Alhassanain(p) Network for Heritage and Islamic Thought

4.0 DEVELOPMENT OF A MODEL OF EFFECTIVE CORPORATE GOVERNANCE

Our model constitutes 4 integrated layers of the corporate governance (see Diagram 2). The most inner layer represents the organizational environment. As a matter of fact, there are 5 major components of the corporate governance. These 5 components areShari’ah Supervisory Board (SSB), Board of Directors (BOD), Management, InternalShari’ah Audit (ISA) and Internal Audit (IA). What makes them to function effectively are internal forces which include the internal control and procedures,shari’ah infused values individuals, human resource development andshuratic decision making. The next layer represents all the significant external forces that are responsible to determine the ‘rules of the game’. On one extreme, the company needs to meet the expectations of the various stakeholders, and on another extreme, there are sets of legal rules and regulations that need to be abided by the company. However, the rules and regulations must be designed in such a way that they are in line with theShar’iah requirements. It also means that themaqasid ofshari’ah must be the utmost important criteria in deriving such rules and regulations. Meanwhile, the most outer layer represents the Islamic worldview which becomes the foundation of the effective corporate governance.

4.1 Components of the Islamic Corporate Governance

4.1.1 Shari’ah Supervisory Board (SSB)

Suleiman (n.d.) claims that:

“Islamic banks (or organizations) have a major responsibility to shoulder…all the staff of such banks and customers dealing with them must be reformed Islamically and act within the framework of an Islamic formula, so that any person approaching an Islamic bank should be given the impression that he is entering a sacred place to perform a religious ritual, that is the use and employment of capital for what is acceptable and satisfactory to God” (p. 101)

This quotation means that Islamic organizations should meet the high expectations of the public especially those who really concern with how Islamic the Islamic organizations. Such expectation leads to a two-tier governance system which consists of the SSB and BOD.

Unfortunately, the current function of the SSB is just to give advice on matters pertaining to products. By right, their functions are wider and include careful scrutinizing of the whole activities of the organization to ensure that they do not contravene theShari’ah teachings. At the end of the accounting period, they need to issue a report to be reported to the shareholders regarding the compliance of the organization on theshari’ah requirements. The report should contain among other things, review on the principles and contracts relating to the transactions and applications introduced by the Islamic Financial Institution; opinion regarding its compliance withShari’ah Rules and Principles, specificfatwas, rulings and other guidelines; procedures involved in the review process; and the allocation of profit, realization of earnings as well as the calculation ofzakah (Governance Standard for Islamic Financial Institutions No. 1, AAOIFI).

Another issue that might be raised here is regarding the independence of the SSB members. Even though physically, the SSB looks independent, the fact that they are appointed by the BOD and subsequently they are paid for their services, the issue of ‘independence of mind’ might need to be taken care of. Since the employer-employee relationship might occur here, there are tendencies that the SSB is tied to the BOD’s instructions.

Diagram 2: A model for an effective corporate governance

Nevertheless, as an individual who might have certain level of interests towards this issue, should bear in mind that their job is not only to criticize and be prejudice. Instead, they should have trusted (husnu az- dzan ) the SSB in discharging their duties. If not us, who else will believe them? In addition, according to Karim (n.d.), the employee relationship does not seem to generate significant doubts about the SSB members’ independence. In fact, their independence tends to stem from deep commitment to Islamic precepts.

In terms of authoritativeness in an organization, SSB is expected to have influence in the BOD, which is the highest authority in a normal organization. This influence is actually reflecting to the SSB’s capacity in giving advice to the BOD in whatever matters pertaining to Islamic conducts, not only in terms of product but also covers the entire operation. To assist the SSB in examining the extent of the compliance of the organization’s activities to the Islamic requirements, there should be an internalshari’ah audit (ISA).

4.1.2 Board of Directors (BOD)

In terms of structure, the BOD should be composed by both executive and non-executive directors. While the majority of the members should be non-executives, some of the Codes on the Corporate Governance emphasize the importance of having independent non-executive directors i.e. Brazilian Institute of Corporate Governance Code of Best Practices (BICGGCBP), Malaysian Code on Corporate Governance (MCCG), Combined Code on Corporate Governance (CCCG) and Code of Best Practices for Corporate Governance in Islamic Financial Institutions (CBPCGIFI). What is meant by the term ‘independence’ as according to BICGGCBP is;

“a director is independent if he or she: has no link to the company besides board membership and share ownership and receives no compensation from the company other than director remuneration or shareholder dividends; has never been an employee of the company (or of an affiliate or subsidiary); provides no services or products to the company (and is not employed by a firm providing major services or products); and is not a close relative of any officer, manager or controlling shareholder” (Gregory and Simms, 1999, p. 17)

In addition to that, there is a need of majority of the BOD to be non-executive. This is to monitor the effectiveness of the non-executive in steering the company. Such monitoring will ensure that the actions taken by these executive directors are in line with the interests of the company and not of themselves. That is why the function of the non-executive directors becomes more important rather than attending ‘paid’ meetings without really concern what is going out in the company. This is what we called ‘sleeping directors’.

