1c-Almutairi Et Al2017

Social Responsibility Journal
Corporate governance: evidence from Islamic banks

Ali R Almutairi, Majdi Anwar Quttainah,
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Ali R Almutairi, Majdi Anwar Quttainah, "Corporate governance: evidence from Islamic banks", Social Responsibility Journal,
https://doi.org/10.1108/SRJ-05-2016-0061
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Corporate governance: evidence from Islamic banks
Key words: Islamic Banks, SSB, SSB Attributes, and Corporate Governance
JEL Classification Numbers: G34, G38, G31, G30.

1. Introduction
Research on the governance of religious establishments, specifically the Islamic banking
industry, has become prolific. Islamic jurisprudence, or Shari’ah,1 has received special attention
for its corporate governance model, which establishes Shari’ah as “the ultimate goal, which
entails the notion of protecting the interests and rights of all stakeholders within the Shari’ah
rules” (Hasan, 2008).
Compared to other banks, Islamic banks (hereafter, IBs) have an additional layer of
internal governance — one that ensures all transactions comply with Shari’ah. This happens via
a Shari’ah supervisory board (hereafter, SSB), which is an independent board that investigates
and audits Shari’ah compliance ex-ante and ex-post for all financial transactions.
SSBs are not ubiquitous in Islamic banking. In Pakistan, Sudan, and Iran, for example,
IBs do not embed SSBs within their governance structures; in other Islamic countries, however,
SSBs are legally required. Proponents of integrating SSBs within the IB governance structure
argue that SSBs improve the reliability, credibility, and legitimacy of IBs (Shaffaii, 2008; Abu
Ghudda, 2001; Suleiman, 2000). On the other hand, opponents claim that SSBs increase
bureaucracy and hence lower the performance of IBs (Grais and Pellegrini, 2006). This paper
studies those claims about the impact of SSBs on IB performance. It also investigates whether
the attributes of SSBs correlate to superior performance.
Based on a sample of 1,803 bank-year observations from 82 IBs in 15 countries between
1993 and 2014, certain findings are clear. First, SSB do tend to improve the financial
performance of IBs. In addition, the results indicate that SSBs within IBs improve financial
performance by an average of 12.43 percent as measured by Tobin’s Q, return on assets, and
1
Shari’ah refers to the Islamic Constitution, which exists to protect the welfare of the people under it by
safeguarding their faith, life, intellect, posterity, and wealth (Al-Ghazali, 1937).
return on equity. This result holds after adjusting for country and year effects and is robust to the
inclusion of various control variables (micro-level and macro-level).
This study also reports a significant positive relationship between the size of SSBs and
financial performance, with larger boards showing an average of 2.26 percent performance
improvement for IBs. In addition, IB performance rises with the degree of SSB integration; we
find that high integration provides an average of 1.71 percent increase in financial performance.
Furthermore, we find that a one-unit increase in the proportion of SSB board members who have
graduate degrees results in a 25.80 percent increase in IB financial performance. IB performance

also rises by an average 94.74 percent when SSB members have expertise in jurisprudence,
contemporary finance, and Islamic finance.
This research contributes to the literature on the effects of SSBs on IBs’ organizational
financial performance, processes, and roles. It is the first to examine empirically the
underpinnings of how SSBs affect organizational financial performance via agency theory and
contingency theory.
The remainder of the paper is organized as follows. The next section reviews extant
literature. In sections three and four, we present research objectives and research framework.
Section five describes the research methods, and section six presents the empirical results,
discussion, and robustness tests. Summary and major conclusions are in section seven.
2. Literature Review
2.1 SSB Mission
Agency theory argues that management does not always act in the best interest of shareholders
and that shareholders can monitor management behavior to minimize management’s
opportunistic behavior (Jensen and Meckling, 1976). One of these monitoring mechanisms is
board oversight. The board represents “a market-induced institution, the ultimate internal
monitor of the set of contracts called a firm” (Fama, 1980). It has the responsibility of protecting
shareholders, and this responsibility includes overseeing accounting and financial reports, as well
as improving corporate performance.
The mission of SSBs in IBs is to monitor and control the religious, behavioral, moral, and
ethical aspects of corporate management, as well as products, services, and transactions.2 SSBs
are responsible for ensuring Shari’ah compliance, thereby assuring depositors and shareholders
that a bank is truly and fully compliant with Shari’ah. CEOs and top managers are required to
provide all necessary and relevant information to help the SSB apply Shari’ah rules to
transactions or products regardless of outcomes. Also, SSBs provide advice and counsel to
external parties (e.g., shareholders, regulators, and central banks) and internal parties (e.g.,
management and employees).
Besides ensuring Shari’ah compliance and issuing fatwas (i.e., religious rulings), SSBs
reply to all depositor, customer, and investor queries and clarify any ambiguity in any
transaction. In addition, SSBs continuously guide and train top managers to apply Islamic rules
in daily transactions to avoid religious or ethical conflicts before making agreements with
investors.
2.2 SSB Appointments and Demographics
In the annual general meeting of each IB, shareholders or boards of directors elect new SSB
members or re-elect current SSB members. To ensure their independence, the International
Association of Islamic Banks (IAIB) prohibits members of SSBs from working in the banks they
serve or being unduly influenced by the board of directors. SSB members are guided by ethical
2
IBs comply with the standard global corporate governance (CG) principles and models, originally issued in 1992,
including the Organization for Economic Cooperation and Development (OECD).
and religious values. SSB members should be honest and independent to gain the trust of
investors and the public (Abdul Rahman and Bukair, 2013). Although the number of SSB
members varies from one IB to another, SSBs have at least three members, one of whom should
have sufficient background in Islamic economics issues (AAOIFI, 2005). Members of SSBs are
Shari’ah scholars who are experts in Islamic commercial law jurisprudence and have a minimum
of three years’ experience lecturing about Shari’ah rulings. To encourage diversity and increase
efficiency, SSBs can include experts in law, accounting, and finance. Each SSB is required to
issue an annual report in a standard format set forth by the Accounting and Auditing
Organization for Islamic Financial Institutions (AAOIFI); it must submit it to the board of
directors and later to the annual general meeting of shareholders for approval (Malkawi, 2014).
SSB Reputation
The role of the SSB is relatively similar to that of external auditors and board audit committees
(Abdul Rahman and Bukair, 2013). Hence, SSB members are prone to the same factors that
affect external auditors and audit committees (Abdul Rahman and Bukair, 2013). However, SSB
members are Shari’ah scholars who try to maintain their integrity by avoiding dubious activities
(Garas, 2012). Due to their great knowledge of Shari’ah law, which lends higher credibility, as
well as their roles as community servants, Shari’ah scholars enjoy strong reputations (Abdul
Rahman and Bukair, 2013). IBs with reputable SSB members are thus often expected to earn
higher returns. Farook et al. (2011), for example, suggest that SSB members’ reputations are
instrumental in measuring corporate social responsibility (CSR). Abdul Rahman and Bukair
(2013) report that IBs with reputable SSB members disclose more corporate social responsibility
in their annual reports, indicating that IBs with reputable SSBs have more effective monitoring
and controls. In addition, because their reputations are valuable, SSB members are expected to
work harder, which improves Shari’ah governance and fatwas, and thus enhances firm
operations and outcomes.
3. Research Objectives
The first objective of this study is to find out whether there is a considerable variation in
performance between Islamic banks that do or do not embed this extra layer of corporate
governance. This may indicate whether SSBs have an additional monitoring value that can
enhance bank performance. The second objective is to establish a basis for religious attributes
that shape the structure of the Islamic banking system. This additional layer of monitoring and
accountability ensures insiders and outsiders that all bank activities and transactions are carried
out according to Islamic principles. The third objective is to identify the characteristics of an
additional layer of corporate governance that could increase IB performance. The variations in
bank performance can be subject to the variation in SSB attributes.
4. Research Framework
Similar to Nicholson and Kiel’s (2004) theoretical model, which reveals the impact of board
functions on corporate performance, this study presents two models. The first one establishes a
link between IB performance and the existence of SSBs. This model includes a large sample of
IB-year observations. The dependent variable is bank performance, measured by different
proxies as shown in the next section, and the independent variable is an indicator variable that
reflects IBs with SSBs and IBs with no SSBs.
The second model shows how SSB characteristics affect IB performance. In this model,
we examine only IBs with SSB-year observations. The independent variables are the
characteristics of SSBs, such as size, outside directors, directorship interlocking, membership of

