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1 Business Ethics and Corporate Governance from an Islamic Financial Perspective Professor Bala Shanmugam Director Banking & Finance Monash University.

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Presentation on theme: "1 Business Ethics and Corporate Governance from an Islamic Financial Perspective Professor Bala Shanmugam Director Banking & Finance Monash University."— Presentation transcript:

1 1 Business Ethics and Corporate Governance from an Islamic Financial Perspective Professor Bala Shanmugam Director Banking & Finance Monash University Malaysia October

2 2 In Islam, Business is viewed as very important “Encouraged upon you is business for in it is nine out of ten of your sustenance” Al-Ghazali, Ihya c ulumuddin, Vol.2

3 3 But business has 2 objectives: 1. Profit maximization 2. Customer welfare

4 4 Objectives need not be mutually exclusive : Win-win situation : Humane approach (the middle path)

5 5 Nik Mustapha (IKIM) “ Islam wants human to pursue what is natural: to eat and drink, to have lodging and comfort, to make of the world a garden, to enjoy sex, friendship and all the good things in life, to develop the sciences and to learn, to usufruct nature, to associate and to build socio-political structure-in short, to do all these things, but to do them righteously, without lying and cheating, without stealing and exploiting, without injustice to self, to neighbour, to nature, and to history.” Business Ethics, p.4

6 6 “ Righteous businessmen will be the first to enter paradise” Al-Tarmizi and Al-Hakim from Abi Said “ A truthful merchant will be raised on the Day of Judgment together with the truthful and the martyrs” op.cit

7 7 Deduction: Business is encouraged Business Ethics is a divine pre-requisite

8 8 All economic Activity fall within the parameters of: HalalHaram (allowed and(prohibited and praiseworthy)blameworthy)

9 9 HALAL – HARAM codes regulate all production and distribution within the notion of adl (justice)

10 10 Business Virtues PositiveNegative iqtisad (moderation)zulm (tyranny) adl (justice)bukhl (miserliness) ibsan (kindness parhirs (greed) excellence) amanah (honesty)iktinaz (hoarding of wealth) infaq (spending to meet israf (extravagance) social obligations) sabr (patience) istislah (public interest)

11 11 Concept of doing the right thing borders along modern (western) notion of corporate governance

12 12 “ Best practice is not just about attaining maximum profitability on economic efficiency but ………also about making sure of moral standards acceptable to the general community” Cadbury 2002

13 13 3 major variations between Islamic and Western perspectives of best practices Western BusinessIslamic Business a. Secular humanistGuideReligious authority (conscience) b. Self-interestRootsWider society c. AgencyGovernanceStewardship

14 14 A. Moral notions of right and wrong are secular based in the West (conscience) In Islam it is strictly Quranic or Hadith based

15 15 B.Self improvement is paramount in conventional systems but the wider society (ummah) is just as important for Islam

16 16 C.Conventional corporate governance seeks to align principle and agent in a non-collision course In Islam all wealth belongs to the Maker and principle and agent are temporarily entrusted (trustees) with it

17 17 Islamic Guideline: The ‘best’ way to ‘take care’ of entrusted holdings is via Shari’ah

18 18 Essence of Islamic Governance: “ …….. to live true in mutual consultation and forbearance, and rely on Allah…….” Sura Ash. Shura

19 19 This Shura encourages all parties to work together freely and frankly to arrive at decisions ie room for asymmetric information is narrowed

20 20 Further ‘policing’ introduced by institution of Hisba. The muhtasib (of the Hisba office) enforced accuracy and honesty in business dealings. Hisba office checked on: correct weights and measures, fair trading rules, possible business frauds, auditing of illegal contracts, prevented hoarding etc

21 21 Islamic Corporate Governance Decision-making Managed Socially responsive Islamic corporate basis corporation corporation governance model Legal concept of CEO and senior Executive and Shuratic decision- firm: decision-making management supervisory making process: by whom? processes consultation and consensus- seeking Economic concept Maximize profits Stakeholders Institution of hisba of firm: decision- Maximize Role of muhtasib making for whom? shareholder value Accounting concept Financial Corporate Shari’a of firm: decision-making governance by responsibility supervision with that resources shareholders and Triple bottom process and to whom is suppliers of line: economic, Religious audit accountability due? finance social and environmental accountability Source: Lewis, 2004

22 22 Unique Characteristics of Banks: 1. Banks are generally more opaque than other institutions which importantly intensifies the agency problem 2. Banks are exposed to extreme regulations 3. Government ownership of banks makes the governance of banks different from other types of organization

23 23 Debate in Corporate Governance: *Protect shareholders or stakeholders *Do directors / management owe fiduciary duties of care and loyalty to shareholders or extend to stakeholders (degree of extension)

24 24 * Anglo-American approach stresses maximization of shareholders wealth over the interest of stakeholders

25 25 *Franco-Germanic approach emphasizes equal attention for both shareholders and stakeholders

26 26 “ The standard law and economics view regarding fiduciary duties [ thus far] is that corporations and their directors owe fiduciary duties to shareholders and shareholders alone” (Macy and O’Hara, 2003)

27 27 *Islamic bank is a corporation as well as partnership (mudaraba) *Management has two categories of equity holders: shareholders and mudaraba parties

28 28 “ How can equity be ensured between shareholders who are investors in the bank, on the one hand and depositors who are investors in mudaraba funds managed by the bank, on the other?” (Vogel and Hayes, 1998)

29 29 * Management has ethical dilemma when faced with conflict of interest between shareholder and mudaraba “partner” *It must bear in mind that only the shareholder enjoys the governance structure of appointing, evaluating and dismissing the management

30 30 *End result: The investing ‘Partner’ relies on shareholders to safeguard their interests *Such reliance has its own limitations and often fails to fully serve the interest of the ‘partner’ * It is not uncommon for profit of ‘partners’ venture goes to shareholders in year when management contract is to be renewed

31 31 *Insufficient disclosure to partner disallows close monitoring and aspects of management misconduct / negligence is seldom discovered

32 32 Conclusion: *Ethics and governance well entrenched in Islamic Business / Finance *May not be as sophisticated to meet today’s needs *Presence of teething problems *Efforts being undertaken by IFSB / AAOIFI etc, to formulate Shariah compliant principles

33 33 References: 1.Business Ethics Magazine (2004), “Corporate Social Responsibility Report”, p.4 2.Cadbury, A., (2002), “Corporate Governance and Chairmanship, Oxford: Oxford University Press 3.Lewis, M.K., (2004), “Developing Islamic Banking and Capital Market – New opportunities, new market and new frontier in Islamic Banking and Finance”, Aug, 2004, Kuala Lumpur 4.Vogel, F.E and Hayes, S.L., (1998), “Islamic Law and Firms: Religion, Risk and Return”, Kluwer Law International


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