Most literatures have focused on the issue of the independence of the members of the BOD. As a matter of fact, these board members are appointed by the major shareholders. This will result in those who have not even own shares in a company, might be appointed as a director. Since he is appointed by the major shareholders, there is a tendency that this director will make decision that will satisfy the needs of majority shareholders and this might be at the expense of minority shareholders.

In addition, most appointment is based on ‘worldly’ criteria such as academic qualification, working experience, competency etc. At the same time, the more ‘spiritual’ criteria such as the moral attitude, ethical behavior and religious commitment of an individual have been sidelined. Thus, there should be a balance between the ‘worldly’ and ‘spiritual’ criteria in the appointment so as to ensure that the future decisions and actions he will undertake are ethically and professionally-based.

BOD, be it executives or non-executives, should refer to the SSB in their decisions. This is to ensure that they strictly follow the Islamic tenets. Meanwhile, the nature of audit requires it to be headed by the non-executive directors. Therefore, the executive directors should not have any influence to the internal audit function. However, the executive directors are responsible to monitor the day-to-day operations of the company.

4.1.3 Management

Management here refers to the senior-level managers. They are the ones who execute the directives from the BOD and able to delegate works to the lower-level employees. As a matter of fact, they are more knowledgeable in terms of the company’s operations.

The management should be expected to act as a bridge between the directors and the employees. Any suggestions or dissatisfaction should be channeled accordingly in order to promote a harmony working environment. Sometimes, there is a conflict between the BOD and management. For instance, unethical board members might instruct the managers to do malpractice. Management, realizing the fact that they are salaried by the company, therefore they feel obliged to fulfill the directions in order to secure their positions.

However, in theQur’an , it is clearly stated that other than Allah and His Prophet, the loyalty to others are so long the instructions do not contravene with theshari’ah requirements;

“Obey God, and obey the Apostle, and those charged with authority among you. If ye differ in anything among yourselves, refer it to God and His Apostle, if ye believe in God and the Last Day: That’s the best, and most suitable for final determination” (4:59).

In this verse, it is clearly stated that the absolute loyalty is towards Allah and His Apostle whereas the loyalty to other than that depending on certain circumstances. This is reflected in thetawheedic worldview that we are talking about whereby men should not be dependent on other men. However, such principle is always forgotten by Muslims nowadays that lead them to blindly follow other persons’ instructions which cause them to get involved in fraudulent activities.

In current practice, if such situation happens management has ‘no shoulder to cry on’. In facing this ethical dilemma, they have only one of two options: whether to follow the instructions or to resign. Therefore, we suggest that the gap between the non-executive directors and management should be bridged. In order to achieve this, the non-executive directors should have frequent communication and work closely with the management. As a result, the management will feel more comfortable to report any unethical instructions from the executive directors. Since the non-executive directors have the privilege to monitor the actions of executive directors, they can properly solve these issues.

On the contrary, if the fraud or malpractice is initiated by the management themselves, there should be an internal audit (IA) and aShari’ah Internal Audit (SIA) to act as effective ‘watchdogs’. Both units will ensure that management has strictly followed the prescribed procedures and has not attempted to contravene the internal controls.

4.1.4 Internal Audit (IA) and Internal Shari’ah Audit (ISA)

Internal Audit (IA) functions to ensure that all internal control systems are in place and the management has followed the procedures stated therein. Any reports on findings should be addressed to the audit committee. While IA focuses more on the financial and operational aspect, InternalShar’iah Audit will focus more on theshari’ah compliance of the organizational activities. Since IA is a normal phenomenon in the current practice, the following paragraphs will only deal with the ISA.

InternalShari’ah Audit (ISA) is another control mechanism that needs to be established especially in Islamic Institutions. As compared to the conventional auditors who are governed by legal rules and professional codes of ethics, religious auditors are guided by their moral beliefs and obligations to religious peers and the community (Rahim, 1998). The need to have an ISA is very important especially in the current times where those who are well-versed in theshari’ah are not necessarily knowledgeable about the present state of affairs in banking, finance and accounting. Similarly, those who are versed in the latter are not necessarily knowledgeable in theshari’ah . Here, we can conclude that the ISA should assist the SSB in ensuring that the company has strictly followed theshari’ah requirements.

Briston and El-Ashker (1986) in Rahim (1998) clarifies that there are 3 functions of Islamic religious auditing, namely ex-ante auditing, ex-post auditing and the audit of Islamic tax. Ex-ante auditing refers to the advising the BOD and managing director, contracts and procedures to ensure that all are in conformity with the Islamic code. While this function is more relevant to the SSB, the other two are mostly related to the ISA. Ex-post auditing checks whether the executive management has complied with all the Islamic principles and with the advice which the SSB has given. Meanwhile, the audit of Islamic tax orzakah fund is necessary to ensure thatzakah on the enterprise’s net assets is properly calculated and the fund is properly administered.