directors, expertise of directors, and educational level of directors. These two models also
include other variables known to affect bank performance, such as board characteristics, year,
and country effects.
4.1 Hypotheses Development
4.1.1 SSB and IB Performance
Shari’ah conformity is the distinguishing feature of Islamic business organizations, and in this
context it is the distinguishing feature of the Islamic banking industry. In practice, the essential
functions of guiding and controlling IB operations rest with respectable, diverse Shari’ah jurists.
International standard-setting bodies and regulators have made numerous efforts to
standardize and homogenize the practices of Islamic banking, even across national borders. Yet,
it is the core responsibility of the SSBs to define the requirements of Shari’ah for different
transactions and contracts. This makes SSBs the central point of conformity, and IBs thus rely on
them as people rely on IBs (Quttainah, 2012; Abidin, 2006; Warde, 2000; Khan, 1995).
Proponents of SSBs contend that IB boards rely on religious rulings provided by in-house
SSBs to ensure compliance with Shari’ah, thus fostering positive managerial behavior and
financial performance by offering additional support to boards (Shaffaii, 2008; Abu Ghudda,
2001; Suleiman, 2000). Quttainah et al. (2013) show that IBs that embed SSB are less likely to
engage in earnings management compared to commercial banks and IBs without SSBs, for
example. Opponents of SSBs, however, argue that embedded SSBs add bureaucracy that hinders
timely responses to urgent issues and results in lower financial performance (Grais and
Pellegrini, 2006).
Regulators in Iran, Pakistan, and Sudan do not require integrated SSBs due to their
reliance on the Shari’ah-Apex. These centralized SSBs are not embedded; rather, they serve
public and private organizations by issuing fatwas (i.e., religious rulings) on certain IB products
and/or services. In these countries, engaging with the Shari’ah-Apex and waiting for their
religious rulings may negatively influence IB performance. An untimely response, for example,
may result in a lost business opportunity for the IBs. Lack of embedded SSBs therefore may
hinder IB performance if they are unable to capitalize on the different roles and services SSBs
provide, such as monitoring, controlling, advising, counseling, and accessing resources. Based
on this discussion and the two competing views of SSBs, we present the following
nondirectional hypothesis:
H1: There is a difference in financial performance between IBs that embed SSBs and IBs
that do not embed SSBs.
However, prior literature shows that not all boards control and monitor management
equally. Also, best monitoring practices depend on environmental conditions, as suggested by
the contingency theory.3 A contingency is a relationship between two phenomena, where a
conclusion drawn from one phenomenon depends on the existence of another phenomenon. For
example, if boards vary in their characteristics, then the quality of monitoring and governance
will be affected. The following sections discuss these characteristics and their expected
association with IB performance.
4.1.2 SSB Size
Jensen (1993) argues that small boards provide effective monitoring and are less likely to be
controlled by managers. Empirical evidence by Yermack (1996) supports this notion. He reports
that the probability of committing financial statement fraud is higher when more directors sit on
3
The contingency theory argues that there is no single best way to manage organizations, and therefore each
organization should develop managerial strategy according to its situation and condition (Ainuddin et al., 2007).
the board. In addition, he shows that board size is negatively related to firm value, as measured
by Tobin’s Q.
Alternatively, larger boards are likely to provide effective monitoring and more
compliance with corporate rules and guidelines. They tend to have better networks and more
expertise (Dalton et al., 1998). Prior studies suggest that firms with larger boards are also less
vulnerable to bankruptcy (Chaganti et al., 1985), enjoy less uncertainty (Birnbaum, 1984), and
have less information asymmetry (Chen and Jaggi, 2000). Also, firms with larger boards have
greater visibility in the community (Provan, 1980) and provide information symmetry that
ensures consistency in allocating resources to firms (Goodstein et al., 1994; Pearce and Zahra,
1992; Pfeffer, 1973).
Pfeffer and Salancik (2003) investigate the impact of board size on the overall firm
performance. They report that firms with larger boards exhibit better performance due to firms’
ability to budget more accurately, access external capital, and tap into leverage from an
environment. Abdul Rahman and Bukair (2013) similarly report higher expectations of collective
knowledge and member experience on larger SSBs. These opposite arguments and the empirical
evidence prompt the following nondirectional hypothesis:
H2: SSB size is related to IB performance.
4.1.3 SSB Outside Directors
Contingency theory suggests that firms can create strategic opportunities and improve their
interactions with the external environment by inviting or appointing outside directors. Outside
directors also provide and safeguard the resources necessary for the survival of the firm. Daily
and Dalton (1994) find, for example, that financially distressed firms are more likely to avoid
bankruptcy if their boards have higher proportions of outside directors. According to the
contingency theory, outside directors are important for their advising and resource-allocation
roles, not merely for their monitoring roles (Zaheer and Bell, 2005; Forbes and Milliken, 1999;
Goodstein et al., 1994; Miller and Roth, 1994).
Extant empirical research also indicates that boards provide more effective monitoring
when they have higher proportions of outside directors. For example, firms with boards that have
a larger percentage of outside representation are less likely to engage in earnings management
(Dechow et al., 1996) or disclose more negative information (Abrahamson and Park, 1994).
Therefore, it is possible that monitoring, networking, and information exchanges flourish when
SSBs have higher proportions of outside members. As a result, IB performance may be higher
when SSBs have more independent members. Thus, we present the following hypothesis:
H3: The number of outside members on an SSB is positively related to IB performance.
4.1.4 SSB Interlocks
Interlocking directorate is “defined as the linkages among corporations created by individuals
who sit on two or more corporate boards” (Domhoff, 2005). Barnea and Guedj (2006), Larcker et
al., (2006), and Hallock (1997), find that interlocked boards are associated with higher CEO
compensation, suggesting that interlocked and connected directors may compromise the
effectiveness of board monitoring. Richardson (1987) even argues that interlocked directors
indicate weak governance and entrenched managers.
On the other hand, interlocks can create channels of communication through which
directors exchange information, especially among directors sitting on multiple boards (Scott,
1997). This is because these directors have access to private information for multiple companies.
Aside from increased information availability, interlocking directorships can benefit companies
by reducing competition and raising prestige (Dogan, 2003). Schonlau and Singh (2009), for
example, note that interlocked directors are indicative of simultaneous information-based
benefits, which demonstrate how important board networks are in resource allocation and
acquisitions that improve organizational performance. These two competing views lead to the
following nondirectional hypothesis:
H4: SSB interlocks are related to IB performance.
4.1.5 SSB Membership
Shari’ah interpretation is diverse due to differences in Islamic jurisprudence schools (i.e.,

