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Evidence from
Political connections, joint audit Islamic
and tax avoidance: evidence from banking
industry
Islamic banking industry
Hana Ajili 155
Department of Accounting, Faculty of Economics and Management,
Laboratory GFC Sfax, University of Sfax, Sfax, Tunisia, and
Hichem Khlif
Department of Accounting, Faculty of Economics and Management,
Laboratory GFC Sfax, University of Sfax, Kerkennah, Tunisia

Abstract
Purpose – The purpose of this paper is to examine the association between political connections and tax
avoidance in Islamic banking industry and to test whether joint audit affects this relationship.
Design/methodology/approach – Tax avoidance is measured using effective tax rate while political
connections represent an indicator variable that equals 1 if a bank has at least one politically connected
director on the board of directors and zero otherwise.
Findings – This study documents that political connections are negatively associated with effective tax
rate, while joint audit is positively related to the same variable. We also find that the negative association
between political connections and effective tax rate becomes insignificant for joint-audited banks, while it
remains negative and significant for banks audited by one auditors.
Originality/value – The findings of this study have policy implications for banking industry because joint
audit reduces the adverse effect of political connections on tax avoidance.
Keywords Tax avoidance, Political connections, Joint audit, Islamic banking industry
Paper type Research paper

1. Introduction
The stream of empirical research dealing with the association between political connections
and tax avoidance has attracted considerable attention among accounting scholars (Abdul
Wahab et al., 2017; Adhikari et al., 2006; Kim and Zhang, 2016). The findings of these studies
are supportive of a positive (negative) association between political ties and tax avoidance
(effective tax rate). All these studies have removed financial companies from their analysis
given the specificity of banking industry in terms of regulation. Accordingly, it becomes
interesting to explore such an association in banking industry (Islamic banking) to test
whether political connections have the same influence on tax avoidance in this sector.
Furthermore, we examine whether joint audit, as a proxy for audit quality, moderates such a
relationship because there is a general wisdom that joint audit improves auditor
independence as it is more expensive for a company to “bribe” two auditors in joint audit
than one auditor in single audit (Deng et al., 2014).
Accordingly, this study tries to complement the above streams of research by exploring Journal of Financial Crime
the direct effect of political connections on tax avoidance in Islamic banking industry and Vol. 27 No. 1, 2020
pp. 155-171
tests whether joint audit affects this association. The choice of Islamic banking industry is © Emerald Publishing Limited
1359-0790
mainly justified by the fact that main Islamic banks have been established in a country DOI 10.1108/JFC-01-2019-0015
JFC characterised by high levels of political involvement in business world and a relationship-
27,1 based economy (e.g. Malaysia, Indonesia and Gulf Cooperation Council (GCC) countries)
(Abdul Wahab et al., 2017; Al-Hadi et al., 2017; Adhikari et al., 2006).
Tax avoidance (effective tax rate) is defined as total income tax expense divided by pre-
tax book income, while political connections is a dummy variable indicating whether a bank
is politically connected. Based on a sample of 18 listed Islamic banks over the 2007-16
156 period, we find that banks with political connections pay tax at significantly lower effective
rates. These results suggest that political connections are an important determinant of tax
avoidance in banking industry. Furthermore, the negative association between political
connections and effective tax rate becomes insignificant for joint audited banks, while it
remains negative and significant for banks audited by a single auditor.
Our research makes the following contributions. First, very little is currently known
about the association between political connections and tax avoidance in banking sector.
Second, we complement previous literature on joint audit because joint audit provides a
unique setting for analyzing both audit evidence precision and auditor independence
(Deng et al., 2014). Although the existing empirical research focuses on the impact of joint
audit on audit quality and audit fees (Gonthier-Besacier and Schatt, 2007; Ratzinger-Sakel
et al., 2013; Thinggaard and Kiertzner, 2008), our paper provides new empirical evidence on
the moderating impact of joint audit on the relationship between political connections and
tax avoidance. Finally, this study should be of interest to tax policymakers and regulators.
Our findings suggest that banks employing politically connected directors exhibit higher
tax avoidance; however, this relationship is weakened with joint audit. Accordingly,
government should strengthen joint audit, as an external control mechanism, in the banking
sector to reduce the adverse effect of political connections on tax avoidance.
The remainder of the paper is structured as follows. Section II presents a review of the
literature and develops hypotheses. Section III outlines the research design and methods.
Section IV discusses the main results. Section V presents the results of additional analyses
and robustness checks. Finally, Section VI provides the conclusion for this study.

