Islamic Ethics -The Missing Link in Corporate Governance.

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THIS ASSIGNMENT IS A PARTIAL FULFILLMENT

FOR IB2003

CERTIFIED ISLAMIC FINANCE PROFESSIONAL (CIFP)

Title of Paper:

Islamic ethics: The missing link in

corporate governance.

Presented By:

FASHOLA OLAYINKA NURUDEEN

ID: 1100275

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CHARTERED ISLAMIC FINANCE PROFESIONAL (CIFP)

PART 2

IB2003 MANAGING ISLAMIC FINANCIAL INSTITUTIONS (JAN 2013)

PROJECT PAPER ASSIGNMENT (Marking Scheme)

Student Name: FASHOLA OLAYINKA NURUDEEN.

Matrix No: 1100275

Criteria Marks Allocation Marks Obtained

Ideas/ Analysis 20 Marks

Research/ Support 10 marks

Organization & Coherence 10 marks

Style 5 marks

Mechanics 5 marks

Total Marks 50 marks

Over all comments:

Examiner:

Date:

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Abstract.

Defining ethics in a business environment and relating it to corporate governance is a little

different than defining personal morals and values. A business is an entity of many parts. Within

that entity, there are both written and unwritten principles that drive actions, ideas, and decisions.

The individuals within an organization determine whether or not those principles manifest

substantively; that is, in good behavior and positive choices.

Ethical business behavior may be defined by law, but it also can be defined by business

leadership. Generally speaking an action or choice can be considered ethically correct if it's

honest, fair, supports a beneficial outcome for both (or all) parties, and generally enables the

overall corporate image and vision.

This implies that what is right in company A, might be wrong in company B given the same

situation and conditions, but in the Islam and the management of Islamic business what is right is

defined by ALLAH and exemplified by the Prophet of Islam, thus in the management of Islamic

business outfit the ethics as defined in the Quran and the sayings of the Prophet are the standards

that should be followed and implemented by the Muslims, thus given the same situation and

conditions what is right in company A will be right in company B if both companies are

managed with the guiding principles of Islam ethical values.

This write up seeks to highlight the fact that the missing link in corporate governance is the lack

of the infusion of Islamic ethics, thus the reasons for big corporate failures in spite of the

implementation of corporate governance.

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1.0 Introduction.

The religion of Islam is by no means just a religion but a way of life, as it encompasses all

aspects of human endeavourer, thus the adherents of the faith are expected to carry out all their

activities be it spiritual, social, economic or otherwise in the light of the dedicates of the faith as

stipulated in the Quran and practiced by the Prophet of Islam – Muhammed (SAW). In the recent

past the Muslims are becoming more conscious of the fact that there financial transactions should

be in the dictates of the Islamic faith, prior to now there were no Islamic financial institution in

the world not until when the first private interest-free bank, the Dubai Islamic Bank, was also set

up in 1975 by a group of Muslim businessmen from several countries. Two more private banks

were founded in 1977 under the name of Faisal Islamic Bank in Egypt and the Sudan. In the

same year the Kuwaiti government set up the Kuwait Finance House1. Since then several other

Islamic financial institutions have been established, the industry worth trillion dollars.

With the growth and spread of Islamic Finance from the Muslim dominated countries of the

Middle East to the Europe where you have few Muslim the concept of Islamic Finance as grown

beyond the boundaries of faith it now a world phenomenon, people are embarrassing not just for

faith but for the core principles with which the Islamic financial transaction is built on which is

fairness, transparency, equity and for the good of all.

Just as every other aspect of the Islamic faith like Solat, Fasting, Hajj among others there is a

universal way of performing this acts of worship irrespective of where you come from or where

you perform these acts its uniform all other the world but little can be said of financial

transactions as we see it today, it’s too diverse and there is need for an effective and common

position and standard on the way the financial transactions – products and service are conduct to

1 AbdulGafoor(1995), Interest Free Commercial Banking. Publisher: APPTEC Publications (May 1995) Language:

English; ISBN-10: 9080235415.

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ensure its universally acceptance. In order to active this purpose all Islamic financial institution

must be governed by the same corporate principles since the sources of all the financial

transactions are predicated on the verses of the Quran or sayings of the Prophet of Islam which is

universally accepted thus the need for effective corporate governance that is ethically driven

which is a process to ensure that the business and management of corporate entities are carried

out in the best possible manner to safeguard and promote the interests of all stakeholders. In

today’s financial world one might finds it difficult to differentiate between Islamic financial

institutions from the conventional finance aside from the name but in terms of operation and

product and services the similarities are more and it’s very difficult to differentiate at times.

Thus the importance of an ethically structured Islamic approach to corporate governance cannot

be over emphasized. This write up is aimed at discussing ethics as the missing link in the

implementation of corporate governance and how the Islamic approach which is founded on

ethical values should be implemented by Islamic financial institution so that what befell the

conventional companies will be avoided.

2.0 Definition of Ethics

The word ethics is derived from the Greek word ethos, which means character or custom2. It

represents a wide meaning of character, behavior or code of conducts. In Islam, the word ethic is

synonym with the term adab and khuluq3.

2.1 Ethics in the Western World.

Ethics in the western world is not based on any religious values, its base on what the individual

or the community feels it’s right, thus the definition of what is right and wrong is epitomizes in

the individual and the community’s view. Every day, individuals face ethical issues at work, and

rarely know how to deal with them. A review of articles published in the Wall StreetJournal

2 Solomon, Robert. C. (1984). Morality and the Good Life. New York: McGraw-Hill.

3 Siddiqui, Ataullah. (1997). Ethics in Islam: Key Concepts and Contemporary Challenges. Journal of Moral

Education, 26 (4), 423- 431.