Hanafi, Hanbali, Maliki, and Shafi’i). Such conflicts foster different perceptions of
ineffectiveness for IBs. Establishing the International Financial Services Board (IFSB) was a
step toward unifying the interpretations of Shari’ah law and religious rulings. The organization
helps regulators and supervisory agencies fine-tune the soundness and stability of the Islamic
financial services industry. In addition, inconsistent or contradictory fatwas create friction and
confusion among IBs, customers, staff, management, and directors. By subscribing to the IFSB,
however, IBs can unify fatwas. This avoids the friction and confusion of uncoordinated fatwas,
thereby improving the quality and soundness of their SSBs, as well as their organizational
behavior and performance. Thus, we state this hypothesis:
H5: SSB membership in the IFSB is positively related to IB performance.
4.1.6 SSB Expertise
AAOIFI provides the necessary Shari’ah expertise for accumulating knowledge, both tacit and
explicit. Tacit knowledge accumulates when IB staff and management execute accounting and
auditing duties in compliance with Shari’ah. In an audit context, this means audit committees
that have directors with backgrounds in accounting and/or finance are more likely to minimize
financial errors, thereby improving disclosure quality (McDaniel et al., 2002). Because an SSB’s
mission is similar to that of an audit committee, as noted earlier, SSB members with accounting,
finance, and/or economics knowledge or practice may have a positive impact on IB performance.
Hence, we propose the following hypothesis:
H6: SSB expertise is positively related to IB performance.
4.1.7 SSB Education Level
SSBs qualifications are important for decision-making. Firms assume qualified members are
strategic resources who provide strategic linkages to different external resources and ensure
effective and sustainable levels of intellectual ability, experience, sound judgment, and integrity
(Ingley and Van der Walt, 2001).
Specifically, empirical research implies that diverse educational backgrounds are linked
with different social statuses, networks, and professional development paths (Useem and
Karabel, 1986). In particular, heterogeneity in educational background provides SSBs with
different perspectives and cognitive paradigms that affect vocational development and social
contacts.4 Education is thus seen as a significant institutional asset that could influence
accounting practices and values (Gray, 1988). Also, education tends to be a unique measure for
determining the level of professionalism (Grace et al., 1995) and an important factor in corporate
disclosure practices (Haniffa and Cooke, 2002). Directors with more education are also likely to
adopt new procedures and accept risks (Hambrick and Mason, 1984). Members with more
education may also have greater analytical capabilities and be richer sources of innovative ideas
and policy development. In total, this suggests that education among SSB members can have a
positive impact on IB performance. Thus, we propose the following hypothesis:
4
Educational heterogeneity is based on whether the SSB members have one or more graduate degrees.
H7: SSB education level is positively related to IB performance.
5. Research Methods
The purpose of this study design is to relate SSB presence, size, and diversity to financial
performance using three techniques. The first technique is a multivariate data analysis that
analyzes data arising from more than one variable. The second technique is a clustered
regression (clustering by bank), which corrects for serial correlation and produces unbiased t-
statistics. Because our sample is drawn from panel data, we expect serial autocorrelation of the
independent variables and error term within banks. In cases where within-company correlation
exists, t-statistics based on average regression coefficients from year-by- year regression are
upwardly biased and potentially severe (Peterson, 2009). Therefore, this study uses a technique
that agrees with Stock and Watson (2002), who show that the standard method of
calculating heteroscedasticity-robust standard errors for the fixed-effects estimator generates
inconsistent variance estimates. Thus, using the clustered regression is consistent with the fixed-
effects estimator. The third technique is a two-stage least-squares regression that helps build an
instrumental variable for robustness tests purposes.
5.1 Measurement Tools
To test the impact of the presence of SSB on IB performance (H1), we estimate the following
regression model:
Performancet = ƒ (SSBt, Control Variablest) (1)
In this paper, we use two accounting proxies, return on assets and return on equity, to
measure IB performance. Return on assets (ROA) is net income divided by total assets, and
return on equity (ROE) is net income scaled by total shareholders’ equity. Both proxies are
widely accepted and used in several studies measuring corporate performance (e.g., Al Manaseer
et al., 2012; Rouf, 2011; Heenetigala and Armstrong, 2011). We also use a market proxy,
Tobin’s Q (TQ), to measure IB performance (e.g., Karaca and Ekşi, 2012; Wahla et al., 2012;
Kang and Kim, 2011). It is the natural logarithm of the sum of market capitalization and total
liabilities, divided by total assets. TQ is known for its “forward-looking” ability and its reflection
of shareholders’ expectations about future performance, which has its basis in previous or current
performance (Wahla et al., 2012; Shan and McIver, 2011).
The main independent variable in equation (1) is SSB, which is an indicator variable that
is equal to 1 if the SSB is within the governance structure of the IB, and 0 otherwise. We include
several control variables based on previous literature. CEO Duality is a dichotomy variable that
is equal to 1 if the CEO is also the chair of the board; it equals 0 otherwise. In Dey et al. (2011)
and Larcker et al. (2011), CEO duality is associated with firm performance. CEO Interlocks
measures CEOs who serve on other boards; it is measured as the ratio of CEO directors to the
total number of board members. Prior studies (e.g., Fich and White, 2005; Park and Luo, 2001;
Peng and Luo, 2000) also show a positive association between CEO interlocks and firm
performance. Board Size is the total number of board members. Research reports mixed results
on the association between board size and firm performance. For example, Gust (2009) and
Haniffa and Hudaib (2006) show that firm performance is lower when boards are larger.
Salancik and Pfeffer (1978), however, show that larger boards contribute to higher firm
performance.
In addition, this study includes Outside Director to control for the positive association
between firm performance and the number of outside directors (Peng, 2004; Jensen and
Meckling, 1976; Shleifer and Vishny, 1997). It is the ratio of outside directors to the total
number of directors on each board. We also add government director (Gov. Director) to equation
(1); it is the ratio of government representatives on the board to the total number of board
members. Studies find that firms with government directors on their boards perform better
(Hillman, 2005), enjoy greater access to capital (Khwaja and Mian, 2005), and achieve higher
stock prices (Niessen and Ruenzi, 2010). Board Interlocks is another control variable in equation
(1). Interlocking enables firms to monitor one another (Mizruchi and Stearns, 1994) and provides
firms with information about business practices (Davis, 1991), thereby improving firm
performance. However, interlocking may also decrease firm performance because of the
excessive burden on the directors (Fich and Shivdasani, 2006; Ferris, et al., 2003). Nonetheless,
Board Interlocks is the ratio of board members with interlocks to the total number of directors on
the board.
International Financial Reporting Standards adoption may also influence IB performance.
For example, Ashbaugh and Pincus (2001) find that firms following International Accounting
Standards (IASs) have more accurate analyst forecasts than firms following domestic accounting
standards. This may be because IASs require greater disclosure relative to domestic accounting
standards. To compare the performance of IBs that adopt IFRS to those that do not, we add the
variable IFRS to model (1). IFRS is a categorical variable that is equal to 1 if the IB employs
IFRS; it equals 0 otherwise.
Further, bank size (Bank Size) is controlled due to its effect on firm performance
(Nicolaou, 2004; Hunton et al., 2003). It is the natural logarithm of total assets. To control for the
variation in IB performance across regions (i.e., the Middle East, the Near East, the Far East, and
North Africa), we add an indicator variable, Middle East, to model (1). Bashir (2003) shows that
macroeconomic environment, financial market structures, and taxation across regions are
significant factors in IB performance.

Nevertheless, this study controls for the change in economic development, proxied by
EIUCR. Economic development likely affects bank creditworthiness, as well as political and
business development trends in a country, which in turn can proxy for regulatory quality and the
legal environment. Moreover, this study controls for country-specific regulatory strength (CSRS)
(Barth et al., 2001). CSRS is a discrete variable that is equal to 1 if a country has more than one
supervisory body; it equals 0 otherwise. Last, we include two indicator variables, Year and
Country, in model (1) to capture year and country specifics, respectively.
To examine the effect of SSB attributes on IB performance (H2-H7), we use the

following regression model:

