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Corporate governance mechanism and the risk exposure of Islamic mutual

funds: evidence from Islamic countries

Article · May 2020

DOI: 10.1108/JIABR-04-2019-0073

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 The current issue and full text archive of this journal is available on Emerald Insight at:
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Corporate
Corporate governance mechanism governance
and the risk exposure of Islamic mechanism

mutual funds: evidence from

Islamic countries
Farrukh Naveed and Syed Zain Ul Abdin Received 15 April 2019
Revised 30 November 2019
AIR University School of Management (AUSOM), AIR University, Islamabad, Pakistan 26 December 2019
10 March 2020
Accepted 25 March 2020

Abstract
Purpose – This study aims to analyze the impact of corporate governance characteristics on the risk
exposure of Islamic mutual funds prevailing in different Islamic countries (Pakistan and Malaysia).
Design/methodology/approach – This study used dynamic panel regression model for analysis and
estimated the results using system generalized method of moment technique. A sample of 185 Islamic funds is
used in the current research, which is selected using judgmental sampling. The data span of this study
consists nine years from 2009 to 2017.
Findings – The results showed that the corporate governance characteristics such as board
independence, directors and institutional ownership and overall governance quality are helpful in
reducing the total and downside risk exposure of Islamic mutual funds. The findings also suggest that
board size and Chief Extractive officer duality play no role in mitigating the risk of Islamic funds
prevailing in both countries.
Practical implications – This study has implication for industry practitioners and fund managers. This
study showed that the corporate governance characteristics are helpful in reducing the risk exposure of
Islamic mutual funds. Therefore, this study provides input to the investment firms to improve the quality of
corporate governance for lowering the risk exposure of mutual funds.
Originality value – To the best of the authors’ knowledge, this study is the first attempt to analyze the
impact of corporate governance characteristics on the risk exposure of Islamic mutual funds and hence
provides significant contribution in the literature of mutual funds.
Keywords Downside risk, Corporate governance (CG), Ownership structure, Board structure
Paper type Research paper

