12 -

0.06

0.00 -

0.41

1.00

tier1 0.05 0.30

0.25

-0.1

3

-0.02

-0.19

-0.13

0.09 0.06 -0.03

-0.10

-0.06

0.12 0.37 1.00

leverage 0.32 0.12

0.57

0.03

-0.15

-0.08

-0.09

-0.02 -0.24 0.00 -0.16

-0.13

-0.36

0.15 -0.04

1.00

religion 0.03 0.1

3

0.2

0

-

0.27

-

0.20

-

0.13

-

0.26

-0.15 0.08 0.04 0.09 -

0.07

-

0.64

0.41 0.23 0.24 1.00

31

log-gdp 0.39 0.2

2

0.2

1

0.4

6

0.55 -

0.27

0.38 0.02 0.10 0.01 -

0.22

0.01 0.44 0.05 0.14 -0.11 -0.44 1.00

PANEL B: Conventional Sample

Tobin’

s Q

roa roe bsi fdti rdi cgi board indep ceo_ chair ceo-

exe

big4 risk size tier1 leverage religion

Tobin’s

Q

1.00

roa -0.19 1.00

roe 0.06 0.8

1

1.0

0

bsi -0.01 0.0

8

0.0

8

1.0

0

fdti -0.13 0.2

0

0.0

6

0.7

9

1.00

rdi 0.13 -0.2

4

-0.2

2

0.65

0.61 1.00

cgi -0.03 0.06

0.00

0.93

0.93 0.80 1.00

board -0.18 0.2

2

0.2

0

0.0

6

0.17 -

0.01

0.10 1.00

indep 0.22 -

0.3

8

-

0.3

1

-

0.1

8

-

0.07

0.17 -

0.06

-0.19 1.00

ceo_chai

r

-0.08 0.0

1

0.1

0

0.2

2

0.21 0.05 0.20 -0.11 -0.09 1.00

ceo_exe -0.32 -

0.1

1

-

0.1

6

-

0.0

5

0.02 -

0.09

-

0.04

0.16 0.11 0.05 1.00

big4 -0.12 0.0

0

0.0

0

0.1

5

0.12 -

0.02

0.11 0.26 -0.23 -0.05 0.15 1.00

risk -0.57 0.27

-0.0

1

-0.0

1

0.17 0.00 0.07 0.24 -0.09 0.13 0.31 -0.21

1.00

size -0.13 -0.4

6

-0.5

0

-0.0

8

-0.19

0.14 -0.08

-0.31 0.17 -0.06 -0.20

-0.15

-0.02

1.00

tier1 0.37 0.26

0.59

0.18

0.16 -0.06

0.13 0.20 -0.13 0.18 -0.19

0.11 -0.39

-0.62

1.00

leverage -0.08 0.6

9

0.5

7

0.1

7

0.31 0.01 0.21 0.42 -0.23 0.04 0.11 0.10 0.35 -

0.70

0.39 1.00

religion 0.27 -

0.5

0

-

0.3

2

-

0.2

4

-

0.36

-

0.06

-

0.27

-0.20 0.10 -0.03 -

0.23

0.05 -

0.66

0.48 -0.06 -0.74 1.00

32

Table 4: Corporate Governance and Risk-Taking of Islamic Banks

This table presents the regression results for corporate governance and risk-taking models. Each panel presents

three models (model 1 contents the corporate governance indices (bsi, fdti, rdi), model 2 contents the corporate governance index (cgi), and model 3 contents the strong board (board and independence) and CEO power (ceo-

chair and ceo-exe) variables. bsi is the board structure index. fdti is the financial disclosure and transparency

index and rdi is the risk-disclosure index. cgi is the corporate governance index. Board is the board size. Indep is

the ratio of independent board members. ceo_chair is the dummy variable for CEO-chair role duality. ceo-exe is

the dummy for internally recruited CEO. big4 is the dummy for big four audit firms. tier1 is the regulatory

capital. size the asset size of the bank. leverage is the leverage ratio of the bank. religion is the dummy for the

major religion of the country. log-gdp is the log of country GDP. ssb is the dummy for IBs Shari’ah Board. ***,

**, * indicate the significance level at 1%, 5%, and 10% levels.

33

PANEL A: ISLAMIC

BANKS

PANEL B: NON-ISLAMIC

BANKS

PANEL C: FULL SAMPLE

MODEL 1.1

MODEL 1.2

MODEL 1.3

MODEL 1.1

MODEL 1.2

MODEL 1.3

MODEL 1.1

MODEL 1.2

MODEL 1.3

bsi .10

(0.57)