2. Research hypotheses
2.1 Political connections and tax avoidance
Managers may have several incentives to enter into politics to be less burdened with
regulations and less exposed to monitoring and oversight (Habib et al., 2017). This is
particularly true within the banking industry, generally considered as highly regulated
sector. Accordingly, the managers of politically connected banks may benefit from their
connections to reduce their tax payments because they will be protected against detection
and future litigation risks and will have private access to preferential information.
The first benefit of corporate political connections is to be protected by politicians
against detection and future litigation risks. Christensen et al. (2015) focus on the
association between tax avoidance and risk. They indicate that, in the case that
reducing taxes can help a firm to keep more of its profits, managers would want to
minimize taxes without exposing firm to any types of risks and uncertainties that tax
avoidance exposes the firm to. Accordingly, Li et al. (2016) document that once the tax
earnings management is discovered, the firm faces severe punishment from both the
securities regulatory committee and tax authority, which may dramatically damage the
firm’s value. Hence, tax avoidance would be optimal only for firms with the ability to
lower their tax burden and avoid punishment, primarily firms with politically
connected management (Li et al., 2016). Furthermore, politically connected firms have
less market pressure to be transparent (Kim and Zhang, 2016). Indeed, tax avoidance
can involve creating more business opacity, which is designed to make it difficult for Evidence from
regulators to identify the true economics of the firm (Christensen et al., 2015). As a Islamic
consequence, it is interesting to be politically connected to reduce any market penalty banking
associated with financial opacity or the political cost of being tax aggressive
(Faccio, 2016).
industry
The second advantage to be a politically connected firm is the ability to access
information regarding future changes in tax regulations and enforcements enables it to 157
explore better time-series differences in tax laws or tax enforcement using complex tax
strategies (Abdul Wahab et al., 2017). In line with this, Faccio (2016) suggest that connected
firms can gain access to preferential information, which allows them to better know when
aggressive tax planning is more likely to be tolerated.
Consistent with the argument that firm can be politically connected to obtain or maintain
a lower tax rates, several empirical studies examine the impact of political connections on
tax avoidance. Based on an analysis of ten year US data, Kim and Zhang (2016) find that
politically connected firms are more tax aggressive than non-connected firms. In China,
Lin et al. (2018) study the association between political connections on boards of directors
and the effectiveness of tax authorities in constraining tax avoidance. Their results show
that political connections reduce the effective enforcement of tax compliance. Other studies
examine the link between tax avoidance and political connections in developing economies.
For example, Adhikari et al. (2006) provide evidence that Malaysian firms with political
connections pay tax at significantly lower effective rates than other firms. In the same
context, Wahab et al. (2017) examine the relationship between political connections and
corporate tax aggressiveness in Malaysia and find that politically connected firms are more
tax aggressive than non-connected firms.
As can be clearly seen from this theoretical and empirical review, there is a consensus
between researchers on the positive effect of political connections on tax avoidance.
Therefore, a firm with a higher political connections level would very likely have a high
level of tax avoidance. While the abovementioned studies removed financial companies
from their analysis, our study focuses on the association between political connections and
tax avoidance in banking industry, precisely the Islamic banking. Thus, we propose the
following hypothesis:

H1. There is a negative relationship between political connections and effective tax rate
within the Islamic banking industry.

2.2 The moderating effect of joint audit on the relationship between political connections and
tax avoidance
Joint audit is defined by Ratzinger-Sakel et al. (2013, p. 176) as:
[. . .] an audit in which financial statements are audited by two or more independent auditors in a
way that involves: coordination of the audit planning; shared audit effort; cross reviews and
mutual quality controls; and issuance of one single auditor’s report signed by the auditors who
are jointly liable.
The evidence with respect to the value of joint audit is mixed in the accounting literature.
Proponents argue that joint audit can be valuable to the client for these reasons:

joint audit enhances audit effectiveness by accumulating audit experience from two
auditors (Al-Hadi et al., 2017);
JFC
enhances auditor independence because it is more expensive for a company to
27,1 “bribe” two audit firms than one single firm; and

produces higher total information precision than just a single auditor (Deng et al.,
2014).

Accordingly, we expect that joint audit may improve audit quality by enhancing audit
158 evidence precision and increasing the degree of monitoring of managerial opportunistic
behaviour, which may translate into lower managerial incentives to undertake aggressive
tax management. The empirical finding of Zerni et al. (2012) supports this view and shows
that voluntary joint audit is positively associated with audit quality both for public and
private firms.
Opponents of this view suggest that the costs of joint audit may exceed its benefits (Zerni
et al., 2012). For instance, joint audit may induce a free-riding problem between the two
external auditors, leading to lower audit evidence precision and, as a consequence, impairs
audit quality (Deng et al., 2014). Finally, the lack of cooperation between two competing
audit firms can result in an insufficient information exchange (Al-Hadi et al., 2017). From an
empirical standpoint, Ratzinger-Sakel et al. (2013) find limited empirical support to suggest
that joint audit lead to increased audit quality.
Prior research on joint audit has examined the determinants of joint auditor pair choice
(Francis et al., 2009), its association with audit fees (Gonthier-Besacier and Schatt, 2007;
Thinggaard and Kiertzner, 2008), its impact on audit quality (Deng et al., 2014) and its
moderation effect on political connections-cost of debt relationship (Al-Hadi et al., 2017).
However, the moderation effect of joint audit on the relationship between political
connection and tax avoidance is not tested.
Accordingly, we test, in this study, the moderating effect of joint audit on the association
between political connections and tax avoidance within banking industry. We expect that
joint audit as an external control mechanism will mitigate the negative relationship between
political connectedness of board members and effective tax rate. Accordingly, the following
hypothesis is tested:

H2. The negative relationship between political connections and effective tax rate is
weaker for Islamic banks audited by two external auditors.