1. Introduction
Mutual funds are considered important investment alternatives, especially for those
investors who do not possess sufficient knowledge, skills and expertise to invest directly to
generate sufficient returns. Mutual fund managers and investors want to increase the
returns on their investment and lower the variability (risk) in the fund returns. Investors,
especially the risk-averse investors, prefer to invest in less risky funds. Chen et al. (2009)
stated that along with overall risk exposure, investors are also concerned with the downside
risk, which is the risk associated with losses or is the probability that an asset (fund) will fall
in price. Corporate governance characteristics of the any firm (including the asset
management firms) affect the risk exposure of these firms. Earlier studies showed that the
good governance practices are helpful in increasing the stock returns and mitigating the
firm’s risk (Mathew et al., 2018; Wang et al., 2015). Journal of Islamic Accounting and
Business Research
Just like the stocks, mutual funds also face various kinds of risks including downside and © Emerald Publishing Limited
1759-0817
systematic risk (Hayat and Kraeussl, 2011). Although, a reasonable amount of literature is DOI 10.1108/JIABR-04-2019-0073
JIABR present on the firm’s risk; however, less attention is paid to analyze the risk exposure of
mutual funds, particularly the Islamic mutual funds. Hayat and Kraeussl (2011) analyzed
the downside risk exposure of Islamic equity funds and found that the downside risk
exposure of these funds is high. Rodriguez (2015) analyzed the risk exposure of large cap
mutual funds, while Droms and Walker (1995) investigated the total risk exposure of mutual
funds along with their determinants. All these studies focused on the risk analysis of mutual
funds without paying attention to the factors affecting the risk of these funds. As the mutual
fund managers want to reduce the risk of underlying funds to attract investors (particularly,
the risk averse investors), it is necessary to investigate the factors affecting the mutual fund
risk. Particularly, it seems necessary to see how the corporate governance practices in the
mutual fund industry are helpful to mitigate the fund’s risk as these practices reduce the
organizational risk. Therefore, this study aims to analyze the impact of corporate
governance characteristics on the risk (total and downside) exposure of Islamic mutual
funds. The literature on corporate governance and firm’s risk provides better motivation for
the current research (Mathew et al., 2018; Jiraporn et al., 2015). This literature suggests that
good governance practices reduce the firm’s risk; however, the question of whether these
governance practices play any role in reducing the mutual fund risk is still ambiguous.
Previous studies ignored the relationship between corporate governance and risk exposure
of mutual funds.
This study extends the previous literature by several ways. First, it analyzes the
impact of corporate governance on the risk of Islamic mutual funds. Previous studies
such as Wang et al. (2015), Hussain and Amir Shah (2017), Jiraporn et al. (2015) and
Mathew et al. (2018) have analyzed the role of corporate governance in mitigating the
total and downside risk of the organizations; however, these studies primarily
considered the organizational risk and ignored the risk exposure of mutual funds.
Rodriguez (2015), Vidal-García and Vidal (2014) and Hayat and Kraeussl (2011)
analyzed the total and downside risk exposure of mutual funds, but they did not focus
on investigating the impact of corporate governance characteristics on mutual fund
risk. Therefore, this study is the first attempt to analyze the impact of corporate
governance on the total and downside risk exposure of Islamic mutual funds. Second,
the studies on corporate governance and firm risk show that corporate governance
characteristics (board structure, overall governance quality) are endogenously
determined (Akbar et al., 2017). If the board structure can affect the firm’s risk, the
reverse can also be assumed. However, the studies on corporate governance and firm’s
risk ignored the endogeneity issue (Wang et al., 2015; Mathew et al., 2018). Therefore,
this study also addresses the endogeneity concern while analyzing the impact of
corporate governance on mutual fund risk. Finally, Hayat and Kraeussl (2011) only
used downside beta and relative beta for measuring the downside risk of Islamic
equity funds. Following Wang et al. (2015), this study uses various measures of
downside risk (value at risk [VAR] expected shortfall) other than downside and
relative betas to make the research more comprehensive and to present a robust
analysis. By these ways, the current research provides significant contribution to the
literature of mutual fund risk.
The current research highlights whether it is possible to lower the risk of mutual fund
portfolios by improving the governance structure and quality of corporate governance. The
fund managers want to mitigate the fund risk along with increasing the fund performance.
Therefore, the current research is significant for industry practitioners and fund managers
working in the Islamic mutual fund industry, as it guides them to reduce the risk of Islamic
funds by implementing good governance practices. The current study is organized as
follows: Section 2 reviews previous literature and develops the study hypotheses. Section 3 Corporate
describes research methodology, whereas Section 4 reports the study results. Finally, governance
conclusion and implications of this research are provided in Section 5.
mechanism
2. Literature review
Previous studies focused on the organizational risk, while little work is done on the risk
exposure of mutual funds. Wang et al. (2015) and Hussain and Amir Shah (2017) analyzed
the impact of corporate governance characteristics on the downside risk exposure of
Taiwanese firms and found that managerial ownership, board independence and overall
governance quality reduce the probability of downside risk. Mathew et al. (2018)
investigated the impact of board structure, board compensation and overall governance
quality on the risk-taking behavior of the UK firms and found that the quality of corporate
governance reduces the probability of firm’s risk. An important attempt is made by Jiraporn
et al. (2015) to investigate the impact of corporate governance and ownership structure on
the firm’s risk and found that the institutional ownership negatively affects the financial
risk. They also found that good governance practices decrease the probability of firm’s risk.
Akbar et al. (2017) analyzed the impact of board structure on the organizational risk-taking
behavior using the data set of the UK firms and found that board independence and Chief
Extractive officer (CEO) duality help to reduce the organizational risk.
As for mutual funds are concerned, the studies such as Rodriguez (2015), Vidal-García
and Vidal (2014) and Hayat and Kraeussl (2011) are considered as important attempts to
analyze various types of risks involved in mutual funds. These studies only investigated the
risk exposure of mutual funds without paying attention on the determinants of mutual fund
risk. Luo and Bhatti (2019) analyzed the co-movement and dependence structure of Islamic
mutual funds using copula methods and showed that Islamic mutual funds have low
dependence with various market indices. Mansor et al. (2019) analyzed the performance of
Islamic mutual funds along with analyzing the risk exposure of these funds. They showed
that Islamic funds outperform market indices even in the crises period. Mansor and Bhatti
(2011) comparatively analyzed the performance and risk of Islamic and conventional mutual
funds and reported that Islamic funds are more risky than their conventional counterparts.
Finally, Mansour and Bhatti (2018) examined the new paradigm of Islamic corporate
governance. They argued that the traditional governance practices are no longer efficient in
Islamic financial institutions, and the Islamic corporate governance is not expected to play
traditional regulatory and supervisory role in the Islamic financial institutions.

2.1 Theoretical foundation and hypotheses development

Different theories of corporate governance (agency, resource dependence and stewardship
theories) lay down the theoretical foundation of the current research. The relationship of
different governance variables with the fund risk is explained in the light of these theories.
2.1.1 Board size and the risk exposure of mutual funds. Board size is considered an
important governance characteristic. Two different viewpoints exist in the literature
regarding the impact of board size on financial risk. According to agency theory, large board
size decreases the firm’s performance and increases overall risk. According to Jensen (1993),
an inverse relationship exists between board size and firm performance because the agency
problem becomes more severe in case of large board size. Large board makes the
coordination and communication process more difficult; therefore, the decisions on
important organizational matters cannot be taken on time, which adversely affects the
performance and increases the chances of risk. The outcome of this viewpoint is that the
firms having large board size experience less risk-taking practices (Cheng, 2008). Contrary
JIABR to the agency theory, the resource dependence theory assumes that large board size
enhances the firm performance and decreases the probability of risk. Haider and Fang (2016)
stated that large board size can get access to various resources from external environment
and thus reduces the uncertainty. Kiel and Nicholson (2003) stated that large board provides
an opportunity to different members having diverse skills and expertise to sit under one
roof, which facilitates quality decision-making. In this case, accurate decisions can be made
by the mutual consultation of the members, which enhances the performance and reduces
the chances of risk. Empirical studies such as Haider and Fang (2016) and Cheng (2008) also
support this viewpoint. Large board can also be helpful in reducing the risk of Islamic
mutual funds, as it reduces the firm’s risk. The above arguments lead to the formation of
following hypothesis:

H1. Board size negatively affects the risk exposure of Islamic mutual funds.
2.1.2 Board independence and the risk of mutual funds. Board independence is another
important governance indicator. Agency theory sheds light on the relationship between
board independence and mutual fund risk. This theory suggests conflict of interest between
directors (agents) and shareholders (principals). Jensen and Meckling (1976) stated that the
agency problem can be reduced by increasing the number of independent nonexecutive
directors in the board. Fama and Jensen (1983) stated that the independent directors perform
supervisory and monitoring functions more effectively and thus play significant role in
reducing the agency problem and enhancing the overall performance. Mallin and Michelon
(2011) stated that the independent directors have professional expertise, skills, knowledge
and external links; therefore, their presence in the board increases the firm’s human and
relational capital, attracts the resources and helps to manage the external dependencies.
Pathan (2009) argued that the independent directors want to protect their reputation in the
labor market; therefore, they prefer to invest in the less risky projects, which help the firm
avoiding losses. By this way, they try to protect the image of their firms. Wang et al. (2015)
stated that board independence decreases the appearance of scandal or negative shocks and
thus reduces the probability of downside risk. Empirical evidence also supports the previous
arguments. The studies such as Akbar et al. (2017), Wang et al. (2015), Pathan (2009) and
Brick and Chidambaran (2008) showed that the presence of independent directors reduces
the probability of financial risk. If the board independence can reduce the firm’s risk, it can
also help to reduce the risk exposure of Islamic mutual funds. Based on this discussion, the
following hypothesis is developed:

H2. Board independence negatively affects the risk exposure of Islamic mutual funds.
2.1.3 CEO duality and the risk of mutual funds. CEO duality refers to the situation where
CEO of asset management firm also works as a board chairman. Agency theory urges the
separation of ownership and control. If CEO also works as board chairman, then all the
powers are concentrated in one hand, and he or she works for his or her self-interest and
does not care about other shareholders (Donaldson and Davis, 1991). Furthermore, the CEO
duality may have negative consequences on the monitoring functions of the corporate board,
which adversely affects the performance (Jensen, 1993). CEO duality encourages the self-
interest managerial behavior, which also affects the firm’s risk. Contrary to the agency
theory, the stewardship theory proposes that managers are good stewards of firm’s
resources, and dual position provides an opportunity to the managers to work with complete
authority and responsibility, which ultimately affects the firm performance and reduces the
organizational risk (Donaldson and Davis, 1994). Previous studies such as Akbar et al. (2017)
and Hussain and Amir Shah (2017) found that CEO duality reduces the organizational risk. Corporate
CEO duality in the asset management firms can also reduce the mutual fund risk, as it governance
reduces the firm’s risk. Based on this discussion, the following hypothesis is developed:
mechanism
H3. CEO duality significantly (negatively or positively) affects the risk exposure of
Islamic mutual funds.
2.1.4 Managerial ownership and the risk of mutual funds. When the wealth of managers
and directors is tied to the firm’s value, they become more risk averse and avoid investment
in risky projects (Benson and Davidson, 2009). Jensen and Meckling (1976) stated that higher
managerial ownership increases the firm performance because in this case, manager’s
interests are aligned with the interests of other shareholders, which reduces agency problem
and increases the performance. It implies that higher managerial ownership also reduces
organizational risk. Wang et al. (2015) stated that low levels of managerial ownership have
an incentive alignment effect. Managers take less risk in case of higher managerial
ownership because of the alignment effect. Managers show risk-aversion attitude as their
ownership increases, which results in the reduction of financial risk. Managerial ownership
affects the risk of Islamic mutual funds in the same way as it affects the organizational risk.
Based on these arguments, the following hypothesis is developed:

H4. Managerial ownership negatively affects the risk exposure of Islamic mutual funds.
2.1.5 Institutional ownership and the downside risk of mutual funds. Institutional investors
keep an eye on the activities of asset management firm and take a keen interest in the
business affairs. Compared to the individual investors, the institutional investors actively
monitor business affairs and try to reduce information asymmetry and agency problems
and thus increase the firm performance (Neubaum and Zahra, 2006). It also implies that the
presence of institutional investors reduces the chances of financial risk. Therefore, previous
studies documented negative relationship between institutional ownership and
organizational risk. Rubin and Smith (2009) stated that institutional investors generally
follow the prudent man rule in pursuing less-risky stocks, and they prefer to invest in the
stocks having lower risk exposure. Jafarinejad et al. (2015) stated that institutional investors
have sufficient influence to lobby senior executives to sway risk-taking decisions in their
favor. Wang et al. (2015) and Rubin and Smith (2009) showed that institutional ownership
negatively affects the organizational risk-taking behavior. The institutional ownership in
the Islamic mutual funds industry can also be helpful in decreasing the fund risk, as it
decreases organizational risk. Based on this discussion, the following hypothesis is
developed:

H5. Institutional ownership negatively affects the risk exposure of Islamic mutual
funds.
2.1.6 Overall governance quality and risk of mutual funds. Apart from individual
governance characteristics, the overall governance quality may also affect the mutual fund
risk. Sami et al. (2011) stated that overall quality of corporate governance reduces the agency
problem and thus lowers the agency cost, which implies that the governance quality
increases firm performance and lowers organizational risk. Jiraporn et al. (2015) formulated
risk-seeking hypothesis, according to which, higher governance quality leads to the lower
risk-taking. They further stated that strong and effective governance mechanism protects
the firms from unnecessary risk-taking. The firms having higher quality of corporate
governance exhibit corporate strategies that are relatively less risky compare to the firms
JIABR having weak governance structure. Previous studies such as Mathew et al. (2018) and
Jiraporn et al. (2015) showed that the governance quality reduces overall risk exposure of the
firms. The governance quality in the Islamic mutual fund industry affects the risk exposure
by the same way as it affects the organizational risk. Based on this discussion, the following
hypothesis is formulated:
H6. Overall quality of corporate governance negatively affects the risk exposure of
Islamic mutual funds.

3. Methodology
3.1 Study variables
3.1.1 Dependent variables. The current study uses total and downside risks as dependent
variables. As the downside risk is considered the part of total risk, the current study also
included it. Total risk is measured by the standard deviation of the monthly fund returns.
Downside risk is measured by using different risk measures including downside beta, relative
beta, VAR and expected shortfall. Bawa and Lindenberg (1977) introduced the downside beta,
which is used to measure the downside risk. According to them, downside beta is a covariance
of the stocks returns (in our case fund returns) with the market returns when the market
returns are below their mean. This risk measure only considers negative market returns for
measuring the downside risk (Hayat and Kraeussl, 2011). Following equation (1) describes this
risk measure, where the nominator indicates the covariance of fund returns with the market
returns, while the denominator indicates the variance of fund and market return provided that
market returns are below their mean (negative market returns):
Covðri ; rm jrm < rm Þ
b
¼ (1)
Varðrm jrm < rm Þ
Hayat and Kraeussl (2011) introduced the relative beta, which is a pure measure of downside
risk. For this purpose, this study first measured the beta of capital asset pricing model
(CAPM) using the following equation:


Rpt
Rft ¼ ap þ b p Rmt
Rft þ m pt (2)

The relative beta is then measured by subtracting the CAPM beta from the downside beta
[measured by equation (1)]. Following equation (3) describes this risk measure:
b rp ¼ b

p
bp (3)

where b
p is the downside beta, while the b p is the CAPM beta. This study also used VAR
for measuring the downside risk. Wang et al. (2015) stated that VAR is the maximum loss
faced by any security (or mutual fund) i at time t at a given confidence interval (1
a).
Finally, expected shortfall is also used for downside risk measurement. Wang et al. (2015)
stated that VAR estimates the chances of losses at a given confidence interval, but the
expected shortfall measures the chances of losses beyond that particular interval for the
worst possible cases. Following equation (4) explains this risk measure:
 n 
X 
ES ¼  Ri;j =n 8Ri;j <
VaRi;t (4)
j¼1

where R is the monthly returns of the mutual funds and n is the number of monthly returns
below VARi,t.
 3.1.2 Independent variables. This study uses different corporate governance characteristics Corporate
as independent variables. Table 1 shows all the study variables along with their measurements. governance
mechanism
3.2 Sample and data collection
The current study selected a sample of 185 Islamic funds including 100 Malaysian and 85
Pakistani funds using judgmental sampling. For measuring fund returns, the data of monthly
net asset values (NAV) is used, which is collected from the Mutual Funds Association of
Pakistan in case of Pakistani Islamic funds. The data of the returns of Malaysian Islamic funds is
extracted from Morningstar database. For implementing CAPM model, the data of risk-free rate
of return is used, which is collected from State bank of Pakistan. The study uses three-months
Treasury bill rate as a proxy of risk free rate of return for Pakistani and Malaysian funds. For
measuring the market return, KMI 30 Shariah index and Bursa Malaysia Hijrah Shariah indices
are used as a market benchmark for Pakistani and Malaysian Islamic funds, respectively. The
data of market prices for these indices is collected from Pakistan Stock Exchange and other
websites. The data of all the governance and control variables is collected from the annual
financial reports of Islamic funds. This study covers a period of nine years from 2009 to 2017.

