Models of Corporate Governance

The basis of the model of corporate governance can be identified in their approach to the three dimensions of decision making which are considered as the essence of corporate governance. The decision making is centered round the three basic questions; (a) by whom the decisions are to be made, (b) for whom the decisions are attempted to be made and (c) what are the resources that back up the decision making approaches. The ultimate aim of analyzing the decision making process through these questions is to underpin the agency to whom the accountability is due to be directed[1]

This part of the study deals aims to contrast the Islamic corporate governance with the Western approach which is exhibited by at least two models which this paper considers.

Governance Framework in Western Perspective

The European system of corporate governance encompasses a socially responsive corporation where the shareholders and others are encouraged to exert influence over policies that are being adopted to the extent that they are not in conformity with a socially responsive attitude. Similarly the board members and managers are not discouraged either to follow their view points so that the decisions make the firm a socially responsive one[2]. However such a direct influence over the functioning of the firm is not provided for in all the market systems. For instance in Germany and other countries like Austria and Switzerland the governance is administered by a two tier board consisting of a ‘supervisory board’ and an ‘executive board’.

The executive board represents the top management and the members of the supervisory board is composed of outside professionals and in some cases employee representatives just to oversee and discipline the executive board. Even in the case of ‘managed corporation’ model widely prevalent in the United States directors and managers found it worth to take the advise of the institutional shareholders in the conduct of the business of the firm. When this relationship is further expanded it leads to the formation of a ‘stakeholder model’ of corporate governance which protects the interest of all stakeholders.[3]

Managed Corporation Model

The model of managed corporation answers the question of ‘by whom’. This model is underlined by large public companies with a dispersed shareholding[4]. Under this model managers occupy the central role with the authority to strategy formulation and setting the policies of the company. While the Board takes the responsible of hiring the managers the managers lead the directors and shareholders.

The Board is also given the responsibility to monitor the performance of the mangers appointed and remove them in case of unsatisfactory performance. The shareholders’ role is limited to replace the Board in case of poor performance of the company. Thus the scope of corporate governance under this model is limited to the extent of appointing the right managers and controlling their performance.

Socially Responsive Corporation Model

This model takes the position to answer the question ‘for whom’. This model presupposes the interest of the shareholders as the foremost principle of corporate governance as laid down by the OECD ‘Principles of Corporate Governance’ [5] Thus the concept of shareholder value has been made the yardstick against which the performance of the management need to be measured.

This is the practice in the United States, the UK and several other Anglo-Saxon countries and has also been recognised as a matter of prominence in Europe and Japan too. Under this model the institutions view the firms eligible for potential investment in their securities to have a clear market directive to enhance the returns on the existing capital. [6]

Accounting and Corporate Governance

The process of identifying, measuring and communicating information for facilitating the user to make meaningful decision is provided by accounting. According to Baydoun and Willet (2000) [7] accounting disclosures in ‘managed corporation model’ is often limited to the extent the individuals that control the resources needs the disclosure. However the fact remains that the corporate governance issues can be addressed and explained by detailed financial statements since these issues are normally concentrated on the agencies having a wider financial stake in the entity. This explains the terms with what resources and to whom the accountability is directed.

Islamic Perspective of Corporate Governance

The important principles of good corporate governance and the codes of best practice developed during the last decade, imply that directing the companies and controlling them to function according to defined moral standards which are acceptable to the community in general[8]. The principles do not just recognize achieving the economic efficiency or earning maximum profitability as the best practice.

According to Mervyn K Lewis (2005)[9] there are two aspects which particularly shape the nature of Islamic corporate governance. The first one is concerned with the Shariah which claims sovereignty over all the aspects of life of any human being. It is so extensive it covers ethical and social issues; and also it talks about civil and criminal jurisdiction.

Shariah lays down the principle that every believer of Islam must conform to the basic principles of Islamic Law. Each one of them is expected to observe the ethical standards derived from economic principles irrespective of the status or social position. “These ethical principles define what is true fair and just, the nature of corporate responsibilities, the priorities to society, along with some specific governance standards” (Mervyn K. Lewis, 2005).

Secondly, Shariah has also provided some specific Islamic economic and financial principles along with the business ethical standards, which have a larger influence upon the corporate practices and principles. “Included here are the institution of zak¥h (the alms tax), the ban on rib¥ (usury) and the prohibition on speculation, calling for the development of an economic system based on profit and loss sharing” (Mervyn K. Lewis, 2005).

Dimensions of Decision Making and Islamic Perspective of Corporate Governance

The three dimensions of decision making with respect to corporate governance under Islamic perspective is answered in the following way:

By Whom

According to Mervyn K. Lewis (2005) the question of by whom the decisions are to be made the Holy Quran is providing a correct response by promoting mutual consultations and once decision is taken then there has to be a firm belief that it will do good to everyone concerned. He further adds that when the basic principles of Shurd are followed it requires the leaders to encourage others to take part in the process of decision making.