.06

(0.88)

.00

(0.03)

fdti .20**

(2.03)

.05

(1.15)

.18**

(2.47)

rdi .03

(0.51)

-.05*

(-1.69)

-.01

(-0.11)

cgi .39***

(2.70)

.05

(1.50)

.22***

(2.76)

board .02

(1.60)

.01**

(2.14)

.02**

(2.29)

indep -.03

(-0.32)

-.06**

(-2.18)

-.05

(-0.84)

ceo_chair .03

(0.26)

.02

(0.25)

ceo_exe -.08

(-1.22)

.04

(0.55)

-.08

(-1.61)

big4 .047

(0.73)

.05**

(2.10)

.047

(1.02)

tier1 .022

(1.58)

.023

(1.64)

.00

(-0.19)

.00

(-0.55)

.00

(-0.80)

.00

(0.50)

.00

(-0.82)

.00

(-0.87)

.00

(-1.08)

size -.05***

(-3.88)

-.05***

(-4.06)

-.04***

(-3.17)

-.01**

(-2.03)

-.01*

(-1.87)

-.02***

(-3.05)

-.04***

(-4.28)

-.04***

(-4.29)

-.04***

(-3.86)

leverage -.01**

(-2.29)

-.01**

(-2.24)

-.01**

(-2.53)

.00

(-1.04)

.00

(-0.90)

.00

(-0.44)

-.01***

(-3.43)

-.01***

(-3.40)

-.01***

(-3.68)

religion -.17

(-1.22)

-.15

(-1.07)

-.10

(-0.72)

.05

(1.10)

.05

(1.12)

.00

(0.09)

-.08

(-0.84)

-.05

(-0.54)

-.06

(-0.60)

log_gdp -.02

(-0.72)

-.01

(-0.58)

.02

(0.85)

.01

(0.58)

.01

(0.53)

-.01

(-1.11)

.00

(-0.21)

.00

(0.13)

.01

(0.57)

ssb .28***

(4.61)

.28***

(4.65)

.27***

(4.16)

constant 1.3**

(2.04)

1.2*

(1.93)

.24

(0.35)

.00

(0.01)

.00

(-0.01)

.49

(1.37)

.56

(1.16)

.38

(0.82)

.07

(0.14)

34

Table 5 Corporate Governance and Firm Performance of Islamic Banks

This table presents the regression results for corporate governance and firm performance models. The table

contents three panel for Islamic Banks, Conventional Banks and Full sample. Each panel presents nine models

combining the performance and firm value. roa is the return on assets. roe is the return on equity. Tobin’s Q is the

firm value. bsi is the board structure index. fdti is the financial disclosure and transparency index and rdi is the risk-

disclosure index. cgi is the corporate governance index. board is the board size. indep is the ratio of independent

board members. ceo_chair is the dummy variable for CEO-chair role duality. ceo-exe is the dummy for internally

recruited CEO. big4 is the dummy for big four audit firms. tier1 is the regulatory capital. size the asset size of the

bank. leverage is the leverage ratio of the bank. risk is the risk-taking variable. religion is the dummy for the major

religion of the country. log-gdp is the log of country GDP. ssb is the dummy for shari’ah supervisory board of

Islamic banks. ***, **, * indicate the significance level at 1%, 5%, and 10% levels.

Pooled Observations

214 214 214 100 100 100 314 314 314

Adj. R square 0.17 0.18 0.16 0.13 0.11 0.21 0.27 0.27 0.28

F-stat 3.95*** 4.65*** 3.01*** 2.14** 2.10** 2.63*** 8.24*** 9.39*** 6.67***

35

PANEL A: ISLAMIC BANKS

Firm Performance Proxy: ROA Firm Performance Proxy: ROE Firm Value Proxy: Tobin’s Q Model 2.1 Model 2.2 Model 2.3 Model 2.1 Model 2.2 Model

2.3

Model 2.1 Model 2.2 Model 2.3

bsi .018

(0.56)

-.16

(-0.79)

-.19

(-0.81)

fdti -.06***

(-3.19)

-.39***

(-3.40)

-.08

(-0.40)

rdi .01

(1.17)

.06

(0.76)