AAOIFI in its Governance Standard for Islamic Financial Institutions No. 3 has listed 4 functions of the internalshari’ah review, namely:

Planning review procedures,

Executing review procedures and preparation and review of working papers,

Performing follow-up, and

Documenting conclusion and report

Under the planning review procedures, ISA should among other things, obtain background information about the activities to be reviewed, establish objectives and scope of work, obtain SSBfatwas , guidelines, prior year’s reports, and also determine the resources necessary to perform the internalshari’ah review. Next, the ISA shall collect, analyze, interpret and document information to support their internalshari’ah review results. Working papers that document the review shall be prepared, completed and organized so that it can be reviewed by the Head of ISA. While performing their tasks, ISA should make regular follow-up in any findings.

The Head of ISA should discuss with the management regarding the audit review before final report can be written. Even though he needs to consult with the management, it does not mean that the management can simply have influence on the report. Instead, it is a kind of formal procedures in respecting the management as the highest level of executives in a company. Then, final report will be submitted to the BOD and SSB.

What kind of ethics that will govern both the auditors in performing their works? AAOIFI has listed 6 principles of ethics as outlined in its Code of Ethics for Accountants and Auditors of Islamic Financial Institutions. As an auditor, he/she must uphold the principles of trustworthiness, legitimacy, objectivity, professional competence and diligence, faith-driven conduct, professional conduct and technical standards.

4.2 Internal Forces

4.2.1 Internal Control and Procedures

The existence of an effective controls system is important for the safety and soundness of all organizations (Chapra and Ahmed, 2002). It can help the realization of organizational goals and achievement of the long term profitability. Experience has shown that the existence of effective internal controls could help prevented or enabled early detection of, many fraudulent activities from occurring. Nevertheless, by only having internal controls system is insufficient since what is more important is the on-going monitoring and examining the systems to ensure compliance with rules and procedures, exposure limits, approvals and authorizations and verification and reconciliation. Thus, critical elements such as the internal audit system must be adequately independent.

Most of the codes on corporate governances are voluntary in nature. It is up to the management of the company whether to follow it or not. However, in Malaysia, by virtue of Paragraph 15.26 of the KLSE Listing Requirements,

“…all listed companies should state in their annual report how they have applied the principles set out in Part 1 of the Code and the extent to which they have complied with the best practices set out in Part 2 and identify and give reasons for any areas of non-compliance, and where applicable, state the alternative practice(s) adopted” (Paragraph 4.1, MCGG, 2000, p. 6).

Therefore, Hamid (2002) suggested that the code on corporate governance to be treated as a part of the ISO standards. It does not only documenting all the procedures that need to be followed but, as a matter of fact, the adoption of the ISO standards, “would subject the company to all kinds of scrutiny such as the surveillance audit and so on” (p. 120). Thus, by having such standards, the external auditor has to conduct a so-called management audit to ensure that all procedures as documented have been strictly followed.

Performance measurement is another aspect that needs a critical attention. A system without measurement is incomplete and useless. Therefore, a company at the end of the day needs to measure the effectiveness of its governance system. One way to measure such performance is through developing an index. Adewirman, Alrazi, Mohd. Nor and Pramono (2003) has developed an index to measure the performance of Islamic banking, One of the components of suchIslamicity index is corporate governance indicator. The indicator is based on the list of items that should be disclosed in the annual report (Refer Appendix 1). Since it is only based on the disclosure, a company might need to have a more comprehensive indicator of governance performance.

4.2.2 Shuratic Decision Making

The institution ofshura or rathershuratic decision making is another factor that can lead to the achievement of effective corporate governance. The importance of making decision based onshura (consensus) is stated in the Qur’an;

“Those who hearken to their Lord, and establish regular prayer, who (conduct) their affairs by mutual Consulation; who spend out of what We bestow on them for Sustenance” (42:38)

Besides, according to Sulaiman (1999),shura constitutes one of the four cardinal principles in the Islamic perspective on socio-political organization. The other three are justice, equality and human dignity.Shura is predicated on three basic percepts. First and foremost, all men are equal in human and civil rights. Secondly, the issues pertaining to the public interest are best decided by majority view. Besides, the three other values namely justice, equality and human dignity are best realized, be it in the personal or public life, under theshura governance. Even though it seems that theshura we are talking about is quite parallel with the democracy propagated by the Western, there are basically three distinguished characteristics between them. Firstly, the decision made undershura is based on the serious consideration of Islamic tenets and the concept ofmaslahah of ummah (public benefits). As compared to the Western democracy, it only deals with the choice of majority. On the contrary,shura, despite being a majority consensus, it stills consider the views of minority. Furthermore, unlike democracy according to the Western’s understanding is a system of governance,shura from an Islamic standpoint is a principle of governance.