3. Research design
3.1 Sample selection
Our initial sample includes all listed Islamic banks at the end of the 2016 financial year.
A total of 83 banks meet these initial requirements. The sample data used in this paper
is a balanced panel hand-gathered from Islamic bank annual reports. The sample size is
reduced when we retain only banks that are founded before 2007 and we remove banks
founded after this year (14). We then remove banks with unavailable information (18)
and exempted banks (16). Finally, following prior tax avoidance research (Adhikari
et al., 2006; Christensen et al., 2015; Gupta and Newberry, 1997), we exclude banks with
negative effective tax rates and those with effective tax rate exceeding one (17). Our
final sample comprises 18 banks over the period of 2007-16 (180 firm-year observations)
located in eight countries (Bahrain, Iran, Jordan, Turkey, Bangladesh, Indonesia,
Malaysia and Pakistan). Table I provides the sample selection criteria (Panel A) and
distribution by country (Panel B).
Panel A: Sample selection
Evidence from
Criteria No. of banks Bank-years Islamic
All listed Islamic banks at the end of the 2016 financial year 83 830 banking
Less:
Banks founded after 2007 (14) (140) industry
Banks with missing data (18) (180)
Exempted banks (16) (160)
Banks with tax rate below 0 or above 1 (17) (170) 159
Final sample 18 180
Panel B: Sample distribution by country
Countries
Bahrain 1 10
Bangladesh 5 50
Indonesia 1 10
Iran 5 50
Jordan 2 20
Malaysia 2 20
Pakistan 1 10 Table I.
Turkey 1 10 Sample selection and
Final sample 18 180 distribution

3.2 Dependent variable: Tax avoidance

Tax avoidance is defined by Hanlon and Heitzman (2010) as activities that reduce the firm’s
explicit taxes liability. In this study, effective tax rate is used to measure tax avoidance for
three reasons. First, effective tax rate reflects variation in tax avoidance across firms
(Badertscher et al., 2013; Dyreng et al., 2008). Second, it is the best measurement to identify
any tax-planning activities (Abdul Wahab et al., 2017). Third, it is widely used in prior
research and understood by a wide range of financial statement users (Abdul Wahab et al.,
2017; Badertscher et al., 2013; Dyreng et al., 2010; Gaaya et al., 2017).
Effective tax rate is defined as the ratio of the income tax expense divided by pre-tax
income for a bank in a given year (Gupta and Newberry, 1997). It is an inverse function of
tax avoidance (Gaaya et al., 2017).
In our robustness tests, we use additional measure of tax avoidance, namely, cash
effective tax rate defined as cash tax paid divided by pre-tax income (Dyreng et al., 2008).

3.3 Independent variable: political connections

Based on related political connections studies in the GCC countries (Al-Hadi et al., 2017),
Malaysian (Abdul Wahab et al., 2017; Adhikari et al., 2006), Indonesian (Habib et al., 2017)
and around the world (Hung et al., 2018) context, we define a bank-year observation as being
politically connected if at least one of its board of directors, is a ruling family director, a
member of the parliament, a member of Khazanah Berhad, a minister or head of a local
government or is closely related to a top official. To identify political connections, we collect
data from the profiles of the board of directors as described in the annual reports. Political
connectedness is operationalized as an indicator variable that equals one if a bank has at
least one politically connected director, and zero otherwise.

3.4 The moderating variable: Joint audit

The joint audit indicates that two independent external auditors are appointed to jointly
conduct the firm’s audit with a single audit report that is signed by two audit firms, which
are jointly responsible for the opinion (Francis et al., 2009). In this study, joint audit is a
JFC dummy variable that equals 1 if the issued audit report is signed by two external auditors
27,1 and 0 otherwise.

