Does Sharia compliance affect financial reporting quality? An evidence from Muslim majority countries

Abstract

PurposeSharia compliance states that the compliant company operates not only under regulations but also to the restrictions and permission of Islam. This study aims to reveal whether Sharia compliance enhances the financial reporting quality.Design/methodology/approachThe sample is constructed from 15 Muslim majority countries, 2,300 companies for the periods between 2005 and 2017 with 23,810 firm*year observations. Financial reporting quality is measured with discretionary accruals and audit aggressiveness. Discretionary accruals is the absolute of Kothari, Leone and Wasley’s (2005) “performance matched discretionary accruals model.” Audit aggressiveness is calculated with Gul, Wu and Yang’s (2013) model.FindingsThis study reveals the behavioral differences in financial reporting quality between Sharia-compliant and non-compliant companies. According to the analyzes, Sharia compliance increases the financial reporting quality by decreasing the discretionary accruals and audit aggressiveness. This result is supported by the robustness tests.Practical implicationsSharia compliance is not limited to business activity, financial restrictions and supervisory board for Sharia-compliant companies. It also enhances the companies’ financial reporting quality. Robustness analysis also showed that the International Financial Reporting Standards (IFRS) increases the financial reporting quality by reducing discretionary accruals and audit aggressiveness.Originality/valueThis study contributes to the accounting literature by providing an insight on the use of Islamic financial instruments. The empirical results also show that the use of IFRS and Islamic financial instruments decreases the discretionary accruals and audit aggressiveness.