The institution ofshura can act as a measure to supervise directors and executives (Rahim, 1998). This requires the directors to listen to other people such as the executives before making any decision. Since the decisions made by the company not only affecting the company but also its internal and external constituencies, it is suggested that other stakeholders involving the employees, the customers, the community, the religious authorities etc. In the case of Islamic banking for example, even though the depositors are actually the one which contributes a substantial amount of capital to the bank, they have no say and no voting rights in the bank. Therefore, it is more ethical to consider their viewpoints before the directors can make any decision.

4.2.3 Shari’ah-Infused Value Individuals

Another internal force that could help in establishing and maintaining the effective corporate governance is individuals whoshari’ah values have become part and parcel of themselves. This is what we callshari’ah -infused value individuals. As have been previously described, if an organization consists of a group ofinsan muttaqun (pious individuals), this will ensure an effective corporate management and governance.

Nowadays, we can read from the newspapers, watch in the televisions and listen from the radio, various social illnesses committed by the individual who is Muslim. Bribery, theft, incest, abolition and prostitution are some of the ethical problems that happen even in the Muslim community. In addition, what makes us wonder is that such uncivilized actions are also done by those who we believe understand the religious teachings, at least by looking at their physical appearance. They read theQur’an , they pray five times a day, they fast duringramadhan and they claim that they are Muslim, but at the same time, such religious activities cannot hinder them from wrongdoings. If we refer to theQur’an , it has clearly stated that;

“Recite what is sent of the Book by inspiration to thee, and establish regular prayer: for prayer restrains from shameful and unjust deeds…” (29:45)

Hence, we can conclude that even though they know Islamic values but they cannot internalize those values in themselves. Therefore, here is some guidance in internalizing Islamic values in oneself.

a. Education

Education is an important aspect in building up a good human being. It is this educational process that determine whether one person can behave like an‘abd or like an evil. In order to generate an ethical Muslim, we need to have a holistic educational system. This system should aim at producing a spiritually-enhanced and technically-competent human being.

According to Al-Ghazzali, the education of the children is an important duty (Umaruddin, 2003). This is in line with the Prophet’s saying regarding the responsibility of parents in educating their children;

“Narrated Abu Huraira:

The Prophet said, "Every child is born with a true faith of Islam (i.e. to worship none but Allah Alone) and his parents convert him to Judaism or Christianity or Magianism, as an animal delivers a perfect baby animal. Do you find it mutilated?"[4]

If he is educated in the traditions and goodness, he will surely follow the truth when grown up, and will attain happiness in both the worlds. However, lack of proper education ruins the child. Therefore, parents should train their children in good conduct, and keep them away from bad company.

While this should be our aim, we therefore need to look at the current educational system especially what so far has been practiced in Malaysia. In Malaysia, it is very sad to accept the fact that we actually implement secular-based educational system. Besides successful in producing citizens who can pass all sorts of examinations, there is not much that can be proud of. There is lack of emphasis in imparting moral and ethical values in each and every subjects taught to the students. In fact, Islam and moral becomes a subject on its own and they called them as Islamic and moral educations.

Hasan (1999) claimed that this type of educational system;

“…is geared toward attaining prosperity and a comfortable life, handling down progress and culture from one generation to the next, in continual search of more luxuries and enjoyment of this life, and attachment to its pleasures. It is aimed at satisfying the base instincts of the people with no direction toward noble goals”.

As a consequence, in order to produce an ethical engineer, a moral accountant and a pious doctor, our educational system needs a total reformation. However, such reformation should not be done over night. It should be implemented bit by bit so that its affects is long-lasting. This is in line with Islam, whereby it advocates evolutionary change as opposed to revolution (Naqvi, 1994 as quoted in Sulaiman and Willet, 2001);

“In the case of abolition of slavery, the Prophet did not abolish slavery outright, but instead, abolished slavery in stages. He taught the followers that freeing a slave is a form of piety. The Prophet himself set the example. While providing a slave for his daughter Fatima, the Prophet persuaded her that the housework should be done on alternate days by Fatima herself” (p. 93)

At the same time, a step-by-step process has also been implemented in the case of prohibition of alcohol (liquor). According to Nasim (1999), there are four stages of prohibition of alcoholic drinks as stated in theQur’an ;

“And from the fruit of the date palm and the vine, ye get out wholesome drink and food: behold, in this also a Sign for those who are wise” (16:67)

“They ask thee concerning wine and gambling. Say: “In them is great sin, and some profit, for men; but the sin is greater than the profit”…” (2:219)

“O ye who believe! Approach not prayers with a mind befogged, until ye can understand all that ye say…” (4:43)

“O ye who believe! Intoxicants and gambling, (dedication of) stones, and (divination by) arrows, are an abomination, - of Satan’s handwork: eschew such (abomination), that ye may prosper. Satan’s plan is (but) to excite enmity and hatred between you, with intoxicants and gambling, and hinder you from the remembrance of God, and from prayer: will ye not then abstain?” (5:90-91)

In these verses, it is clear that to change something, especially the ones that have been in place for quite some times, it should be done on stage by stage. The first verse was revealed during the time where almost Muslims including the Prophet’s companion consumed alcohol. Therefore, it should be aim at giving explain that will cause them to think. The total prohibition nevertheless was only done after the fourth verse has been revealed, after they have understood the damages which alcohol brings about.