Performancet = ƒ (SSB Sizet, Outside SSBt, SSB Interlockst, IFSBt, AAOIFIt,
SSB Educationt, Control Variablest) (2)
SSB Size is the total number of SSB members, and Outside SSB is the ratio of exogenous
SSB members to total SSB members. SSB Interlocks is the ratio of interlocked SSB members to
total SSB members on each board. IFSB is an indicator variable that is equal to 1 if the SSB
member is also an IFSB member; it equals 0 otherwise. AAOIFI and SSB Education are also
indicator variables. AAOIFI equals 1 if at least one SSB member has an accounting, finance,
and/or economics background; it equals 0 otherwise. SSB Education is equal to 1 if the SSB
member holds a postgraduate degree; it equals 0 otherwise. As for the rest of the variables, they
are defined as above (see Appendix for variables definition).
5.2 Data Collection and Sample Selection
We retrieve information for all IBs available in the BankScope database between 1993 and 2014.
The search process yields over 100 IBs. To make a fair comparison, we construct a balanced
panel sample and exclude banks that do not have full, 21-year information. We also exclude IBs
established after 1993.5 In total, the final sample includes 82 IBs, consisting of 1,803 IB-year
observations from 15 countries: Bahrain, Bangladesh, Egypt, Indonesia, Iran, Jordan, Kuwait,
Lebanon, Malaysia, Pakistan, Qatar, Saudi Arabia, Sudan, Turkey, and United Arab Emirates.
Table 1 reports the observation distribution by country. Bahrain has the highest number of
observations (396), representing about 22 percent of the entire sample. Since the late 20th
century, Bahrain has invested in the financial and banking sector. Therefore, it has become
attractive to many large financial institutions (Al-Hassan et al., 2010). Indonesia has the lowest
number of observations (17), representing 1 percent of the whole sample, due to the economic
crisis of 1997. Since then the banking industry has become more regulated and heftier (Sato,
2007).
In addition, we manually collect information about SSB traits, regular board
characteristics, and number of directors from banks’ websites.6 In addition, we collect data on IB
specialization, assets, liabilities, earnings, expenses, credit ratings, country credit ratings, and
risk rating information mainly from the BankScope database and supplement it with information
from several country-level and bank-level websites.
Insert Table (1)
Panels A and B of Table 2 provide descriptive statistics for both the subsample of IBs
with SSB and the entire sample of IBs, respectively. Table 2 reveals large variances. Values
higher than the mean by plus or minus three standard deviations are considered outliers. This is
based on the characteristics of a normal distribution, for which 99.87 percent of the data appears
within this range. Hence, possible options include dropping the extreme values or winsorizing
data. Winsorizing the data is the best possible approach by replacing extreme values in the data
5
We acknowledge that our results might not be generalized to IBs that started after 1993.
6
We collect data on SSB characteristics from relevant sources.
set with a percentile value from each end.7
In Panel A, we see that approximately 41 percent of the bank-year observations embed
SSBs. The mean (median) ROA in our subsample is 4 percent (3 percent). The average (median)
ROE and TQ of the subsample is 16 percent (4 percent) and 11 percent (5 percent), respectively.
For the entire sample (Panel B), the mean (median) ROA, ROE, and TQ are 3 percent (2 percent),
16 percent (4 percent), and 4 percent (0.1 percent), respectively. Notably, IBs with SSBs exhibit
higher performance than their counterparts.
The mean (median) asset size of the banks in our sample is $0.70 billion ($0.62 billion)
with the 25th (75th) percentile equal to $0.53 billion ($0.77 billion). For the IBs with SSBs, the
mean (median) value is $0.71 billion ($0.67 billion), with the 25th (75th) percentile equal to
$0.55 billion ($0.93 billion). Accordingly, our subsample and entire sample represent a wide
range of bank sizes with a skewed distribution. In addition, IBs with SSBs are larger in terms of
asset size than IBs with no SSBs.
In IBs with SSBs, each SSB, on average, consists of about five directors. Also, the
average number of outside directors and interlocked directors in IBs with SSBs is approximately
four and one, respectively. About 80 percent of directors in IBs with SSBs have high-level
academic degrees. Not surprisingly, the nature of the SSB mission requires IB boards to
nominate competent Shari'ah scholars who have comprehensive knowledge of Shari'ah law and
its interpretations.
In terms of board features of all IBs, the mean (median) number of directors is about 10
(9) directors. Similar values are reported for the subsample group. In IBs with SSBs, the ratios of
outside directors, government directors, and interlocked directors are 164 percent, 150 percent,
and 106 percent, respectively. Because financial stability is crucial to the overall health of the
7
Normality and linearity are checked.
Islamic economy, government regulators and Islamic Financial Institutions (IFIs) closely
scrutinize IBs (Matoussi and Grassa, 2012) should be more concerned with IBs with SSBs.
Therefore, IBs with SSBs are likely to have more government and outside directors. Further, we
find IBs with SSBs have greater regulatory strength on average (CSRS = 9 percent), higher
quality legal environments (EIUCR = 4.10), and more compliance with International Financial
and Reporting Standards (IFRS = 84 percent). This suggests IBs with SSBs tend to be more
compliant with regulations and standards.
A higher percentage of interlocking board directorships in IBs with SSBs could be a sign
of maximizing resources through greater access to strategic information (Pfeffer, 1991).
Nonetheless, CEO duality and CEO interlocks in IBs with SSBs have a mean value of 176
percent and 38 percent, respectively. This suggests CEO networks can minimize uncertainty and
secure external resources (Mizruchi and Stearns, 1994), and that CEO duality may facilitate
timely, more effective decision-making (Finkelstein and D'Aveni, 1994) and minimize confusion
among managers, employees, shareholders, directors, and SSBs.
Insert Table (2)
6. Empirical Findings and Discussion
6.1 Main Results
Table 3 shows the results of t-tests for the performance of IBs with SSB and IBs without SSBs.
The results show a significant difference between these two groups across the three proxies of
performance.8 In particular, IBs with SSB have higher ROA, ROE, and TQ than IBs without
SSBs. This suggests IBs with SSBs are more likely to outperform their counterparts.
Insert Table (3)
8
We also run the Mann Whitney U test; the results are in line with those reported under the t-test.
Table 4 displays Pearson correlations for most variables in equations 1 and 2. Results
show that SSB has a positive and significant (two-tailed p-values of 0.05 or less) association with
the three measures of performance. These preliminary results suggest that, other things being
equal, IBs with SSB perform better than IBs without SSBs. Table 4 also shows that SSB Size and
SSB Interlocks are positively and significantly related to all measures of performance at two-
tailed p-values of 0.10 or less. In addition, Outside SSB, IFSB, AAOIFI, and SSB Education have
positive and significant (at two-tailed p-values of 0.10 or less) correlations with ROA, ROE, and
TQ. All other control variables, in general, have a significant association with the three measures
of performance.
Insert Table (4)
Table 5 shows regression results for H1 through H7. ROA, ROE, and TQ are the proxies
for IB performance. We present regression results separately for each of the three IB
performance measures. Columns 1, 2, and 3 of Table 5 show the results for H1. The coefficient
on SSB is positive and significant at two-tailed p-values less than 0.001.
These results suggest IBs with SSBs outperform IBs without SSBs. This supports H1 and
could be a result of the role SSBs play in fostering managerial behavior to increase bank
performance. All other control variables are statistically significant, and each carries its expected
sign based on prior empirical studies.
Columns 4, 5 and 6 of the same table show the results of H2 through H7. Under each
performance regression model, the coefficient on SSB Size is positive and statistically significant
at two-tailed p-values less than 0.001. This suggests IB performance improves as the number of
SSB directors increases. More SSB members is a potential avenue for more expertise, better
networks, and more connections, which can positively affect bank performance. Therefore, H2 is
supported.
The results of Table 5 also show that Outside SSB is positively and significantly related
to all measures of performance (two-tailed p-value < 0.01), which supports H3. That is, the more
outside directors there are on an SSB, the better the IB performs. Outsiders are appreciated for
their advising and resource-allocation roles, as suggested by the contingency theory, which
makes them better monitors and a valuable means for enhancing bank performance.
In addition, SSB Interlocks is positive and statistically significant at a p-value less than
0.001 under the ROA (column 4) and ROE (column 5) regression models, and it is statistically
significant at a p-value less than 0.10 under the TQ (column 6) regression model. These findings
indicate that interlocked and connected SSB members have a positive impact on IB performance,
thus supporting H4. This suggests that interlocking directorship can thus create ample channels
of communication with other corporations, greater resource allocations, and in turn better bank
performance.
Insert Table (5)
Nevertheless, the coefficient on IFSB is positive and statistically significant at two-tailed
p-values less than 0.10 under the ROA and TQ models, and it is highly statistically significant (p-
value < 0.001) under the ROE model. These findings support H5, suggesting that SSB directors
who have IFSB membership tend to positively influence IB performance. This also suggests that
IFSB membership tends to improve SSB quality by helping unify fatwas within the Islamic
financial services industry and minimizing frictions among parties (e.g., directors, managers,
employees, depositors, and others), thereby increasing bank performance.
As for AAOIFI and SSB Education, each carries its predicted sign and is statistically
significant at two-tailed p-values less than 0.001. These results are consistent across the three
measures of IB performance. SSB members with business knowledge or practice (e.g.,
accounting, finance, and/or economics experience) positively affect IB performance. H6,