3.3 Research model

Following Wang et al. (2015), this study analyzed the impact of governance characteristics
on the downside and total risk of Islamic funds using dynamic panel regression model,
where all the governance characteristics are used as explanatory variables, while the funds

Variable Measurement Sign

Dependent variables
Mutual fund total risk Standard deviation of the monthly fund returns –
Mutual fund downside risk Measured by using downside beta, relative beta, VAR (95%) and –
expected shortfall
Independent variables
Board size It is measured by total number of the board members _
Board independence Ratio of independent nonexecutive directors to the total number of _
board members
CEO duality Dummy variable, which is equal to 1 if the CEO and board þ/

chairman are same person and zero otherwise.
Managerial ownership Ratio of mutual fund units held by managers or executives to the _
total number of the fund units
Institutional ownership Ratio of the mutual fund units held by various institutions such as _
banks and insurance companies to the total number of fund units
Overall governance quality It is measured by constructing a governance index. The total _
score of this index measures the governance quality
Control variables
Fund size Natural log of the total net assets of the mutual funds _
Fund age Total number of years a fund has been in existence since its _
inceptions
Expense ratio Ratio of total operating expense of the fund to the fund’s total þ
assets
Management fee Management fee of the fund expressed in percentage þ
Manager’s experience Total experience of fund manager expressed in years _ Table 1.
Manager’s education Dummy variable equal to 1 if fund manager holds professional _ Study variables and
degree (CFA, ACCA) and zero otherwise their measurement
JIABR and managerial characteristics are used as control variables. In dynamic panel model, the
lagged values of fund risk (dependent variable) are used as explanatory variables to capture
the risk persistence effect. The parameters of dynamic model are estimated using system
generalized method of moment (GMM) because the usual fixed or random effect model
provides biased results in this case owing to the presence of endogeneity (Wintoki et al.,
2012). Therefore, to address the endogeneity concern, GMM technique is used. Following
equation (6) indicates the study model:
Fund risk it ¼ a0 þ b 1Fund Risk t
1 þ b 2BSIZEit þ b 3BINDit þ b 4CEODULit
þ b 5MANGOWNit þ b 6INSOWN þ b 7CGINDXit þ b 8FSIZEit
þ b 9FAGEit þ b 10EXPRATIOit þ b 11MGMTFEEit
þ b 12EDUCATIONit þ b 13EXPERIENCEit þ vit þ « it
(5)
where, the Fund risk indicates either total or downside risk exposure of the mutual fund i at
time t. BSIZE is the board size, BIND and CEODUL are the board independence and CEO
duality, respectively. MANGOWN and INSOWN indicate the managerial and institutional
ownership, respectively. CGINDX is the corporate governance index, which is developed to
measure the quality of corporate governance. FSIZE and FAGE are the size and age of the
mutual fund i at time t, respectively. EXPRATIO and MGMTFEE are the expense ratio and
management fee of the fund i at time t, respectively. Finally, EDUCATION and
EXPERIENCE indicate the fund manager education and experience, respectively.
vit indicates the year fixed effect and « it is the error term.

4. Empirical results
4.1 Descriptive statistics
Tables 2 and 3 report the descriptive analyses of Pakistani and Malaysian Islamic funds,
respectively. According to Tables 2 and 3, the mean values of total risk for Pakistani Islamic
funds are found lower than Malaysian Islamic funds. It is because the investors in Pakistan
generally exhibit risk-averse investment behavior (Yasir, 2015). Similarly, the average
values of all downside risk measures are also lower in case of Pakistani Islamic mutual
funds. It indicates that total and downside risks in Pakistani Islamic mutual funds are lower
compared to their Malaysian counterparts. Among the corporate governance characteristics,
the average board size in the Pakistani and Malaysian asset management firms is almost the
same. The average board independence in Malaysia funds is found to be higher than
Pakistani Islamic funds. The mean values of CEO duality indicate that majority of the CEOs
in the asset management firms of both the countries do not work as board chairman. The
mean value of director’s ownership of Malaysian funds is found to be higher than Pakistani
Islamic funds. The average value of institutional ownership of Pakistani Islamic funds is
higher than that of the Malaysian funds. Finally, the governance quality in the asset
management firms of both countries is almost the same.

4.2 Dynamic panel generalized method of moment results

Tables 4-6 show the results of dynamic panel system GMM. According to Tables 4-6, the
coefficients of board size and CEO duality are not found significant in all the study samples
because of the higher p values (p > 0.05). It indicates that board size and CEO duality have
no impact in reducing the total and downside risk exposure of Islamic mutual funds. Based
 Mean Minimum Maximum SD
Corporate
governance
SD return 3.081 0.665 5.970 1.733 mechanism
DownBeta 0.272
1.801 2.875 1.089
ReltBeta 0.099
2.441 2.229 0.986
VAR
4.328
9.684
0.049 3.221
ES
6.163
12.25
0.148 3.823
BSIZE 8.763 5.000 10.00 1.189
BODIND 0.305 0.167 0.571 0.068
CEODUL 0.042 0.000 1.000 0.201
DIROWN 3.526 0.000 20.43 6.573
INSOWN 53.99 2.760 95.66 27.94
CGINDX 28.54 24.00 32.00 2.388
FundSize 13.59 11.52 16.79 1.310
FundAge 4.849 1.000 18.00 3.582
Expratio 2.456 0.397 4.780 1.395
MgmtFee 1.522 0.000 3.000 0.604 Table 2.
Education 0.435 0.000 1.000 0.496 Descriptive statistics
Experience 10.43 2.500 22.00 5.010 (Pakistani funds)