Such beautiful verses should make us think rationally that in order to change the current educational system, it should begin with a series of explanation and trials and errors. What is more important is planning and target so that the implementation will be on certain schedule and if any problem persists, it can be easily rectified.

Therefore, the Ministry of Education should conduct a careful research and come out with an educational system that put a balance emphasis on both ethico-religious and technical aspects. Such educational system should;

“…be based on purification of the human personality, by way of directing the intellect and its associated functions to reflect on this universe, and reflect within oneself - to arrive at the conclusion of the existence of the Creator, of His Uniqueness, greatness, power, and care and mercy to the human” (Hasan, 1999)

At the same time, any initiatives done by others in order to introduce such educational system should not be slashed down.

b. Love for knowledge

Man has been endowed with‘aql (intellectual) which makes him the perfect creature. He needs to us the‘aql, to search for knowledge of all kinds. According to Raba (2001), knowledge is one of man’s basic nature and basic purpose at the same time. By knowledge and through knowledge man can know his God. And by knowing his God, he can be a good servant, a good believer and a good Muslim.

The importance of acquiring knowledge has been stated in the Qur’an as the first word revealed to the Prophet Muhammad (pbuh) was,

“Proclaim! (or Read!) in the name of thy Lord and Cherisher, Who created- Created man, out of a (mere) clot of congealed blood: Proclaim! And thy Lord is Most Bountiful, - He Who taught (the use of) the Pen, - Taught man that which he knew not.” (96:1-5)

Knowledge is an essential element in making people different in this life and in the life to come. It is actually a key to success. The reason behind the success of most non-Muslims nowadays is because they continue to acquire knowledge. Such situation enables them to control the mind of Muslims. Nevertheless, knowledge should guide man to be a better‘abd and not to go against the teachings of Islam.

Knowledge is the way to achieve faith and happiness. Knowledge is the light that can guide man to know himself and his role in this life as well as how to keep a good balance between all his dimensions.

c. Tazkirah (Reminder)

One of man’s basic characteristics derived from his nature is forgetfulness. According to Al-Attas (1990) as quoted in Raba (2001);

“…man is also composed of forgetfulness (nisyan)…and he is called (insan) basically precisely because, having testified to himself the truth of the covenant he sealed with God, which entails obedience of His commands and prohibitions, he forgot (nasia) to fulfill his duty and his purpose.” (p. 44)

Therefore,tazkirah plays an important role in reminding Muslims to help them realize their functions in this world, which is to obey the God. In fact, it has become our responsibility;

“Allah’s Messenger (pbuh) said: “Whoever among you sees an act of wrong should change it with his hands. If he is not able to do so, then he should change it with his tongue. If he is not able to do so, then with his heart, and this is the weakest of faith” [5]

Apart from that, Allah S.W.T has clearly stated in the Qur’an;

“But teach (thy Message): for teaching benefits the Believers”. (51:55)

Nevertheless, we have the tendency to expect the community to do something for solving our problems (Shafaat, 2001). In this case, we expect persons other than us to perform thetazkirah. But how do things start in the community? From some individuals! At the same time, we should also understand that the individual is held responsible not only for his own action, but also for errors of fellow beings in his vicinity (Bashir, 1998).

The internalization of values is really a difficult but possible task. In order for values to be internalized in oneself, there need both internal and external forces. The suggestion we made just now i.e. education, love for knowledge andtazkirah are among the external forces. Nevertheless, such external forces are meaningless without the power of internal forces. This is what we callediman (faith). Without a strong faith, the process of internalization of values becomes more difficult. Allah has stated in theQur’an ;

“It is true thou wilt not be able to guide every one, whom thou lovest; but God guides those whom He will and He knows best those who receive guidance” (28:56).

A very classical example on the verse above is the Prophet’s uncle, ‘Abdullah who died inkufr. Even though he always accompanied and defended the Prophet during his life, he died without submission to Allah. Therefore, we should not feel helpless in our efforts to inculcate the Islamic values in other people and also ourselves. Whether the efforts are fruitful, it is at the Will of Allah.

4.2.4 Human Resource Development

In any organization, human resource department plays an important role. It is responsible in hiring people, developing their career, determining their salaries, etc. Apart from that, its ‘ideal’ function includes building an employee to become a better person, technically and spiritually. Spiritually-enhanced employee is achieved by implementing the moral codes and behaviors.