therefore, is supported. This suggests that SSB members serving in the AAOIFI gain better
expertise, which could help them better understand the language of business, thereby
contributing to bank performance.
In addition, we find that IB performance improves with SSB education level. Thus, H7 is
also supported, suggesting SSB directors with higher degrees have greater analytical skills,
innovative ideas, and policy development skills. Last, the results of control variables in columns
4, 5, and 6 of Table 5 are, in general, in line with those reported in columns 1, 2, and 3 of the
same table, except for Middle East and EIUCR.9

6.2 Robustness Test Results
We use a panel regression model with fixed effects. The results (not tabulated) of this technique
are in line with the initial findings reported earlier. However, in order to provide further evidence
of the relationship between SSB size and organizational performance, and to address
endogeneity and reverse causality concerns, the analysis requires an instrumental variable that
correlates with SSB sizes but not the error term of equations (except through variables already
included in the regression).
Using a two-stage-least squares regression helps in building an instrumental variable. The
suggested instrumental variables, loan-loss provision ratio (LLPR), and asset growth, (AG), are
dependent variables in this analysis. LLPR is a proxy of organizational performance, and AG is a
proxy of organizational risk.
Using the instrument, we perform a Hausman test of the hypothesis that SSB size and
composition are uncorrelated with the error term. The results fail to reject the null. To the extent
that the chosen instruments are valid, this suggests that endogeneity of SSB size and composition
9
All variables in equations 1 and 2 have VIF values less than 10, indicating multicollinearity is not a major concern.
due to reverse causality is not a big concern. However, another concern is that endogeneity could
drive the results due to omitted variables; it is also possible that other sources of endogeneity
exist rather than the ones considered here. However, besides controlling for a wide range of
governance variables, country, and years, we perform a robustness test once on the entire sample
and once again using only the subsample of IBs with SSBs. Regression models below are used
for testing the entire sample (i.e., 3a and 3b) and the subsample (i.e., 4a and 4b), respectively.
AGt = ƒ (SSBt, Control Variablest) (3a)
LLPRt = ƒ (SSBt, Control Variablest) (3b)

AGt = ƒ (SSB Sizet, Outside SSBt, SSB Interlockst, IFSBt, AAOIFIt,

SSB Educationt, Control Variablest) (4a)
LLPRt = ƒ (SSB Sizet, Outside SSBt, SSB Interlockst, IFSBt, AAOIFIt,

SSB Educationt, Control Variablest) (4b)
A key function of any SSB is to review, guide, and reinforce Shari’ah compliance. Its
functions may overlap with corporate board functions when monitoring management behavior
(Van del Berghe and Baelden, 2005). Both, for example, investigate and audit conformity (ex-
ante and ex-post), risk strategies, and managers’ risk-taking behavior in a timely and effective
manner.
Table 6 assesses the effect of SSBs and their composition on organizational financial risk
and growth return using two measures: risk and performance. Table 6 also presents
unstandardized beta coefficients and standard errors (in parentheses), along with significance
levels. Models (3a) and (3b) investigate the association among SSBs, AG, and LLPR. Models
(4a) and (4b) use an instrumental variable (Shari’ah boards and corporate boards index) to
confirm that SSB sizes are not endogenous and do not have reverse causality. The models also
confirm the initial results that the existence of both boards has a positive impact on IB financial
performance.
In addition, Table 6 depicts results for the instrumental variables two-stage least-square
analysis. The results thus far from the instrumental variable-2SLS and OLS robust estimation
provide evidence that the size and existence of SSBs improve a corporation’s monitoring,
controlling, advising and counseling capabilities. This enhances organizational behavior (by
decreasing managements’ self-serving behavior) and decreases firm-level risk. As column 1 of
Table 6 (model 3a) shows, the existence of SSBs within IBs adversely affects organizational risk.
The result is economically and statistically significant (β = -0.0578, p < 0.001), indicating that a
one unit increase in SSBs is associated with a 5.78 percent decrease in risk. This supports the
initial findings from the OLS robust regression that IBs with SSBs outperform IBs without SSBs.
Furthermore, column 2 (model 3b) analyzes how the existence of SSBs within IBs affects
managerial behavior and organizational financial performance. The result is economically and
statistically significant (β = 0.0465, p < 0.001), indicating that a one-unit increase in SSBs is
associated with a 4.65 percent increase in IB performance. This result further confirms the initial
OLS robust findings and the first instrumental variable-2SLS.
Additionally, this finding is consistent with Shaffaii (2008), Abu Ghudda (2001), and
Suleiman (1999). Shaffaii (2008) and Suleiman (1999) find that the benefits associated with
SSBs include religious compliance with Shari’ah; monitoring and controlling the moral, ethical,
and religious behavior of management; and conducting monthly ex-ante and ex-post audits of all
IB transactions. Furthermore, SSB members in some Islamic countries (e.g., Malaysia) have the
authority to dismiss any corporate board member who violates corporate governance codes or
Shari’ah (Grais and Pellegrini, 2006).
Columns 3 and 4 (models 4a and 4b) of Table 6 show the effects of SSB size and
composition on organizational behavior and performance using two instrumental variables.
Column 3 shows that IBs with larger SSBs have lower organizational risk. The coefficient of
SSB size is economically negative and significant (β = -0.787; p < 0.001), meaning that a one-
unit increase in SSB size is associated with a 78.7 percent decrease in bank risk. Further, column
3 of the same table shows that the coefficient of SSB Interlocks is economically negative and
significant (β = -0.90; p < 0.001). SSB Education is another determinant. In column 3 of Table 6,
the results show that the more educated the SSB is, the more likely bank risk will decrease. The
coefficient of SSB Education is significant and has an adverse impact on bank risk (β = -0.538; p
< 0.001).
Column 4 shows that IBs with larger SSBs perform better. The coefficient of SSB Size is
economically positive and significant (β = 0.004; p < 0.001), meaning that a one-unit increase in
SSB size is associated with a 0.4 percent increase in bank performance. Moreover, column 4
shows the coefficient of SSB Interlocks is economically positive and significant (β = 0.051; p <
0.001). Also, the coefficient of SSBs’ Education is significant and has an adverse impact on risk
(β = 0.008; p < 0.01), suggesting that more educated SSBs lead to lower risk.
The results of models (3a), (3b), (4a), and (4b) further support and are in line with the
initial findings reported under the OLS robust regression. They additionally support the
contingency theory view, which encourages larger board sizes (Zahra and Pearce, 1992), as well
as the view that improved networks and interlock relationships provide greater access to
resources, improve organizational behavior, and improve financial performance (Daily and
Dalton, 1994; Baysinger and Butler, 1985). This suggests that the strategic choice of appointing
qualified members with greater experience and education in Shari’ah jurisprudence, including
Islamic finance and contemporary finance, improves decision-making.
Furthermore, Useem and Karabel (1986) find heterogeneity in educational background
provides SSBs with different perspectives and cognitive paradigms that affect vocational
development and social contacts of organizational behavior and performance. The results also
support Ingley and van der Walt (2001), who find that highly educated directors tend to offer a
richer source of innovative ideas and policy development due to their intellectual abilities,
experience, sound judgment, and integrity. Further, the results support and are consistent with
DeAngelo (1981), Dopuch and Simunic (1980), and Dopuch and Simunic (1982), which find that
directors with auditing expertise act as a “surrogate for audit quality,” which directly influences
organizational behavior and performance.
Insert Table (6)

