| Summary: | Income smoothing is a commonly used accounting application by financial institutions including Islamic banks to reduce fluctuations in reported earnings and mitigate risks. The usage of profit equalisation reserve (PER) to smooth income is no longer relevant in the context of Malaysian Islamic banks.
Alternatively, Islamic banks may have the implicit flexibility to manage their depositors profit di tribution ex-post to smooth their returns to the investment account holders (IAHs). This study aims to examine whether the Malaysian Islamic banks do manage their distribution of depositors' return to smooth
income, and if so, to what extent earnings and capital management are associated with the decisions of depositors' return distribution. The study utilises a sample of sixteen Malaysian Islamic banks for a five-year period from years 2008 to 2012. The data is analysed using generalized least square (GLS) estimation method. The result reveals that earnings management has a positive, but insignificant effect on distribution of depositors' return (DDR). While capital management indicates a positive and significant effect on DDR. Results using interactive dummy variables show that dummy negative earnings interacted with earnings management is positive and significant, which in turn, leads to a higher provision for distribution of depositors' return. The dummy variable of loan loss reserve when interacted with capital management provides a positive and insignificant effect on DDR. As for control variables, non-performing financing (NPF) and age of the bank (AGE) are positive and negative significantly related to DDR, respectively. As such, it can be argued that a well-managed DDR will help Islamic banks risk mitigation to stabilize return and reduce fluctuations in a situation of bad or negative earnings.
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