Rahman (1996) in Pomeranz (n.d.) had focused on how to internalize ethics in the work place. One aspect is to recruit those who are most likely to have values and virtues. This dimension requires a stringent screening mechanism. Thus, when selecting a candidate, it must be a balanced between job experience, educational achievement and ethical/moral background. However, this is still insufficient since those workers should be employed on a probationary basis until it is evidenced that they are ethical personnel. Therefore, such a strict recruitment process together with the probationary period will at least can reduce the probability of ethical problems in the work place. The incident of a 10-year old schoolgirl in Johore who has been raped, sodomized and strangled by a security guard and his friends to her death, among other reason is because a very negligent approach in employee recruitment.

Another aspect under the human resource development which is important is training. Training emphasis should not only be placed on the work-related, but also the values and principles. According to Pomeranz (n.d.), refocusing on values promotes security and confidence and strengthens resistance to temptation. Religious/moral speeches,usrah, retreats etc should be conducted regularly to create a corporate culture with strong moral and ethical foundation.

Since not all employees are well-versed in the Islamic spheres, they should be exposed to this. For instance, in the case of Islamic banking, the staff needs to be trained in terms of Islamic products and Islamic code of ethics (Chapra and Ahmed, 2002). This is to ensure that they are well-developed technically and spiritually.

4.3 External Forces

4.3.1 Stakeholders

Stakeholders in a company are someone who has an interest or ‘stake’ on it and are affected by what the company does. Each stakeholder expects the company to behave or react on behalf of their interest. Some of the stakeholder groups have some power to influence the company decision making and company actions. A large company normally has a large number of stakeholders. Although some of the stakeholders can influence the company decision, others just rely on the company management to take decision that is in their interest. Therefore, company has to balance the demands and needs of various group of stakeholders. One of the key issues in corporate governance is to balance the power between different stakeholders and how it is exercised.

The good corporate governance is where stakeholder is become “check and balance” system among them and according to Yaacob (2002, p. 55);

“The good corporate governance is the responsibility of not just the directors and management of a corporation but also that of all players in the system”.

Stakeholders who are not involved directly in company management such as employees and shareholders can be a “monitoring eye” to the company management and will ensure the company action will not give detrimental effect to them. In this paper, stakeholders group are divided into four groups which are believed to have different enforcement power. The groups are shareholders, employees, general public and lenders or creditors.

Shareholders

Board of director has the responsibility for giving direction to the company. They are holding the highest executives powers in bringing the company to achieve its objective. Lack of monitoring to the board of directors will lead to the fraudulent conduct in power. Board of directors will make a decision on their own interest disregard to other stakeholders.Therefore, shareholders should play a major role to ensure their interest and other stakeholders’ interests are given priority by the board of directors when they make any decision. This can be done by closely monitoring the company’s activities and shareholders with their controlling interest are able to influence decision of the company through their ability in controlling the composition of the board of directors. However, nowadays, there is a conflict where major shareholders tend to appoint someone that has close relationship with them to be directors of the company to fulfill their own benefits regardless the minority interest. Minority shareholders with less decision will be deprived their right to involve in company decision.

a. Employees

Another conflict that normally arises is between employees and shareholders. Normally employees request increment in their salary, and this can be exercised at the expense of shareholders by cutting their dividend and in normal circumstances, shareholders will reject the employees’ requests. On the other hand, boards of directors that represent the major shareholders tend to increase their salaries or remuneration although the company’s financial position is in bad condition. All this thing can be done as they control the information and able to manipulate it by not releasing the negative information to the employees. However, in most of the countries employee’s right is protected by the employees act. Nevertheless, the scope and implementation of this act is very limited.

Employees as an internal party and involve directly in the operation can use their “inherent power” to enforce the management if they know their company involves in non-halal products or activities. One of the most powerful action can be taken by the employees is to boycott the operation. This will lead the management more aware on the production.

b. General public

The environmental issue has been growing in the minds of most community (Medley, 1997). Nowadays, general public especially a community and consumers are more concerned about the pollution created by the company. They take a proactive action such as boycott the company that causes pollution.Social responsibility is one of the company responsibility to the public, however, most of them only concern about the profit and release the pollution burden to the public’s shoulder. The argument for ignoring this responsibility among other things is very costly for the company to reduce or to operate in clean environment as they need to invest in high technology to prevent the pollution. Therefore, as a consequence, company just ignores their responsibility to the public. If there is a company that shows their concern towards the environmental problem, it is just to portray the company’s good image. However, community are expecting the company to carry out their activity within the boundary of what is deemed accepted by them (Wilmshurst and Frost, 2000 and Said, 2001). In Islamic community, they expect the company to producehalal products in lawful manners. Therefore, it is unethical for the company to produce non-halal products and sell it to the Islamic community. Indeed, company should disclose all the necessary information regarding the product to reduce the community curiosity. Hence, when the company is successful meeting this “contract”, this leads to the congruence between the public and the company and company will be more acceptable as part of the society.