7. Conclusion
Incorporating SSB functions, structures, and processes ensures conformity to Shari’ah. The
results indicate that IBs with SSBs outperform IBs without SSBs and better monitor management
behavior. They also show that integrating SSBs into IB governance structures improves strategic
design and implementation, and offers more guidance to directors, managers, and employees.
This study further uses subsample panel data to determine whether SSB functions and
characteristics improve IBs’ overall organizational performance and managerial behavior. The
findings suggest that large corporate boards and large SSBs are more efficient in dealing with
different monitoring and advisory roles than small SSBs. Consequently, this suggests that
increasing the size of corporate boards and SSBs should improve monitoring and advisory
functions, management behavior, and organizational performance.
SSB members affiliated with the AAOIFI tend to have knowledge and expertise that
complements the abilities of SSBs. It is possible that there is an upper limit to this benefit,
however; we do not explore this limit, which therefore provides opportunities for additional
research. Because Shari’ah compliance relates only to a rational legal framework of negative
screening relegated to interest prohibition and limiting uncertainty. The interest prohibition and
limiting uncertainty have not been investigated between the two samples due to data
unavailability. In addition, limited accounting-based measures of financial performance may not
accurately portray IB performance; hence, we implement an additional market measure, which is
Tobin’s Q.
Corporate boards, CEOs, and SSB members with interlock relationships play special
roles in dealing with organizational complexity. In particular, they add value in more complex
IBs that face different Shari’ah issues. SSB education is also associated with better financial
performance, which merits further study. In addition, the results indicate that IFSBs improve
organizational function, structure, processes, and performance. These results hold after
controlling for the measure of performance and differences in the regulatory and institutional
setting, and they go beyond the national boundaries of any particular country or year.
Ultimately, these findings could help IBs improve their financial results by enhancing
their internal and external governance mechanisms (Walsh and Seward, 1990). They provide a
basis for developing larger, more diverse SSBs that are more focused on complying with
Shari’ah and corporate governance.
The results also have significant policy implications for improving firm-level corporate
governance versus improving country-level institutional factors. Both views have their
advocates. However, it is very difficult to reform the legal system in a short time. Still, this study
shows that struggling IBs have a way to improve their corporate governance and simultaneously
improve their financing environment.
Future research could examine how effective SSB members are in monitoring the ethical
behavior of managers in other types of Islamic institutions (e.g., service, investment, and real-
estate companies) and Islamic mutual funds. Researchers could also explore the role SSBs can
play in minimizing information asymmetry among market participants. In addition, future
research should look at the ownership concentration in IBs with SSBs and those with no SSBs.
Based on the findings of this study, IBs that embed SSBs may have more concentrated
ownership.
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Biographical Details:
Ali R. Almutairi is an associate Professor of Accounting at College of Business at Kuwait
University. He received his PhD in Business Administration with Emphasis in Accounting from
Florida Atlantic University, Boca Raton, Florida. Area of Research Interests includes Corporate
Governance, Audit Quality, Capital Market, and Information Asymmetry Teaching Interests
includes Financial Accounting, Forensic Accounting, and Auditing. Published several academic
papers in Local, Regional, and International Journals.
Majdi Anwar Quttainah is an assistant professor of Strategic Management & Corporate

Governance at the College of Business Administration, Kuwait University. He obtained his PhD
from the Lally School of Management & Technology, Rensselaer and his MBA with merits from
the Business School & Entrepreneurship at the University of Newcastle Upon Tyne, UK.
Professor Quttainah's research interests are in the areas of strategic management of distinct
organizations, and corporate governance, with special focus on board of directors and code of
governance and their effects on managerial behavior, firms’ strategies and performance.
Professor Quttainah’s exposure and thirst for knowledge has no boundaries and thus far he
managed to publish in management journals as well as interdisciplinary journals. He is a member
of several editorial advisory boards in several local, regional, and international management
journals.
Table 1
Frequency of Islamic Banks Across Countries
Country Freq. Percentage
BAHRAIN 396 21.96%
BANGLADESH 60 3.33%
EGYPT 66 3.66%
INDONESIA 17 0.94%
IRAN 132 7.32%
JORDAN 37 2.05%
KINGDOM OF SAUDI ARABIA 66 3.66%
KUWAIT 132 7.32%
LEBANON 44 2.44%
MALAYSIA 154 8.54%