3.5 Control variables

Based on prior research on tax avoidance studies (Adhikari et al., 2006; Christensen et al.,
2015; Richardson et al., 2016), we include the following bank-specific characteristics as
160 control variables in our regression models: the bank size (SIZE), financial leverage (LEV),
profitability (ROA), capital intensity (CINT), intangible assets (INTANG) and Zakat
(ZAKAT).
SIZE is measured by taking the natural logarithm of total assets in US dollars of the
current year. Based on previous studies, we expect a negative relation between bank size
and effective tax rate because larger corporations have more economic and political power to
pay less tax (Adhikari et al., 2006; Richardson et al., 2016). LEV is calculated as the ratio of
total debts to total assets. ROA is the return on assets of the current year, which is defined as
the ratio of net income to total assets. Given the inconsistent results reported by previous
research (Huang et al., 2016), we do not predict the sign of LEV and ROA. We use CINT,
defined as the ratio of fixed assets to total assets, and INTANG, defined as the ratio of
intangible assets to total assets, to control for differences in financial reporting and tax
reporting rules (Cen et al., 2017; Christensen et al., 2015).
As a specific variable related to Islamic banking, we control for the effect of ZAKAT,
measured as the ratio of zakat expense to pre-tax income. Zakat, mandatory almsgiving,
constitutes what may be described as an annual solidarity payment on accumulated wealth
and assets charged on the rich for distribution to poor and needy people (Bouslama and
Lahrichi, 2017). Zakat is unique and distinct payment, which should not be interpreted
merely as a tax on income (Ghosh et al., 1996). Islamic banks have to redistribute part of
their profits to society in the form of zakat (Imama and Kpodar, 2016) either on behalf of
their shareholders and/or disclose the amount payable per share in their annual reports
(Vinnicombe, 2010).
We also include two variables to control for institutional conditions (Cen et al., 2017):
GDP growth rate measured as annual GDP growth rate of a country from World Bank’s
“Countries and Economies” databank (GDP) and inflation rate defined as annual inflation
rate of a country based on consumer price index from World Bank’s “Countries and
Economies” databank (INFL). Finally, we include year fixed effect (Year FE) (not reported in
tables) to control for changes in tax avoidance activities in Islamic banks over the 2007–16
period. Appendix presents the definitions of all variables included in our study.

3.6 Regression models

To test our hypotheses, we apply fixed-effects ordinary least squares (OLS) estimation
method. Specifically, the regression model used to examine the relationship between
political connections and tax avoidance (test of H1) is as follows:

ETRit ¼ a0 þ a1 PCit þ a2 JAit þ a3 SIZEit þ a4 CINTit þ a5 INTANGit þ a6 LEVit

þ a7 ROAit þ a8 ZAKATit þ a9 GDPit þ a10 INFLit þ YearFE þ « it (1)

To examine the moderating effect of joint audit (test of H2), we introduce an interaction
term between political connections and joint audit (PC*JA) and estimate the following
model:
 ETRit ¼ a0 þ a1 PCit þ a2 JAit þ a3 PCit * JAit þ a4 SIZEit þ a5 CINTit þ a6 INTANGit Evidence from
þ a7 LEVit þ a8 ROAit þ a9 ZAKATit þ a10 GDPit þ a11 INFLit Islamic
banking
þ YearFE þ « it (2) industry
The dependent variable tax avoidance is the ETR. The independent and moderating
variables are the politically connected directors (PC) and Joint Audit (JA), respectively. In all 161
regressions, we control for bank size (SIZE), capital intensity (CINT), intangible assets
(INTANG), leverage (LEV), profitability (ROA), zakat (ZAKAT), GDP growth rate (GDP)
and inflation rate (INFL). We also included Year FE in our models to control for the year
fixed effect.

4. Empirical results and analysis

4.1 Descriptive statistics
Table II reports descriptive statistics of the variables used in our regressions. Panel A
provides statistics for the full sample. The mean of effective tax rate in our sample accounts
for 0.310 (31 per cent) and ranges from 0.002 (0.200 per cent) to 0.804 (80.400 per cent). The
percentage of politically connected banks in our sample accounts for 35.500 per cent (0.355).
Furthermore, 22 per cent (0.220) of Islamic banks are audited by two external auditors (joint
audit), while the rest of banks appoint only one auditor.
Table II Panel B presents the statistics for the sub-samples categorized by political
connections and joint audit. The mean of effective tax rate accounts for 0.349 (34.900 per
cent) for non-politically connected banks, while it amounts to 0.241 (24.100 per cent) for
politically connected banks. The difference between the two types of Islamic banks in terms
of effective tax rate is 0.108 (10.800 per cent) and it is highly significant (t = 4.890; p = 0.000).
This result provides preliminary support for H1. For the second sub-sample, joint audited
banks have a mean effective tax rate of 0.407 (40.700 per cent), while banks appointing one
external auditor have an average effective tax rate of 0.283 (28.300 per cent). The difference
between the two groups in terms of effective tax rate is highly significant (t = 4.847; p =
0.000), indicating that joint audit control mechanism plays crucial role in reducing
aggressive tax management among Islamic banks. This result provides preliminary
evidence that there is a significant negative association between the joint audit and tax
avoidance.