.04

(0.44)

cgi -.05*

(-1.77)

-.56***

(-3.27)

-.13

(-0.73)

board .00*

(1.85)

.02

(1.53)

.00

(-0.23)

indep .04***

(2.94)

.10

(0.92)

-.10

(-0.93)

ceo_chair -.00

(-0.01)

-.06

(-0.41)

-.05

(-0.36)

ceo_exe -.01

(-0.83)

-.03

(-0.32)

0

(-0.06)

big4 -.02

(-1.56)

.00

(0.05)

.07

(0.81)

tier1 .00

(-0.93)

.00

(-1.09)

.00

(-0.78)

-.01

(-0.57)

-.01

(-0.71)

-.01

(-0.48)

.00

(0.21)

.01

(0.37)

.01

(0.46)

size 0*

(-1.73)

0

(-1.37)

0

(-0.85)

.01

(0.79)

.02

(1.07)

.02

(0.90)

-.04*

(-1.76)

-.04*

(-1.81)

-.04

(-1.60)

leverage 0***

(-2.67)

0***

(-2.92)

0***

(-2.97)

.02***

(4.14)

.02***

(3.91)

.02***

(3.48)

.01**

(2.46)

.01**

(2.52)

.01**

(2.59)

risk .03**

(1.97)

.02*

(1.79)

.03**

(2.06)

.08

(0.86)

.07

(0.74)

.00

(-0.00)

-.24

(-1.22)

-.26

(-1.37)

-.26

(-1.21)

religion .08***

(3.25)

.06***

(2.66)

.06**

(2.42)

.27

(1.63)

.19

(1.17)

.2

(1.13)

.27

(1.20)

.22

(1.05)

.24

(1.05)

Log_gdp .01***

(2.66)

.01**

(2.06)

.00

(0.80)

.05**

(2.06)

.04

(1.55)

.01

(0.53)

.12***

(3.85)

.11***

(4.89)

.11***

(4.51)

constant -.2*

(-1.74)

-.12

(-1.12)

-.03

(-0.26)

-1.31*

(-1.79)

-.90

(-1.20)

-.41

(-0.47)

-2.60***

(-2.88)

-2.2***

(-3.52)

-2.25***

(-3.19)

Pooled

Observation

s

214 214 214 214 214 214 173 173 173

Adj. R

square

0.12 0.09 0.14 0.14 0.13 0.09 0.28 0.3 0.21

F-stat 2.82*** 2.59*** 2.64*** 3.26*** 3.29*** 2.03** 2.87*** 3.43*** 2.06**

PANEL B: CONVENTIONAL BANKS

Firm Performance Proxy: ROA Firm Performance Proxy: ROE Firm Value Proxy: Tobin’s Q

Model

2.1

Model 2.2 Model 2.3 Model 2.1 Model 2.2 Model

2.3

Model 2.1 Model 2.2 Model

2.3

bsi

.03

(1.56)

.31**

(2.04)

.00

(-0.45)

fdti

.02

(1.33)

-.14

(-1.36)

.00**

(-2.19)

rdi

-.04***

(-4.30)

-.14*

(-1.96)

0***

(2.77)

cgi .00

(-0.04)

-.09

(-1.09)

.00

(-1.16)

board .00

(0.04)

-.01

(-0.71)

.00

(-1.43)

indep -.02

(-1.51)

-.14*

(-1.90)

.00

(0.91)

ceo_exe .00

(0.17)

-.08

(-0.43)

.00

(-1.32)

big4 -.03**

(-2.60)

-.05

(-0.81)

.00

(0.11)

tier1 .00 .00 .00 .00 .00 .00 .00 .00 .00

36

(0.16) (-0.23) (-1.04) (0.57) (0.67) (0.27) (0.22) (0.62) (0.20)

size

.00

(-0.17)

.00

(0.32)

.00

(0.19)

.00

(0.21)

.00

(0.12)

.01

(0.26)

.00

(-1.09)

.00

(-1.60)

.00

(-0.28)

leverage

0***

(-3.04)

0**

(-2.37)

0***

(-2.95)

.03***

(2.98)

.03***

(3.36)

.03***

(2.83)

0***

(4.35)

0***

(3.94)

0***

(4..25)

risk

-.07*

(-1.87)

-.03

(-0.79)

-.03

(-0.69)

-.26

(-0.96)

-.15

(-0.55)

-.23

(-0.66)

