Impact of Corporate Governance on Earnings Management and Bank Performance in Islamic and Conventional Banks of Pakistan
Purpose: The purpose of this research work is to find out the impact of corporate governance on bank performance through
earnings management in Pakistan. Earnings management is our mediating variable and different dimensions of corporate
governance are our independent variables. Our dependent variable is bank performance. Further, we also compare the impact
of corporate governance in Islamic and conventional banks.
Design/methodology/approach: Data of 3 Islamic and 15 Conventional banks has been collected for the period from2006-
2015 andPooled regression has been applied to investigate the impact of earnings management and corporate governance on
bank performance. We measure bank performance with return on assets and return on equity; earnings management as
(discretionary loan loss provisions) and corporate governance as board size, board independence, audit committee size, and
audit committee independence. We also take bank size as control variable. Further, we apply structural equation modelling to
investigate the mediating role of earnings management between bank performance (ROA/ROE) and corporate governance.
Findings: Results show that there is a significant impact of board size, audit committee independence and bank size on
return on assets and return on equity in Islamic banks. On the other hand, there is a significant impact of Earnings
Management (discretionary loan loss provisions), board independence, and audit committee size on return on assets in
Conventional banks. Results also show that there is no mediation impact of Earnings Management (discretionary loan loss
provisions) in Islamic banks. In Conventional banks;we find significant indirect as well as direct impact of board
independence and audit committee size on return on assets. Further, we find significant indirect as well as direct impact of
board size and audit committee independence on return on equity of conventional banks.
Practical Implication: This paper will help the Pakistani banks to know about the impact of Corporate Governance
mechanisms and Earnings management practices on their performance. The results explain that there is no mediating role of
Earnings management in Islamic banks but in conventional banks. These results explain that either Islamic banks are not
involved in Earnings management practices due to their strong Sharia board or corporate governance practices in Islamic
banks are too weak to have any impact of Earnings management. If it is the weak corporate governance mechanism in
Islamic banks then there is need to improve the corporate governance practices in Islamic banks.
Originality/value:To the best of authors’ knowledge, this is the first paper that investigates the mediating role of earnings
management between corporate governance and bank performance in Pakistan.
Keywords - Islamic banks, Conventional banks, earnings management, and corporate governance.