4.2 Univariate analysis

Table III shows the correlation among the variables used in our regressions. We find a
negative and significant correlation between political connections and effective tax rate
(0.344). This result provides preliminary evidence that politically connected banks have
higher levels of tax avoidance. In addition, the correlation between joint audit and effective
tax rate is positive and significant with a Pearson coefficient accounting for (0.341). We also
find that effective tax rate is significantly and negatively correlated with size, profitability
and Zakat ratios, but significantly and positively correlated with GDP.

4.3 Multivariate analyses

Table IV presents the multivariate regression results for hypotheses testing. In model 1,
finding suggests that PC, our main variable of interest, is negatively and significantly
related to ETR (Coeff = 0.107; t = 5.080). This finding indicates that politically
connected Islamic banks have lower effective tax rate and consequently avoid more
JFC Panel A: statistics for full sample
27,1 Variables N Mean SD Minimum Maximum
ETR 180 0.311 0.151 0.002 0.804
PC 180 0.355 0.480 0 1
JA 180 0.222 0.417 0 1
SIZE 180 15.009 1.104 12.774 17.551
CINT 180 0.021 0.023 0.001 0.183
162 INTANG 180 0.003 0.006 0 0.034
LEV 180 0.746 0.272 0.124 0.963
ROA 180 0.012 0.008 0.001 0.044
ZAKAT 180 0.009 0.022 0 0.114
GDP 180 4.459 3.605 7.445 13.386
INFL 180 9.605 8.199 0.788 39.266
Panel B: mean by sub-sample
Variables Political connections-basedsub-sample Joint audit-basedsub-sample
PC = 0 PC = 1 t-Statistic JA = 0 JA = 1 t-Statistic
(N = 116) (N = 64) (N = 140) (N = 40)
ETR 0.349 0.241 4.890*** ETR 0.283 0.407 4.847***
JA 0.241 0.187 0.830 PC 0.371 0.300 0.829
SIZE 14.914 15.179 1.546 SIZE 15.003 15.027 0.121
CINT 0.020 0.023 0.645 CINT 0.021 0.023 0.424
INTANG 0.003 0.002 0.795 INTANG 0.003 0.002 1.171
LEV 0.707 0.815 2.570** LEV 0.759 0.610 1.214
ROA 0.011 0.015 3.321*** ROA 0.012 0.014 1.712*
ZAKAT 0.009 0.010 0.157 ZAKAT 0.012 0 3.060***
GDP 4.574 4.250 0.576 GDP 4.372 4.762 0.602
INFL 10.459 8.056 1.896* INFL 9.620 9.551 0.046

Notes: This table presents the summary statistics of the main variables. The Panel A reports the statistics
for the full sample, while the Panel B presents the mean value for sub-sample based on the political
connections and joint audit, as well as the F values for the mean difference test using a two-tailed t-test. The
dependent variable tax avoidance is the ETR. The independent variables are the politically connected
directors (PC) and joint audit (JA). The control variables are bank size (SIZE), capital intensity (CINT),
Table II. intangible assets (INTANG), Leverage (LEV), profitability (ROA), zakat (ZAKAT), GDP growth rate (GDP)
Summary statistics and Inflation rate (INFL). All variables are as defined in the Appendix. *, **, and *** denote statistical
of main variables significance at the 10, 5, and 1% levels, respectively

taxes than their non-connected counterparts, thus providing support for H1. This
indicates that political connections increase directors’ ability to undertake aggressive
tax management greater behaviours to pay tax at significantly lower effective rates
because they are protected by politicians and may have access to preferential tax
information. This finding is in line with results previously documented by Abdul
Wahab et al. (2017) and Adhikari et al. (2006) in developing economies. We also find a
positive and significant relationship between joint audit and effective tax rate (Coeff =
0.118; t = 5.780). This finding suggests that joint audit acts as an external control
mechanism that limits tax avoidance incentives of politically connected firms within
the Islamic banking industry.
In model 2, we assess how political connections may affect effective tax rate without
taking into consideration joint audit variable and the effect of political connections on tax
avoidance remains stable as compared to model 1. Similarly, in model 3, we assess only the
effect of joint audit on tax avoidance and the finding remains stable as compared to model 1.
Variables 1 2 3 4 5 6 7 8 9 10

1 ETR 1.000
2 PC 0.3442*** 1.000
3 JA 0.3415*** 0.062 1.000
4 SIZE 0.389*** 0.115 0.009 1.000
5 CINT 0.283*** 0.048 0.032 0.478*** 1.000
6 INTANG 0.368*** 0.059 0.087 0.273*** 0.342*** 1.000
7 LEV 0.043 0.189** 0.091 0.148** 0.055 0.026 1.000
8 ROA 0.368*** 0.241*** 0.127* 0.110 0.427*** 0.305*** 0.001 1.000
9 ZAKAT 0.144* 0.011 0.224*** 0.088 0.052 0.090 0.218*** 0.149** 1.000
10 GDP 0.144* 0.043 0.045 0.169** 0.027 0.266*** 0.057 0.110 0.084 1.000
11 INFL 0.227*** 0.140* 0.003 0.144* 0.255*** 0.429*** 0.225*** 0.238*** 0.296*** 0.453***