Thus consultation is made the key word by Shariah and this implies that

“An employee would be expected to contribute his or her knowledge to the formulation and implementation of the organizational vision, and consultative procedures should be applied to all those affected, i.e. shareholders, suppliers, customers, workers and the community” [10]

For Whom

Under Islamic perspective of decision making process there is the clear answer to the question as to for whom the decisions are attempted to be made. The answer is that the ultimate end of any business and economic activity that involve the human beings are to be considered as being done to the grace of Allah and the ways and means employed to accomplish the activities should never deviate from the law of Islam as quoted by Shariah in any way (Mervyn K. Lewis, 2005).

With Whom and to Whom

Mervyn K. Lewis (2005) points out that the third requirement for ensuring corporate governance principles in an Islamic perspective involves the process by which an effective religious supervision is undertaken.

The objective of this supervision is to ensure that the operations, contracts, and procedures of the enterprise are in conformity with the Islamic code. Algaoud and Lewis (1999)[11] observe that the process covering the religious supervision is explicitly illustrated in the case of Islamic Financial Institutions.

In addition the religious auditors provide a comprehensive report on the adherence of the Islamic principles across the full spectrum of the business activities. The religious audit helps to improve the functioning of any corporation towards achieving the Islamic principles by undertaking the following distinct functions:

(1)   the religious auditor advises the Board and the top management about the acceptability of the transactions and the contracts proposed to be entered by the firm and also on the development of new products

(2)   the second function of the religious auditor is to make a comprehensive report to the shareholders as to the compliance by the management the Islamic principles in the running of the organization and

(3)   the audit of the creation of Zakah fund to ensure that the fund is created after a proper assessment of the amount to be contributed and the administration and distribution of the funds are carried out as per the Islamic principles (Mervyn K. Lewis, 2005)

Points of Distinction

Hanifa and Hudaib (2003) [12] identify the following difficulties that the Islamic perspective of corporate governance face while adopting the best corporate governance practices.

(1)   Under the Western approach to the corporate governance the business morality is primarily based on ‘secular humanist’ values governing the ethical foundations of the business while the Islamic perspective of corporate governance follows the principles laid down by shariah as the guiding force

(2)   The basic beliefs and values in the Western corporate culture predominantly considers the self interest and even with some modifications there may not be the case that the larger interest of the society will be considered. This is totally against the Islamic principles

(3)   Thirdly the Western model of corporate governance is based on agency theory and there is no place for stewardship theory.[13]The basic difference lies in the actors who are agents with a self interested opportunistic approach who can not be motivated to be stewards to act in the best interest of the principals. In the case of Islamic perspective of corporate governance there is no place for self interest of the agents,

[1] Mervyn K. Lewis (2005) ‘Islamic Corporate Governance’ International Association for Islamic Economic

Review of Islamic Economics Vol. 9 No 1 pp 5 – 29
[2] Mervyn K. Lewis (2005) ‘Islamic Corporate Governance’ International Association for Islamic Economic

Review of Islamic Economics Vol. 9 No 1 pp 5 – 29
[3] Lannoo, K. (1995). Corporate Governance in Europe. CEPS Working Party Report No 12. Brussels: Centre for European Policy Studies.
[4]Pound, J. (1995). ÒThe Promise of the Governed CorporationÓ, Harvard Business Review, March-April, reprinted in Corporate Governance (2000), Harvard: Harvard Business School Press.
[5] OECD (1999). OECD Principles of Corporate Governance. Paris: OECD.
[6] Lewis, M.K. (2003b). ÒGlobalisation and Corporate GovernanceÓ in M. Shanahan and G. Treuren (eds.), Globalisation: Australian Regional Perspectives. Adelaide:Wakefield Press.
[7] Baydoun, N. and Willett, R. (2000). ÒIslamic Corporate ReportsÓ, ABACUS, 36(1), pp. 71-89.
[8] Gooden, S. (2001). ÒParticipation of Stakeholders in the Corporate Governance of Islamic Financial InstitutionsÓ, New Horizon, 114, November, pp.12-15.
[9]Mervyn K. Lewis (2005) ‘Islamic Corporate Governance’ International Association for Islamic Economic

Review of Islamic Economics Vol. 9 No 1 pp 5 – 29
[10] Baydoun, N.; Mamman, A. and Mohmaud, A. (1999). ÒThe Religious Context of Management Practices: The Case of the Islamic ReligionÓ, Accounting, Commerce &Finance: The Islamic Perspective Journal, 3(1 & 2), pp. 52-79.
[11] Algaoud, L. M. and Lewis, M. K. (1999). ÒCorporate Governance in Islamic Banking: The Case of BahrainÓ, International Journal of Business Studies, 7(1),pp.56-86.
[12] Haniffa, R. and Hudaib, M. A. (2002). ÒA Theoretical Framework for the Development of the Islamic Perspective of AccountingÓ, Accounting, Commerce & Finance: The Islamic Perspective Journal, 6 (1&2), pp. 1-74.
[13] Davis, J. H.; Schoorman, F. D. and Donaldson, L. (1997). ÒTowards a Stewardship Theory of ManagementÓ, Academy of Management Review, 22(1), pp. 20-47.