Mean Minimum Maximum SD

SD return 3.455 0.266 7.593 2.345

DownBeta 0.298
0.430 1.249 0.596
ReltBeta 0.113
1.997 1.001 0.761
VAR
6.344
14.09
1.657 4.136
ES
7.026
17.89
1.956 4.837
BSIZE 8.345 6.000 12.00 0.976
BODIND 0.313 0.200 0.500 0.072
CEODUL 0.095 0.000 1.000 0.293
DIROWN 7.576 0.000 25.00 10.08
INSOWN 31.66 4.040 57.38 19.27
CGINDX 28.71 26.00 32.00 1.971
FundSize 14.05 12.12 19.77 1.416
FundAge 7.568 1.000 28.00 4.713
Expratio 2.663 0.500 4.460 1.233
MgmtFee 1.547 0.750 2.500 0.475 Table 3.
Education 0.411 0.000 1.000 0.492 Descriptive statistics
Experience 11.00 3.000 26.00 5.357 (Malaysian funds)

on this result, H1 and H3 are rejected. This result is consistent with the findings of Akbar
et al. (2017), Alam and Ali Shah (2013) and McNulty et al. (2013). Tables 4-6 also reports the
coefficients of board independence, which are found to be statistically significant at 1% and
5% in case of Malaysian and Pakistani Islamic funds, respectively. It clearly indicates that
board independence plays a significant role in reducing the downside and total risk
exposure of Islamic mutual funds. According to this result, H2 is accepted, which supports
the agency theory viewpoint. Previous studies such as Wang et al. (2015), Hussain and Amir
Shah (2017) and Akbar et al. (2017) also showed negative and significant impact of board
independence on the downside risk and total risk exposure of the firms. The coefficients of
director’s ownership are also reported in Tables 4-6, which are negative and statistically
significant at 1%, 5% or 10% in all the study samples. It indicates that the director’s ownership
 funds)
JIABR

Table 4.

exposure of
(CG (Corporate
Dynamic panel

Pakistani Islamic
system GMM results

Governance) and risk

(1) (2) (3) (4) (5)
Variables SD Return DownBeta ReltBeta VAR ES

Total risk t
1 0.170 (0.332) – – – –

Down risk t
1 –
0.003 (0.915) 0.037 (0.244) 0.068* (0.096) 0.130*** (0.004)
BSIZE 0.074 (0.337) 0.031 (0.360)
0.030 (0.239)
0.087 (0.616)
0.340 (0.112)
BODIND
0.766 (0.687)
1.366** (0.013)
2.473*** (0.000)
1.119 (0.700)
6.890** (0.016)
CEODUL
0.399 (0.312)
0.175 (0.108)
0.264 (0.116) 0.826 (0.300)
0.008 (0.988)
DIROWN 0.036* (0.073) 0.003 (0.644)
0.016* (0.055)
0.123*** (0.000)
0.190*** (0.000)
INSOWN
0.023*** (0.000)
0.011*** (0.000)
0.007*** (0.000)
0.030*** (0.004)
0.003 (0.785)
CGINDX
0.230*** (0.001)
0.181*** (0.000)
0.105*** (0.000)
0.619*** (0.000)
0.359** (0.017)
FundSize
0.031 (0.673)
0.034 (0.149)
0.002 (0.930) 0.139* (0.096)
0.134 (0.418)
FundAge 0.059* (0.067) 0.015** (0.022) 0.009 (0.138) 0.041 (0.233)
0.055 (0.327)
Expratio
0.162 (0.130)
0.154*** (0.000)
0.108*** (0.000)
0.182 (0.102)
0.362* (0.079)
MgmtFee
0.192 (0.158) 0.139*** (0.000) 0.136*** (0.000)
0.277* (0.095) 0.566* (0.087)
Education
0.279 (0.161)
0.037 (0.575) 0.0291 (0.589)
0.431** (0.035) 0.214 (0.606)
Experience
0.018 (0.300)
0.019*** (0.001)
0.013** (0.015)
0.023 (0.352) 0.018 (0.613)
Constant 11.03 (0.000) 6.837*** (0.000) 4.582*** (0.000) 3.567*** (0.000) 11.1** (0.014)
Wald test Prob 288.43 (0.000) 2023.3 (0.000) 1406.1 (0.000) 6725.8 (0.000) 931.6 (0.000)
AR(1) test Prob
2.850 (0.004)
4.420 (0.000)
4.130 (0.000)
3.980 (0.000)
4.460 (0.000)
AR(2) test Prob 1.630 (0.103) 0.620 (0.537) 1.480 (0.139) 1.020 (0.309)
1.690 (0.910)
Hansen test Prob 21.10 (0.274) 49.41 (1.000) 56.72 (1.000) 34.60 (1.000) 48.77 (1.000)