Notes: This table reports the Pearson correlation matrix of the variables. The dependent variable tax avoidance is the ETR. The independent variables are the
politically connected directors (PC) and joint audit (JA). The control variables are bank size (SIZE), capital intensity (CINT), intangible assets (INTANG), leverage
(LEV), profitability (ROA), zakat (ZAKAT), GDP growth rate (GDP) and Inflation rate (INFL). All variables are as defined in the Appendix. P-values are presented
in the parentheses below the correlation coefficients. *, **, and *** denote statistical significance at the 10, 5, and 1% levels, respectively

Table III.
Islamic
Evidence from

matrix of variables
Pearson correlation
163
banking
industry
 JFC
27,1

164

Table IV.

effective tax rate

and joint-audit on
OLS Regression of

connected directors
the effect of political
Variables 1 2 3 4 5

PC 0.097*** (5.060) 0.107*** (5.080) 0.074*** (3.230)

JA 0.118*** (5.780) 0.127*** (5.810) 0.143*** (5.790)
JA* PC 0.087* (1.790) 0.030 (0.700)
SIZE 0.039*** (4.070) 0.035*** (3.420) 0.048*** (4.780) 0.041*** (4.340) 0.045*** (4.140)
CINT 0.690 0.606 (1.160) 0.769 0.689 (1.460) 0.675 (1.200)
1.450 1.500
INTANG 3.411** (2.240) 4.639*** (2.810) 2.886* (1.770) 3.364** (2.230) 4.266** (2.400)
LEV 0.072** (2.110) 0.049 (1.320) 0.018 (0.510) 0.038 (0.990) 0.022 (0.540)
ROA 5.195*** (3.890) 4.029*** (2.790) 7.186*** (5.250) 5.446*** (4.090) 5.996*** (3.990)
ZAKAT 0.959** (2.350) 1.519*** (3.490) 0.899** (2.050) 1.060** (2.590) 1.578*** (3.280)
GDP 0.004 (1.160) 0.002 (0.780) 0.001 (0.120) 0.004 (1.230) 0.001 (0.210)
INFL 0.006*** (3.470) 0.006*** (3.200) 0.003* (1.840) 0.006*** (3.510) 0.003 (1.650)
Year FE Yes yes Yes Yes Yes
Observations 180 180 180 180 180
Adj-R-square 0.496 0.394 0.419 0.503 0.299
Probability> F 0.000 0.000 0.000 0.000 0.000
F-stat 10.280 7.490 8.180 10.060 5.260

Notes: This table presents the estimates of OLS regressions of PC, JA and JA*PC on ETR. The dependent variable tax avoidance is the ETR. The independent
variables are the politically connected directors (PC) and joint audit (JA). The control variables are bank size (SIZE), capital intensity (CINT), intangible assets
(INTANG), leverage (LEV), profitability (ROA), zakat (ZAKAT), GDP growth rate (GDP) and Inflation rate (INFL). All variables are as defined in the Appendix.
The year fixed effects are included but not reported. The t-statistics are reported in parentheses below the coefficient estimates. *, **, and *** denote statistical
significance at the 10, 5, and 1% levels, respectively
In models 4 and 5, we test for moderating effect joint audit on the association between Evidence from
political connections and effective tax rate. Accordingly, we introduce an interaction Islamic
variable (JA*PC) that captures the effect of political connectedness on effective tax rate only
if the bank is audited by two external auditors. In model 4, we introduce the interaction
banking
variable in model 1. For this interaction term (JA*PC), the negative and significant industry
association between political connections and effective tax rate becomes less significant
(Coeff = 0.087; t = 1.790)[1]. In model 5, we examine the effect of this interaction variable
(JA*PC) without considering political connections and joint audit variables. In this model, 165
the association between our interaction variable and effective tax rate becomes insignificant
(Coeff = 0.030; t = 0.070). Our findings suggest that joint audit variable weakens the
negative association between political connections and effective tax rate; thus, H2 is
confirmed. These results suggest that joint auditor, as an external control mechanism, plays
a crucial in reducing the adverse effect of directors’ political connections on tax avoidance
and aggressive tax management within the Islamic banking industry.
With respect to control variables, findings show that corporate size has a significant
negative impact on effective tax rate, indicating that larger Islamic banks undertake
aggressive tax management activities and this result is in line with that reported by
Adhikari et al. (2006). Similarly, Islamic banks characterized by high level of intangible
assets and higher profitability pay lower taxes. ZAKAT ratio is negatively and significantly
associated with effective tax rate, suggesting that banks with high levels annual solidarity
payments are more tax avoidant. With respect to institutional variables, the coefficient on
INFL is significantly negative, suggesting that Islamic banks located in high inflation
environments have more incentive to engage in higher tax avoidance.
Overall, our empirical analyses are consistent with our prediction and suggest that joint
auditors perform external monitoring role, mitigate agency problems and reduce tax
avoidance activities in politically connected Islamic banks. These findings shed light in the
importance of joint audit, as an external corporate governance mechanism, in enhancing the
reliability and transparency of financial information to a wide range of stakeholders with
respect to corporate duties in terms of tax payments.