PAKISTAN 198 10.98%
QATAR 83 4.60%
SUDAN 176 9.76%
TURKEY 88 4.88%
UAE 154 8.54%
Total 1803 100.00%

Table 2
Descriptive Statistics
Panel A: Islamic Banks with SSBs Panel B: All Islamic Banks Sample
Variable Obs Mean S.D. Min 0.25 Mdn 0.75 Max Obs Mean S.D. Min 0.25 Mdn 0.75 Max
ROA 1000 0.04 0.080 0.0003 0.020 0.03 0.06 0.08 1803 0.03 0.02 0.0001 0.009 0.02 0.04 0.08
ROE 1000 0.16 0.23 0.0003 0.0103 0.041 0.22 0.65 1803 0.16 0.23 0.0003 0.0103 0.041 0.22 0.65
TQ 1000 0.11 0.16 0.001 0.01 0.05 0.08 0.60 1803 0.04 0.10 0.0002 0.0001 0.001 0.04 0.60
SSB 1000 1.00 0.00 1.00 1.00 1.00 1.00 1.00 1803 0.41 0.49 0.00 0.00 0.00 1.00 1.00
SSB Size 1000 5.35 1.52 3.00 4.00 5.00 7.00 9.00 1803 2.20 2.81 0.00 0.00 0.00 5.00 9.00
Outside SSB 1000 3.63 3.14 0.00 0.00 3.00 5.00 10.00 1803 3.23 0.75 0.43 0.00 3.00 5.00 10.00
SSB Interlocks 1000 1.36 1.98 0.00 0.00 0.09 0.15 0.25 1803 0.05 0.07 0.00 0.00 0.00 0.11 0.25
IFSB 1000 1.75 1.98 0.00 0.00 0.00 1.00 1.00 1803 0.52 0.49 0.00 0.00 0.00 1.00 1.00
AAOIFI 1000 1.59 1.86 0.00 0.00 1.00 1.00 1.00 1803 0.15 0.36 0.00 0.00 0.00 0.00 1.00
SSB Education 1000 0.80 0.40 0.00 1.00 1.00 1.00 1.00 1803 0.67 0.46 0.00 0.00 0.00 1.00 1.00
CEO Duality 1000 1.76 1.99 0.00 0.00 0.10 0.30 1.00 1803 0.49 0.50 0.00 0.00 0.00 1.00 1.00
CEO Interlocks 1000 0.38 0.16 0.00 0.00 0.10 0.00 0.53 1803 0.11 0.18 0.00 0.00 0.01 0.11 0.53
Board Size 1000 10.21 8.49 5.00 6.00 9.00 11.00 56.00 1803 9.55 7.71 3.00 6.00 9.00 10.00 56.00
Outside Director 1000 1.64 1.99 0.00 0.00 0.50 0.86 1.00 1803 0.17 0.28 0.00 0.00 0.00 0.43 1.00
Gov. Director 1000 1.50 0.18 0.00 0.00 0.00 0.03 0.25 1803 0.08 0.07 0.00 0.00 0.10 0.14 0.25
Board Interlocks 1000 1.06 1.60 0.00 0.14 0.50 0.83 1.00 1803 0.34 0.30 0.00 0.00 0.30 0.56 1.00
IFRS 1000 0.84 0.37 0.00 1.00 1.00 1.00 1.00 1803 0.15 0.36 0.00 1.00 1.00 1.00 1.00
Assets ($M) 1000 0.71 0.84 0.29 0.55 0.67 0.93 1.55 1803 0.70 0.233 0.289 0.529 0.615 0.772 1.55
Middle East 1000 0.52 0.50 0.00 0.00 0.00 1.00 1.00 1803 0.65 0.48 0.00 0.00 1.00 1.00 1.00
EIUCR 1000 4.10 3.39 1.00 1.00 1.00 4.00 5.00 1803 2.10 1.39 1.00 1.00 1.00 3.00 5.00
CSRS 1000 0.09 0.50 0.00 0.00 0.00 0.00 1.00 1803 0.05 0.22 0.00 0.00 0.00 0.00 1.00
Table 3
Mean Comparison Between Banks With and Without SSB Using t-Test
Performance Measure SSB N Mean Diff in Means t-Value Two Tailed p-Value
No 923 0.038
ROA -0.01 -2.543 0.011
Yes 880 0.047
No 923 0.011
ROE -0.036 -3.024 0.003
Yes 880 0.0192
No 923 0.025
TQ -0.047 -11.517 0.000
Yes 880 0.071
Table 4
Pearson Correlation Coefficients
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
ROA 1
1
ROE 0.18*** 1
2
TQ 0.08*** 0.03 1
3
SSB 0.08** 0.05* 0.75*** 1
4
SSB Size 0.13*** 0.16*** 0.04† 0.13*** 1
5
Outside SSB 0.06** 0.07** 0.17*** 0.26*** 0.26*** 1
6
SSB Interlocks 0.11*** 0.12*** 0.04† 0.0100 0.09*** 0.14*** 1
7
IFSB 0.10*** 0.12*** 0.11*** 0.26*** 0.49*** 0.37*** 0.40*** 1
8
AAOIFI 0.13*** 0.10*** 0.10*** 0.19*** 0.47*** 0.48*** 0.37*** 1
9 0.14***
SSB Education 0.04† 0.02 0.16*** 0.27*** 0.01 0.03 0.10*** 0.11*** 0.07*** 1
10
CEO Duality 0.14*** 0.03 0.01 0.09*** 0.00 0.02 0.04† 0.72*** 0.70*** 0.01 1
11
CEO Interlocks 0.0225* 0.04† 0.07** 0.15*** 0.24*** 0.28*** 0.30*** 0.94*** 0.91*** 0.11*** 0.01 1
12
Board Size 0.17*** 0.15*** 0.12*** 0.25*** 0.46*** 0.36*** 0.33*** 0.67*** 0.03** 0.04† 0.00 0.03 1
13
Outside Director 0.01 0.01 0.07** 0.05* 0.07** 0.12*** 0.46*** 0.18*** 0.21*** 0.18*** 0.16*** 0.00 0.04† 1
14
-
Gov. Director 0.13*** 0.16*** -0.04† 1.00*** 0.26*** 0.09*** 0.07** 0.49*** 0.47*** 0.01 0.24*** 0.07** 0.01 1
15 0.13***
-
Board Interlocks 0.07** 0.08*** -0.13*** 0.45*** 0.35*** 0.40*** 0.95*** 0.92*** 0.06* 0.06* 0.70*** 0.87*** 0.19*** 0.03 1
16 0.26***
IFRS 0.10*** 0.11*** -0.05* 0.16*** 0.44*** 0.07** 0.39*** 0.94*** 0.87*** 0.10*** 0.52*** 0.69*** 0.88*** 0.16*** 0.02 0.06* 1
17
-
Bank Size 0.15*** 0.12*** 0.06** 0.0200 0.36*** 0.31*** 0.18*** 0.21*** 0.04*** 0.00*** 0.18*** 0.91*** 0.67*** 0.70*** 1
18 0.13*** 0.94*** 0.72***
-
Middle East 0.10*** 0.12*** 0.06* 0.44*** 0.07** 0.39*** 0.44** 0.18*** 0.13*** 0.10*** 0.39*** 0.13*** 0.36*** 0.12*** 0.15*** 1
19 0.18*** 0.96*** 0.31***
EIUCR 0.44*** 0.16*** 0.11* 0.10*** 0.39*** 0.45*** 0.13*** 0.26*** 0.08*** 0.40*** 0.13*** 0.37*** 0.40** 0.11** 0.18** 0.27*** 1
20 0.35*** 0.26*** 0.16***
CSRS 0.39*** 0.67*** 0.04* 0.12*** 0.59*** 0.94*** 0.91*** 0.93*** 0.37*** 0.67*** 0.93*** 0.67*** 0.60*** 0.53*** 0.69*** 0.03* 0.09*** 0.56*** 0.96***
21 0.73***
† p<0.10, * p<0.05, ** p<0.01, *** p<0.001.