Notes: P-values are shown in parentheses; ***p < 0.01; **p < 0.05; *p < 0.1. The coefficients are estimated using robust standard errors to tackle the issue of
heteroscedasticity
 (1) (2) (3) (4) (5)
Variables SD Return DownBeta ReltBeta VAR ES

Total risk t
1 0.387* (0.080) – – – –

Down risk t
1 – 0.143** (0.024)
0.006 (0.823)
0.0121 (0.733) 0.036 (0.324)
BSIZE
0.077 (0.506) 0.017 (0.326)
0.001 (0.945) 0.0481 (0.773)
0.028 (0.880)
BODIND
6.459*** (0.000)
0.711*** (0.002)
2.762*** (0.000)
11.48*** (0.000)
17.79*** (0.000)
CEODUL
0.096 (0.766) 0.003 (0.939)
0.012 (0.859)
0.480 (0.412)
0.424 (0.528)
DIROWN 0.021 (0.277)
0.004** (0.026)
0.016*** (0.000) 0.010 (0.553) 0.004 (0.839)
INSOWN
0.044*** (0.000)
0.0161*** (0.000)
0.003** (0.011)
0.069*** (0.000)
0.068*** (0.000)
CGINDX
0.177** (0.037)
0.086*** (0.000)
0.030** (0.032)
0.203** (0.047)
0.204 (0.111)
FundSize 0.069 (0.362)
0.006 (0.574) 0.010 (0.515)
0.023 (0.831) 0.0411 (0.727)
FundAge 0.030** (0.031) 0.000 (0.836) 0.003 (0.464)
0.048* (0.084)
0.067** (0.026)
Expratio 0.396** (0.018) 0.004 (0.801) 0.101*** (0.000) 0.325** (0.013) 0.530*** (0.001)
MgmtFee
0.453 (0.156)
0.090** (0.024)
0.020 (0.730) 0.429 (0.190) 0.312 (0.332)
Education 0.566*** (0.009) 0.004 (0.875)
0.054 (0.226)
0.013 (0.955)
0.132 (0.657)
Experience 0.032 (0.301) 0.003 (0.401)
0.035*** (0.000)
0.181*** (0.000)
0.220*** (0.000)
Constant 8.944*** (0.004) 3.634*** (0.000) 1.883*** (0.000) 5.944 (0.110) 7.494* (0.094)
Wald test Prob 205.31 (0.000) 4116 (0.000) 1181.3 (0.000) 1844.0 (0.000) 1213.0 (0.000)
AR(1) test Prob
3.310 (0.001)
4.860 (0.000)
6.150 (0.000)
6.260 (0.000)
6.430 (0.000)
AR(2) test Prob 1.550 (0.120)
0.690 (0.490)
1.480 (0.140)
0.120 (0.904)
0.580 (0.562)
Hansen test Prob 7.210 (0.615) 12.34 (0.195) 16.67 (0.215) 13.00 (0.839) 5.030 (0.975)

Notes: P-values are shown in parentheses ***p < 0.01; **p < 0.05; *p < 0.1. The coefficients are estimated using robust standard errors to tackle the issue of
heteroscedasticity

Dynamic panel

exposure of
(CG and risk
system GMM results
Table 5.
mechanism
Corporate

Malaysian funds)
governance
 JIABR

Table 6.
Dynamic panel

combined sample)
(CG and fund risk
system GMM results
(1) (2) (3) (4) (5)
Variables SD Return DownBeta ReltBeta VAR ES