5. Additional analysis and robustness tests

In this section, we present additional tests using an alternative measure of tax avoidance
(cash effective tax rate). In addition, we adopt sub-sample analysis as an alternative to test
for the moderating effect of joint audit on the association between political connections and
tax avoidance.

5.1 Alternative measure of tax avoidance

We test whether our results are robust with the inclusion of the cash effective tax rate
(CETR) as an alternative measure of tax avoidance. Cash effective tax rate is defined as cash
tax paid divided by pre-tax income for a bank in a given year (Dyreng et al., 2008).
According to Cen et al. (2017), this measure captures tax deferral strategies that are not
captured in the traditional GAAP effective tax rate. We re-estimate our regression models
with this alternative tax avoidance variable, and the results are reported in Table V. We find
in model 1 that political connections are negatively and significantly related to cash effective
tax rate (Coeff = 0.053; t = 1.710). Furthermore, this negative association between
political connections and cash effective tax rate becomes insignificant for the interaction
variable between joint audit and political connections as reported in model 5 (Table V)
(Coeff = 0.025; t = 0.410). Accordingly, the use of cash effective tax rate as an alternative
measure of tax avoidance provides further support that political connections increase the
 rate
JFC
27,1

166

Table V.

cash effective tax

and joint-audit on
OLS Regression of

connected directors
the effect of political
Variables 1 2 3 4 5

PC 0.053* (1.710) 0.107*** (5.080) 0.002 (0.050)

JA 0.146*** (4.500) 0.151*** (4.630) 0.203*** (5.180)
JA* PC 0.193** (2.500) 0.025 (0.410)
SIZE 0.016 (1.030) 0.035*** (3.420) 0.021 (1.380) 0.022 (1.450) 0.018 (1.110)
CINT 0.606 (0.800) 0.606 (1.160) 0.649 (0.850) 0.604 (0.810) 0.540 (0.660)
INTANG 0.674 (0.280) 4.639*** (2.810) 0.390 (0.160) 0.571 (0.240) 1.999 (0.780)
LEV 0.054 (0.990) 0.049 (1.320) 0.083 (1.600) 0.128** (2.090) 0.128** (2.200)
ROA 8.103*** (3.800) 4.029*** (2.790) 9.180*** (4.480) 8.66*** (4.110) 7.809*** (3.580)
ZAKAT 0.660 (1.010) 1.519*** (3.490) 0.628 (0.960) 0.884 (1.360) 1.410** (2.020)
GDP 0.016*** (3.060) 0.002 (0.780) 0.017*** (3.470) 0.015*** (3.030) 0.019*** (3.530)
INFL 0.003 (1.240) 0.006*** (3.200) 0.005* (1.870) 0.003 (1.230) 0.005* (1.760)
Year FE Yes Yes Yes Yes Yes
Observations 180 180 180 180 180
Adj-R-square 0.299 0.394 0.290 0.321 0.196
Probability> F 0.000 0.000 0.000 0.000 0.000
F-stat 5.020 7.490 5.070 5.240 3.440

Notes: This table presents the estimates of OLS regressions of PC, JA and JA*PC on CETR. The dependent variable is the cash effective tax rate (CETR), which
equals cash taxes paid divided by pretax income. The independent variables are the politically connected directors (PC) and joint audit (JA). The control variables
are bank size (SIZE), capital intensity (CINT), intangible assets (INTANG), Leverage (LEV), profitability (ROA), zakat (ZAKAT), GDP growth rate (GDP) and
Inflation rate (INFL). All variables are as defined in the Appendix. The year fixed effects are included but not reported. The t-statistics are reported in parentheses
below the coefficient estimates. *, **, and *** denote statistical significance at the 10, 5, and 1% levels, respectively
likelihood of undertaking aggressive tax management, joint audit reduces tax avoidance Evidence from
practices and joint audit reduces the adverse effect of directors’ political connections on tax Islamic
avoidance and aggressive tax management. banking
industry
5.2 Sub-sample analysis
To provide further insights into the moderation effect of joint audit (H2), we partition our
sample according to whether Islamic banks are joint audited or not. The results are 167
presented in Table VI. For the sub-sample of Islamic banks with joint audit, the coefficient
for political connections is insignificant (Coeff = 0.066; t = 0.810), indicating that
directors’ political connections have no effect on the tax avoidance among joint audited
banks. In contrast, we observe that the coefficient for political connections is negative and
significant for firms without joint audit (Coeff = 0.075; t = 3.370), suggesting that the
absence of joint auditors leads to more tax avoidance. These results provide further support
for H2.