Table 5
Multivariate Models Explaining Performance of Islamic Banks
1 2 3 4 5 6
ROA ROE TQ ROA ROE TQ
Expected Std- Std- Std- Std- Std- Std-
t-Value t-Value t-Value t-Value t-Value t-Value
Sign Error Error Error Error Error Error
SSB +⁄− 0.0341*** 5.27 0.234*** 6.04 0.1049*** 3.71
SSB Size +⁄− 0.0556*** 12.4 0.0053*** 6.06 0.007*** 4.45
Outside SSB + 0.133** 2.69 0.144** 2.97 0.156** 3.12
*** *** *
SSB Interlocks +⁄− 0.008 3.32 0.0268 3.92 0.914 2.08
IFSB + 0.0117* 2.21 0.0651*** 4.05 0.914* 2.08
*** *** ***
AAOIFI + 0.504 14.45 0.585 24.8 1.239 6.34
*** *** ***
SSB Education + 0.692 24.89 0.0631 3.66 0.0190 6.39
CEO Duality +⁄− 0.0970** 3.11 0.123*** 5.91 0.100*** 5.04 0.0478*** 9.38 0.0361* 0.43 4.6210** 2.62
*** * *** ** ***
CEO Interlocks + 0.0310 10.16 0.0418 2.03 0.393 4.37 0.0095 2.8 0.007 1.14 1.277 22.54
Board Size +⁄− 0.0074* 2.25 0.0244*** 3.33 0.0144*** 3.96 0.0021*** 3.38 0.0569*** 11.12 0.003*** 3.87
Outside *** *** * * *** *
+ 0.854 14.57 0.0330 7.94 5.780 2.13 0.0138 2.16 0.0889 5.28 0.0625 2.31
Director
* ** *** * *** ***
Gov. Director + 2.051 2.26 0.0294 3.27 1.621 4.54 0.0173 2.13 0.268 10.18 0.0194 3.76
Board *** *** *** * *** ***
+⁄− 0.148 6.01 0.527 21.2 0.037 9.02 0.0138 2.1 0.224 37.91 0.0546 7.74
Interlocks
*** *** * *** *** ***
IFRS + 0.0135 3.82 0.0645 7.69 0.0151 2.09 0.209 10.7 0.0140 10.93 0.420 16.02
*** *** *** *** ***
Bank Size +⁄− 0.036 5.01 0.039 4.43 0.191 5.85 0.0462 4.06 0.0151 5.07 0.58 1.35
Middle East ? 0.163** 2.6 0.176** 2.85 0.137* 2.18 0.00575 1.06 0.0015 0.09 4.100* 2.12
EIUCR ? 0.211*** 3.36 0.238*** 3.86 0.188** 3.02 0.0829 0.67 -0.290*** 6.09 -0.319*** 4.9
CSRS ? 0.3410* 2.01 0.531* 2.26 0.8111*** 3.98 0.00421 0.68 0.585*** 24.8 1.239*** 6.34
Year ? Yes Yes Yes Yes Yes Yes
Country ? Yes Yes Yes Yes Yes Yes
N 1803 1803 1803 1000 1000 1000
2
R 0.109 0.433 0.323 0.094 0.44 0.494
adj. R2 0.099 0.394 0.199 0.065 0.31 0.47
Notes: The t-values are adjusted using the heteroscedasticity adjustment approach of White (1980).
† p<0.10, * p<0.05, ** p<0.01, *** p<0.001.
Table 6
2SLS Association Between SSBs and BODs on IBs Risk and Return
1 2 3 4
AG LLPR AG LLPR
SSB -0.0578*** 0.0465***
(-5.59) (4.10)
SSB Size -0.787*** 0.00444***
(-6.31) (5.19)
Outside
-0.142** 0.151**
SSB
(2.66) (2.59)
SSB
-0.900*** 0.0510**
Interlocks
(-21.16) (3.28)
IFSB -0.0185** 0.0415***
(-2.79) (4.49)
AAOIFI -0.0344** 0.198**
(-2.97) (3.15)
SSB
-0.0538*** 0.00786**
Education
(-3.84) (3.21)
CEO *** *** **
-2.224 0.0226 -0.0980 0.0656*
Duality
(-37.91) (4.54) (-3.17) (1.99)
CEO *** *** ***
-0.0569 1.146 -0.240 0.142**
Interlocks
(-11.12) (35.13) (-5.82) (2.94)
Board ** *
0.00235 0.0129 -0.0158 0.00887**
Size
(0.65) (2.98) (-2.31) (2.60)
Outside *** *** ***
-0.0209 0.0498 -0.0592 0.0491***
Director
(-3.38) (8.93) (-3.45) (8.93)
Gov.
-0.0138* 0.0496*** -0.222*** 0.0346***
Director
(-2.10) (6.18) (-4.03) (7.56)
Director *
0.00305 0.00137 -0.0108 0.242***
Interlock
(0.82) (0.34) (-2.06) (10.10)
IFRS -0.0212** 0.0221*** -0.0523** 0.308***
(-3.16) (4.02) (-3.18) (5.39)
Bank Size -0.00150*** 0.00329*** -0.00481 0.00299***
(-3.58) (5.70) (-1.04) (7.13)
Middle
-0.0134* 0.00931 0.468*** 0.00527
East
(-2.20) (1.42) (13.24) (1.37)
EIUCR -0.00853 0.0142*** -0.307*** 0.0115***
(-1.96) (4.01) (-10.68) (4.01)
CSRS -0.00832* -0.00647 0.228*** 0.00768*
(-2.21) (-1.86) (8.50) (2.47)
Country
Yes Yes Yes Yes
& Year
** *
_cons 0.871 -0.147 -12.92 40.33*
(0.72) (-2.81) (-2.05) (2.27)
N 1803 1803 1000 1000
R2 0.257 0.364 0.209 0.463
adj. R2 0.179 0.454
Notes: The t-values are adjusted using the heteroscedasticity adjustment approach in White (1980).
The dependent variables are AG as a proxy for return and LLPR as a proxy for risk. The instrumental variable is G-Index, which consists of SSB and
BOD sizes, composition, and functioning.
† p<0.10, * p<0.05, ** p<0.01, *** p<0.001.
Appendix
Variables Definition
Variable Definition
Dependent Variables:
ROA Return on assets: net income divided by total assets.
ROE Return on equity: net income divided by shareholders' equity.
TQ Tobin's Q: the natural log of market capitalization plus total liabilities of the IB, scaled by total asset value.
AG Asset growth: the year-over-year percentage change in total assets.
Independent Variables:
SSB An indicator variable that is equal to 1 if SSB is within the governance structure of the IB, and 0 otherwise.
SSB Size The total number of SSB members on the board.
Outside SSB The ratio of SSB members exogenous to the IB to the total number of SSB members.
SSB Interlocks The ratio of SSB members' interlocks to the total number of SSB members on each board.
IFSB An indicator variable that is equal to 1 if the IB is a member of the International Financial Services Board, and 0 otherwise.
AAOIFI A proxy for SSB expertise; it equals 1 if at least one SSB member serves as a member in the AAOIFI, and 0 otherwise.
SSB Education An indicator variable that is equal to 1 if a member of the SSB holds a postgraduate degree, and 0 otherwise.
Control Variables:
CEO Duality An indicator variable that is equal to 1 if the CEO is also the chairman of the board, and 0 otherwise.
CEO Interlocks The ratio of CEO directors to the total number of directors on each board.
Board Size Total number of directors on the board.
Outside Director The ratio of outside directors to the total number of directors on each board.
Gov. Director The ratio of government directors to the total number of directors on each board.
Board Interlocks The ratio of board members with interlocks to the number of directors on each board.
IFRS An indicator variable that is equal to 1 if the IB complies with International Financial and Reporting Standards, and 0 otherwise.
Bank Size The natural logarithm of total assets of the firm.
Middle East An indicator variable to control for the fixed region effects.
A proxy for the change in the economic development and the quality of legal environment measured by the European Intelligence
EIUCR
Unit country risk.
CSRS A proxy for the country specific regularity strength; it equals 1 if the country has more than one supervisory, and 0 otherwise.
Year An indicator variable to control for the fixed-year effects.

Country An indicator variable to control for the fixed-country effects.

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Social Responsibility Journal

Corporate governance: evidence from Islamic banks

*Related content and download information correct at time of download.

JEL Classification Numbers: G34, G38, G31, G30.

Research on the governance of religious establishments, specifically the Islamic banking

rules” (Hasan, 2008).

the attributes of SSBs correlate to superior performance.

Based on a sample of 1,803 bank-year observations from 82 IBs in 15 countries between

performance by an average of 12.43 percent as measured by Tobin’s Q, return on assets, and

inclusion of various control variables (micro-level and macro-level).

graduate degrees results in a 25.80 percent increase in IB financial performance. IB performance

contemporary finance, and Islamic finance.

2.1 SSB Mission

and that shareholders can monitor management behavior to minimize management’s

as improving corporate performance.

management and employees).

2.2 SSB Appointments and Demographics

operations and outcomes.

bank performance can be subject to the variation in SSB attributes.

IB-year observations. The dependent variable is bank performance, measured by different

reflects IBs with SSBs and IBs with no SSBs.

characteristics of SSBs, such as size, outside directors, directorship interlocking, membership of

and country effects.

4.1 Hypotheses Development

4.1.1 SSB and IB Performance

International standard-setting bodies and regulators have made numerous efforts to

that do not embed SSBs.

equally. Also, best monitoring practices depend on environmental conditions, as suggested by

the contingency theory.3 A contingency is a relationship between two phenomena, where a

association with IB performance.

4.1.2 SSB Size

1992; Pfeffer, 1973).

evidence prompt the following nondirectional hypothesis:

H2: SSB size is related to IB performance.

4.1.3 SSB Outside Directors

Goodstein et al., 1994; Miller and Roth, 1994).

H3: The number of outside members on an SSB is positively related to IB performance.

4.1.4 SSB Interlocks

Interlocking directorate is “defined as the linkages among corporations created by individuals

indicate weak governance and entrenched managers.

following nondirectional hypothesis:

H4: SSB interlocks are related to IB performance.

4.1.5 SSB Membership

Shari’ah interpretation is diverse due to differences in Islamic jurisprudence schools (i.e.,

behavior and performance. Thus, we state this hypothesis:

H5: SSB membership in the IFSB is positively related to IB performance.

4.1.6 SSB Expertise

Hence, we propose the following hypothesis:

H6: SSB expertise is positively related to IB performance.

4.1.7 SSB Education Level

(Ingley and Van der Walt, 2001).

Karabel, 1986). In particular, heterogeneity in educational background provides SSBs with

positive impact on IB performance. Thus, we propose the following hypothesis:

calculating heteroscedasticity-robust standard errors for the fixed-effects estimator generates

instrumental variable for robustness tests purposes.

5.1 Measurement Tools

Performancet = ƒ (SSBt, Control Variablest) (1)

performance (Wahla et al., 2012; Shan and McIver, 2011).

International Financial Reporting Standards adoption may also influence IB performance.

IFRS; it equals 0 otherwise.

significant factors in IB performance.

Country, in model (1) to capture year and country specifics, respectively.

To examine the effect of SSB attributes on IB performance (H2-H7), we use the

† p<0.10, * p<0.05, p<0.01, * p<0.001.