Total risk t
1 0.293 (0.182) – – – –

Down rRisk t
1 – 0.118** (0.016)
0.0764 (0.227)
0.0121 (0.893)
0.056 (0.228)
BSIZE
0.026 (0.733)
0.0479 (0.376)
0.104 (0.240) 0.144 (0.750)
0.134 (0.742)
BODIND
5.152*** (0.000)
0.428 (0.599)
4.228*** (0.005)
15.67* (0.055)
13.90*** (0.008)
CEODUL
0.178 (0.487)
0.310 (0.114)
0.414 (0.162)
0.026 (0.986)
0.576 (0.577)
DIROWN 0.0116 (0.429)
0.016** (0.011)
0.019** (0.027)
0.100** (0.035)
0.105** (0.012)
INSOWN
0.030*** (0.000)
0.012*** (0.000)
0.001 (0.788) 0.010 (0.625)
0.047** (0.012)
CGINDX
0.243*** (0.000)
0.126*** (0.000)
0.116** (0.043)
0.660** (0.017)
0.335 (0.169)
FundSize
0.001 (0.982)
0.019 (0.203)
0.006 (0.784) 0.008 (0.937)
0.071 (0.533)
FundAge 0.030** (0.049) 0.006 (0.119) 0.007 (0.227)
0.049 (0.124)
0.127*** (0.000)
Expratio 0.236*** (0.002)
0.104*** (0.000)
0.049** (0.014) 0.019 (0.827) 0.328*** (0.000)
MgmtFee
0.233 (0.174) 0.085** (0.014) 0.072 (0.125) 0.423 (0.125) 0.675** (0.014)
Education 0.266* (0.084) 0.024 (0.511) 0.003 (0.945)
0.115 (0.654)
0.224 (0.387)
Experience 0.006 (0.740)
0.000 (0.976)
0.018** (0.015)
0.126*** (0.005)
0.092** (0.027)
Constant 11.67*** (0.000) 5.382*** (0.000) 5.809*** (0.000) 18.03** (0.020) 11.36 (0.125)
Wald test Prob 327.0 (0.000) 2002.7 (0.000) 984.2 (0.000) 1032.4 (0.000) 964.50 (0.000)
AR(1) test Prob
3.190 (0.001)
5.940 (0.000)
5.760 (0.000)
5.270 (0.000)
6.450 (0.000)
AR(2) test Prob 1.610 (0.106)
0.970 (0.334)
0.550 (0.585) 0.350 (0.727)
1.720 (0.860)
Hansen test Prob 7.670 (0.568) 75.54 (0.304) 57.59 (0.187) 49.08 (0.470) 113.3 (0.446)

Notes: P-values are shown in parentheses ***p < 0.01; **p < 0.05; *p < 0.1. The coefficients are estimated using robust standard errors to tackle the issue of
heteroscedasticity
negatively affects the risk exposure of Islamic mutual funds prevailing in both countries, which Corporate
confirms H4 and supports the interest alignment viewpoint. This result is also consistent with governance
the findings of Wang et al. (2015), Hussain and Amir Shah (2017) and Gulamhussen et al. (2012).
Tables 4, 5 and 6 also report the coefficients of institutional ownership. These coefficients are
mechanism
found negative and statistically significant at 1% or 5% in all the study samples, which
indicates that institutional ownership negatively affects the total and downside risk exposure
of Islamic mutual funds. This result leads to the acceptance of H5 and supports the active
monitoring viewpoint. Previous studies such as Wang et al. (2015), Hussain and Amir Shah
(2017) and Jafarinejad et al. (2015) also showed that higher institutional ownership helps to
reduce the total and downside risk exposure of the organizations. Finally, the coefficients of
Corporate Governance Index are also found to be significant in all the study samples. The
negative coefficients indicate that the total and downside risk exposure of Islamic mutual funds
can be reduced by improving the overall quality of corporate governance. This result confirms
H6 and is consistent with the notion of agency theory. Previous studies such as Mathew et al.
(2018), Hussain and Amir Shah (2017) and Jiraporn et al. (2015) reported the same results in the
context of organizational risk. All the results of Wald test reported in Tables 7-9 are significant,
which indicate the goodness of the fit of the study models. The values of AR (2) and Hansen J
tests reported in these tables are insignificant in all the subsamples, which indicate the absence
of second-order serial correlation and validity of study instruments.

4.3 Summary of the results and decision on hypotheses

Table 7 indicates the summary of the results and decision on hypotheses.

5. Conclusion and implication

This study aims to analyze the impact of corporate governance characteristics on the total and
downside risk exposures of Islamic mutual funds prevailing in Pakistan and Malaysia. The
study used dynamic panel regression model, and the results are estimated using system GMM
technique. The result showed that the corporate governance characteristics such as board
independence, governance quality and directors’ and institutional ownership negatively affect
the risk of Islamic mutual funds. It can be concluded that the risk of these funds can be reduced
by improving the governance structure and quality of corporate governance.
This study has both theoretical and managerial implications. From the theoretical
viewpoint, the findings of the current research suggest that the theories of corporate
governance are also applicable to the Islamic mutual fund industry. It suggests that just like
the firm’s governance structure, the governance structure of mutual fund companies also
play a significant role in reducing the risk of the funds under their management. This study
is also important for fund managers and industry practitioners. Fund managers are
concerned with reducing the probability of fund’s risk. This study suggests investment
firms and fund managers to improve the quality of corporate governance, which would help

Variable Hypothesized direction Results Decision on hypotheses

Board size
Insignificant Rejected

Board independence
Significant Accepted
CEO duality þ/
Insignificant Rejected Table 7.
Director’s ownership
Significant Accepted Summary of the
Institutional ownership
Significant Accepted results and decision
Governance quality
Significant Accepted on the hypotheses
JIABR them to reduce the risk exposure of Islamic mutual funds and attract large number of
investors, especially the Shariah-compliant risk-averse investors.

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Further reading
Sila, V., Gonzalez, A. and Hagendorff, J. (2016), “Women on board: does boardroom gender diversity
affect firm risk”, Journal of Corporate Finance, Vol. 36 No. 1, pp. 26-53.

Corresponding author
Farrukh Naveed can be contacted at: farrukhnaveed22@gmail.com

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