6. Conclusion
Tax avoidance and its relationship with political connections is an important research topic
that remains unexplored within the Islamic banking industry. This paper aims to fill the gap
in accounting literature by investigating the effects of political connections on tax avoidance
in the Islamic banking context and whether this association is moderated by joint audit.
Using a sample comprising 180 bank-year observations, we find that politically connected
Islamic banks engage more in tax avoidance by reducing their effective tax rate. We find
that joint audit weakens the negative association between political connections and effective
tax rate. These results remain robust after using alternative measure of tax avoidance
(the cash effective tax rate) and undertaken sub-sample analyses.

Variables JA = 1 JA = 0

PC 0.066 (0.810) 0.075*** (3.370)

SIZE 0.009 (0.220) 0.046*** (4.930)
CINT 0.558 (0.290) 0.354 (0.760)
INTANG 1.858 (0.270) 4.116*** (2.810)
LEV 0.374** (2.700) 0.009 (0.230)
ROA 13.731*** (4.390) 2.588* (1.790)
ZAKAT 0.971** (2.500)
GDP 0.027*** (3.850) 0.001 (0.060)
INFL 0.010** (2.830) 0.004** (2.600)
Year FE Yes Yes
Observations 40 140
Adj-R-square 0.673 0.474
Pro > F 0.000 0.000
F-stat 5.730 7.970
Table VI.
Notes: This table presents the estimates of OLS regressions of PC on ETR for the joint audit based sub- OLS Regression of
sample. The dependent variable tax avoidance is the ETR. The independent variable is the politically the effect of political
connected directors (PC). The control variables are bank size (SIZE), capital intensity (CINT), intangible connected director on
assets (INTANG), Leverage (LEV), profitability (ROA), zakat (ZAKAT), GDP growth rate (GDP) and
Inflation rate (INFL). All variables are as defined in the Appendix. The year fixed effects are included but effective tax rate by
not reported. The t-statistics are reported in parentheses below the coefficient estimates. *, **, and *** joint audit Sub-
denote statistical significance at the 10, 5, and 1% levels, respectively sample
JFC These findings have important policy implications. Our findings could assist government in
27,1 understanding fully the role of political connections and joint audit in monitoring tax
avoidance in banking sector. More importantly, the empirical findings about the roles that
joint auditors play in reducing tax avoidance behavior can becomes crucial for regulators to
require joint audit in the banking sector to reduce the damaging impacts of tax avoidance
strategies.
168 Our study has two main limitations. First, this study only covers 18 Islamic banks, which
is a relatively small sample size. However, this is a common issue facing researchers when
conducting empirical studies within banking industry. Second, we only use two measures of
tax avoidance (effective tax rate, cash effective tax rate). Although it has been argued that
these indices are optimal measures of tax avoidance (Abdul Wahab et al., 2017), it is possible
that other measures could produce different results; therefore, our results should be
interpreted with caution.
Accordingly, future empirical enquiries may examine the effect of other proxies of
political connections (e.g. ownership, CEO) on tax avoidance. In addition, further analysis
may extend our empirical study to examine the same associations within conventional
banking industry or insurance companies.

Note
1. Significant at 10 per cent as compared to the effect of political connections on effective tax rate in
model 1 which was significant a 1 per cent significance level.

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Appendix
Name
Dependant variable
Effective tax rate (ETR)
Independent variable:
Political connections (PC)
Moderating variable
Joint audit (JA)
Controle variables
Size (SIZE)
Financial leverage (LEV)
Profitability (ROA)
Capital intensity (CINT)
Intangible assets
(INTANG)
Zakat (ZAKAT)
GDP growth rate (GDP)
Inflation rate (INFL)
Evidence from
Islamic
banking
Calculation Source industry
Total income tax expense divided by pre- Annual report 171
tax income. ETR is set as missing when the
denominator is zero or negative and we
winsorize ETR to the range [0, 1]
Dummy variable equal to one if a bank has Annual report
at least one politically connected director,
and zero otherwise
Dummy variable equal to one if a bank uses Annual report/auditor
a joint audit, and zero otherwise report
The natural logarithm of total assets in US Datastream
dollars of the current year
The ratio of total debt to total assets Datastream
The ratio of net income to total assets Datastream
The ratio of fixed assets to total assets Datastream
The ratio of intangible assets to total assets Datastream
The ratio of zakat expense to pre-tax Annual report/Datastream
income
Annual GDP growth rate of a country World Bank’s “Countries
and Economies” databank Table AI.
Annual inflation rate of a country World Bank’s “Countries Variable
and Economies” databank measurement

Corresponding author
Hana Ajili can be contacted at: ajilihana@hotmail.fr

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