The Effect of Islamic Law (Shariah-compliance) on Accounting Quality

In this paper, we examine the effect of Islamic law on accounting quality. Islamic law also known as Shariah is a comprehensive system that defines everything in the Muslim world, such as religious life from personnel to family, society, economy, politics and international relations. Thus, Shariah is a very different law than the other law systems with respect to its impact on human life. We investigate whether a firm who follows this Shariah law (Shariah-compliance) reports higher quality of accounting information than that of non-followers. We use discretionary accruals as well as performance- matched discretionary accruals for the proxies of accounting quality. By using 210 Malaysian public firms of year 2016, we hypothesize and find the negative relation between Shariah-compliance and earnings management. We further find that Shariah law reduces both positive and negative earnings management. Collectively, our results suggest that Islamic law enhances accounting quality.