Community can be a significant force to the company as they are also the consumer of the company’s products. Therefore, company is ultimately depending on their purchasing behavior. Community can boycott products of a company which causes pollution or has been unethical in performing their operations.They can force the company to be more ethical and concern about the environment. Company should produce a product that benefited the community without causing any damage to the environment.

c. Lenders/Creditors

Most of the large company is depending on the financial lenders to run their operation. According to Basel Committee (1999), the primary agents for good corporate governance are board of directors and senior bank management. In modern economic system, lenders especially bankers or credit company play a major role to ensure that the company operation is running smoothly. Most of the time, before bankers or creditors extending financial facilities to the company, they will thoroughly examine the company’s financial reports. Therefore, this implicitly will be a monitoring process to the company and although after releasing the facilities to the company, some banks still request the company’s financial report. Hence, the board of directors will be more careful in managing the company. Banks will ensure any action taken by the company will not give any detrimental effect to them to the extent that they are not able to pay back the loans. As a consequence, board of directors’ action will be based on the interest of all parties and not just on their own interest. Corporategovernance can be improved by addressing a number of legal issues, enforceability of contracts, clarifying governance role, ensuring company is free from corruption and bribery, law and regulations aligning the interest of managers, employees and shareholders (Basel Committee, 1999).

All in all, it seems that the stakeholders group can be an enforcer to the company’s management. However, it is quite difficult to balance all the needs of the stakeholders as each group has different interests. Good corporate governance also cannot ensure all the interests will be met by the company. Therefore, it always happens when the dominant groups satisfy their interest regardless of other groups.Currently, there is a lot of code of ethics are being developed. Indeed, it is useless if the codes of ethics are surrounded by unethical people. This people are very creative and will try to find any room to do unethical action to meet their own interest. Nevertheless, these problems can be solved if everybody in the groups internalized Islamic values. Any action is deemed as worship to Allah. Therefore, any action will be in lawful or ethical manner to get the blessing of Allah and to achievefalah as ultimate objective.

4.3.2 Legal Requirement

The second external force is the legal requirement. Legal requirement is something needs to be followed by the company. This is the responsibility of the national regulatory agencies to ensure robust and effective monitoring and surveillance of company. Company as a legal personality is subject to law and rules which govern its existence and conduct (Koh, 2001). We have grouped legal requirement into three group consists of external control, accounting standard and acts. This requirement is important to ensure the company is properly managed and to protect the interest of stakeholders. Although it cannot ensure 100% free from malfeasance, at least to a certain extent, it can reduce the risk of wrongdoing.

a. External Control

Currently there are two boards as the main company’s external control which is external auditor and security commission (SC) for the listed company. The main objective of external auditor is to give a true and fair view of company financial reports. External auditor also will ensure there is no dubious accounting practice used by the company.External auditor can be assumed as a “Business Police” in monitoring the company activities especially from the financial view. However, the external auditors should adopt a stakeholder orientation in addition to current shareholder (Vinten, 2003) to meet the need of wider interested groups. Nevertheless, external auditor functions have been questioned and in hotly debated due to the collapses of few gigantic corporations such as Parmalat, Enron and WorldCom as a result of the failure in accounting practices. External auditor has loose their integrity and credibility as a body that should govern the company and not to help the company manipulate accounting practice. Most of the external auditor now has been a “business partner” rather than “business police”. They involve in auditing and consulting for the same company.

The new external control to monitor Islamic corporation is NationalShari’ah Advisory Council (NSAC). NSAC is established to guide the Islamic company not to violate theShari’ah law. NSAC will come out the guideline that needs to be followed by the Islamic companies.However, currently NSAC is not actively involved in company’s operation. They only focus in the policy development rather than closely monitoring the company’s operation. Therefore, we believe NSAC need to do random checking on the company that claim they have met the Islamic requirement to ensure there is no malpractice. In other words, the NSAC should act as the centralized SSB.

b. Accounting standard

Accounting standard is the important tool to regulate business activities. In fact, accounting standard is not just a regulation but pulse of the company. Without good accounting practice, company is unable to know their profit, to choose pricing strategy, to do strategic planning and other decision. Currently, most of the company is regulated by International Accounting Standard (IAS) and the standards at the operation country such as Malaysia Accounting Standard (Malaysia) and Financial Accounting Standard Board (US).

However, some of accounting standards have loopholes that give room for manipulation it. This has been proved by the Enron case. The sanctioning of off-balance sheet financing vehicles and Special purpose entity by the FASB and SEC provide an opportunity for Enron to hide most of its debt and mislead creditors and investors (Baker, 2002). Enron case showed to us what will happen to the weakness accounting standards. If the accounting standard is more tighten and concern about the stakeholder interest, Enron and other cases may not happen.