.00

(-1.04)

.00*

(-1.73)

.00

(-0.54)

religion

.08***

(5.38)

.08***

(4.76)

.07***

(3.73)

.36***

(3.36)

.32***

(2.96)

.32**

(2.56)

.00

(-0.73)

.00

(-0.74)

.00

(-0.25)

log_gdp

.00

(1.26)

.00

(0.93)

.00

(0.55)

.01

(0.39)

.00

(-0.03)

.01

(0.27)

.00

(-0.51)

.00

(-0.49)

.00

(0.49)

constant -.15

(-1.24)

-.14

(-1.11)

-.06

(-0.42)

-.56

(-0.67)

-.27

(-0.31)

-.36

(-0.37)

0

(0.63)

0

(0.77)

0

(-0.28)

Pooled

observations

100 100 100 100 100 100 98 98 98

Adj. R

square

0.47 0.34 0.43 0.43 0.4 0.46 0.43 0.36 0.39

F-stat 7.06*** 5.31*** 5.15*** 6.12*** 6.27*** 5.54*** 6.14 5.69 4.52***

PANLE C: FULL SAMPLE

Firm Performance Proxy: ROA Firm Performance Proxy: ROE Firm Value Proxy: Tobin’s Q

Model 2.1 Model 2.2 Model 2.3 Model 2.1 Model 2.2 Model

2.3

Model 2.1 Model 2.2 Model

2.3

bsi .0236

(1.11)

.0706

(0.50)

-.0175

(-0.18)

fdti -.03**

(-2.26)

-.30***

(-3.39)

.08

(1.09)

rdi .00

(0.26)

.04

(0.63)

-.04

(-0.98)

cgi -.02

(-1.19)

-.28***

(-2.81)

.02

(0.45)

board .00

(1.83)

.00

(1.25)

.00

(-0.48)

indep .02**

(2.23)

.02

(0.20)

-.02

(-0.51)

ceo_chair .00

(-0.16)

-.09

(-0.68)

-.09

(-1.05)

ceo_exe -.01

(-1.08)

-.02

(-0.34)

-.03

(-0.74)

big4 -.012**

(-2.35)

-.03

(-0.48)

.04

(1.05)

tier1 .00

(-0.47)

.00

(-0.47)

.00

(-0.62)

.00

(-0.88)

.00

(-0.78)

.00

(-0.42)

.00

(0.94)

.00

(0.72)

.00

(0.81)

size -.02

(-1.05)

-.02

(-1.07)

0

(-0.61)

.01

(1.15)

.01

(1.11)

.01

(0.79)

.01

(1.12)

.01

(1.47)

.01

(1.14)

leverage 0***

(-4.30)

0***

(-4.35)

0***

(-3.90)

.02***

(5.17)

.02***

(5.00)

.02***

(4.87)

.01***

(2.96)

.01***

(2.94)

.01***

(2.17)

risk .02**

(2.16)

.02**

(1.99)

.03**

(2.56)

.06

(0.82)

.04

(0.57)

.00

(0.06)

-.05

(-0.58)

-.04

(-0.44)

-.05

(-0.49)

religion .08***

(4.28)

.07***

(3.96)

.06***

(3.53)

.30**

(2.57)

.24**

(2.08)

.23

(1.86)

.11

(1.49)

.13*

(1.80)

.15*

(1.80)

log_gdp .01*

(1.92)

.00

(1.56)

.00

(0.67)

.03

(1.62)

.02

(1.10)

.02

(0.75)

.05***

(4.00)

.05***

(4.73)

.05***

(4.27)

ssb .03***

(2.90)

.03***

(2.90)

.02**

(2.01)

.05

(0.68)

.06

(0.72)

.11

(1.26)

.22***

(4.52)

.2***

(4.36)

.22***

(4.00)

constant -.14

(-1.62)

-.10

(-1.21)

-.03

(-0.36)

-.90

(-1.55)

-.55

(-0.97)

-.39

(-0.57)

-1.5****

(-4-05)

-1.69***

(-4.98)

-1.68***

(-4.43)

Pooled

Observatio

ns

314 314 314 314 314 314 271 271 271

Adj. R

square

0.23 0.22 0.27 0.20

0.19 0.19 0.40 0.40 0.37

F-stat 6.38*** 7.01*** 6.03*** 5.58*** 5.85*** 4.21*** 7.97*** 9.20*** 5.86***