For Muslim corporation, the additional standards have been established to cater the unique feature of its operation and the standards are Accounting, Auditing and Governance Standards for Islamic Financial Institution (AAOIFI) and MASBi -1 for Malaysia. The objective of AAOIFI are to develop accounting and auditing that relevant to Islamic financial institution, to disseminate accounting and auditing thoughts relevant to Islamic financial institution and its applications, to prepare, promulgate and interpret accounting and auditing standards for Islamic financial institution and to review and amend accounting and auditing standards for Islamic Financial Institution (AAOIFI, 2002).On the other hand, MASBi -1 objectives are to provide a basis for the presentation, disclosure and guidelines of financial statements of Islamic financial institution. AAOIFI and MASBi -1 are created based onShari’ah guidelines.These additional standards are to promote the Islamic company operate in healthy business environment. At least it can reduce malfeasance of the company and enhance the quality of financial report.

c. Acts

The acts in Malaysia that directly relate to the company are Companies Act 1965, KLSE listing requirement, Financial Reporting Act 1997, Securities Industry Regulation 1999 and Income Tax Act 1967. All these acts are created to regulate the company in their financial reporting. Company is enforced to follow all the acts that applicable to them. By having these types of acts can help the government to promote the best practice of corporate governance. Therefore, its will reduce the case of corruption and accounting fraud.

In addition to the above acts, we suggest the government should imposezakah act to the Islamic organization.Zakah as one of the Islamic pillar is paid for the benefit of the needed and poor people. The principle underlying on this principle is to purify the company wealth. Although it sounds odd to make it legal regulation, at least it can nurture Islamic companies to be more responsible to the society.

All in all, legal requirement is very important to enforce the company asQur’an never reveals everything.Qur’an just give an abstract overview on what should be done, therefore, we need a clear standard to regulate a company. Nevertheless, the standard should not contradict with what has been revealed byQur’an .

4.3.3 The Institution of Hisba

Hisba is an important socially religious institution under the authority of the state that has been practiced by the Muslim society since the early period of Islam (Rahim, 1998) which Prophet Muhammad (pbuh) was the firstmuhtasib (active participle ofhisba ). The establishment of this institution is to “safeguard society from deviance, protect the faith, and ensure the welfare of the people in both religious and worldly manners according to the Law of Allah[6] ”. Apart from safeguarding the limits of Allah from being violated, protecting the honor of the people and ensuring public safety, hisbah is also responsible in monitoring the marketplace, craftsmanship and manufacturing concerns to make sure that the laws of Islam are upheld by these entities.

Based on the Divine code of approved social behavior, themuhtasib will enforce this code to enjoin what is right and forbid what is wrong. The responsibility borne by themuhtasib requires him to be a Muslim with a high degree of integrity, insight, reverence, and social status. He must be knowledgeable in Islamic jurisprudence, with a high degree of in-depth knowledge of the local customs and mores.

Hayashi as quoted in Rahim (1998) has listed out the duties of thishisba which is relating to the corporate and business affairs:

“a) to ensure a fair trading transaction in the market,

b) to check business frauds,

c) to audit illegal contracts,

d) to keep the market free from unhealthy competition

e) to prevent necessities from being hoarded” (p. 64).

In addition to that, the duties of themuhtasib permeate throughout every aspect of human, animal and environmental life. Therefore, the rights of each one of these categories should be protected according toShari’ah law, order, norms and socially accepted practices. If this is the case, it can reduce the level of environmental degradation as well as animal exploitation initiated by the greedy and individualistic business entities.

As time passes by, this institution ofhisba has been abandoned in our Muslim society. That is perhaps the reason why the level of business and ethical corruption keep mushrooming nowadays. Thus, if only this institution can be re-established, we believe that at least it can become an external force to ensure the right conduct and forbid unethical behavior in the wider social concern (Rahim, 1998).

The establishment in current times might be different from the Prophet’s time. As compared to the one single institution ofhisba during the Prophet’s time, in current situation, it can be more than one institution. All institutions that act as a public watchdog can be regarded as the institution ofhisba.

4.4 Shari’ah Law

Among all of the acts, laws and standards,Shari’ah law is the ultimate law that govern everything, not just the company but also included the legal authority that prepare accounting standards and acts and also to the stakeholders. According to Karim (1995),Shari’ah doctrine acts as the basic value and fundamental principles to guide the Muslim in all aspect of their life at all times.Shari’ah is a Divine law and should be the major reference for the company. Good governance practice can be achieved by adoptingShari’ah law because it is not just focusing to the worldly issues but goes beyond to the hereafter. However, according to Karim (1995),Shari’ah does not cover all the issues and detail for which an accounting policy would be required, therefore, the other accounting standards can be used provided they do not violate theShari’ah injunction.

4.5 Worldview - The Most Outer Layer

Islamic worldview represents a dual worldview; a belief in the world and the hereafter. Islamic encompasses all aspects of man’s existence. Therefore, according to Hassan (1998), all virtues performed by individual or group are consider religious. If individual considers their action as worship to Allah; corruption, accounting fraud and other problems will not happen. Individual will try to seek Allah pleasures. Hence, Islamic worldview can be considered as governance that imposes in human action.