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during only one week in 1991 uncovered a whole array of issues being faced by employees:

stealing, lying, fraud and deceit, etc4

Surveys both in the USA and internationally reveal rampant unethical behavior in businesses.

For instance, a recent survey of 2,000 major US corporations revealed that the following ethical

problems (arranged in order of importance) concerned managers:

1. Drug and alcohol abuse

2. Employee theft

3. Conflicts of interest

4. Quality control issues,

5. discrimination in hiring and promotion,

6. Misuse of proprietary information,

7. Abuse of company expense accounts,

8. Plant closings and lay-offs,

9. Misuse of company assets, and

10. Environmental pollution5

Internationally, the ethical values of businesses are also deficient. In a survey of 300 companies

across the world, over 85% of senior executives indicated that the following issues were among

their top ethical concerns: employee conflicts of interest, inappropriate gifts, sexual harassment,

and unauthorized payments6.

The problem of ethical standards is a great issue in the west because there is no common

consensus on what is right and what is wrong and that is why in these societies’ people can do

anything and justify it.

4 Cherrington, J. O. and Cherrington, D. J. 1993. “A Menu of Moral Issues: One Week in the Life of the Wall Street

Journal.” Journal of Business Ethics, 11, pp. 255-265. 5 America’s Most Pressing Ethical Problems. 1990. Washington, DC: The Ethics Resource Center, p. 1. 6 Baumann, Mary. 1987. “Ethics in Business.” USA Today. She was citing data from the Conference Board.

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2.2 Ethics in Islam.

Islam places the highest emphasis on ethical values in all aspects of human life. In slam, ethics

governs all aspects of life. Ethical norms and moral codes discernable from the verses of the Holy

Qur’an and the teachings of the Prophet (SAW) are numerous, far reaching and comprehensive.

Islamic teachings strongly stress the observance of ethical and moral code in human behaviour.

Moral principles and codes of ethics are repeatedly stressed throughout the Holy Qur’an. Besides,

there are numerous teachings of the Prophet (SAW) which cover the area of moral and ethical

values and principles. Says the Holy Qur’an:

“You are the best nation that has been raised up for mankind; You enjoin right conduct,

forbid evil and believe in Allah.7”

The Prophet (SAW) also says:

“I have been sent for the purpose of perfecting good morals.8”

This goes without saying that there is a general consensus among human beings about certain

fundamental ethical values. However, the Islamic ethical system substantially differs from the

so-called secular or western ethical systems as well as from the moral code advocated by other

religions and societies. In the Islamic scheme of things, adherence to moral code and ethical

behaviour is a part of Iman (faith) itself. According to the Islamic teachings, Muslims have to

jealously guard their behaviour, deeds, words, thoughts, feelings and intentions. Islam asks its

believers to observe certain norms and moral codes in their family affairs; in dealings with

relatives, with neighbours and friends; in their business transactions; in their social affairs, nay in

all spheres of private and public life.

Islam highlights some basic ethical standards which every financial/ business transaction must

adhere to these are but not limited to:

1. Prohibition of Riba: Allah says: “O you who have attained faith! Remain conscious of

God, and give up all outstanding gains from Usury, if you are (truly) believers9”

7 Quran 3 verse 110

8 Collection of Hadith by Ibn Hambal, (No: 8595)

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2. Prohibition of Maysir (Gambling): Allah says: “O you who believe! Intoxicants and

gambling, (dedication of) stones and (divination by) arrows, are an abomination of Satans

handwork: Abstain from such (abomination), that you may prosper. Satans plan is (but)

to excite enmity and hatred between you with intoxicants and gambling, and hinder you

from the remembrance of Allah, and from prayer: Will you not then abstain?10”

3. Prohibition of Gharar (Uncertainties): Abu Hurayra reported that the Prophet (SAW)

prohibited the pebble sale and the gharar sale11.

4. Good Character and Behavior (Islam insists on obligation to observe good character

and behavior as the Prophet himself is sent to us for purpose of perfecting the best of

character.): Abd Allah ibn 'Amr said, the Prophet used to say: "The best of you are those

who have the most excellent morals12” Hadith narrated by Abu Hurairah, the Messenger

of Allah said: "The most perfect of the believers in faith is the best of them in moral

excellence, and the best of you are the kindest of you to their wives13". Muadh Ibn Jabal

reported that the Prophet said: Fear Allah wheresoever you may be, follow up an evil

deed by a good one which will wipe (the former) out and behave good-naturedly to

people14”

5. Generosity in Doing Business (Generosity in doing business refers to willingness and

kindness in giving away either rights or property or times for the benefit of others):

Uthman bin Affan reported that the Prophet said: “Allah will admit to the Paradise a man

who is lenient as a seller and a buyer.15” Jabir bin Abdullah reported that Allah‟s

9 Al Quran, 2: 278, 2: 275, 3: 140, 4: 161 and 30: 39.

10 Al Quran, 5: 90-91

11 Hadith narrated by Muslim, Ahmad, 'Abu Dawud, Al Tirmidhi, Al Nasa'i, Al Darami and Ibn Majah

12 Reported by: Bukhari, 61: 23

13 Reported by: Al Tirmidzi, 10: 11

14 Reported by: Al Nawawi, 2001: 35

15 Reported by: Ibn Majah, 3: 2202

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Messenger said: “May Allah have mercy on the bondsman who is kind when he sells,

kind when he buys and lenient when he demands (his debt)16”

On the contrary, all that is defined and recognized by Islam as an ethical standard which should

not be engaged in is what thrives in the west and in fact it’s the best rock of their financial

transaction for example Riba is a core principle of banking in the west, the insurance sector is

riddled with uncertainty and gambling, while good charter and behavior is defined by individual

as opposed divinely defined as it is in Islam. Generosity in business is only done under the guise

of corporate social responsibility, that is, given back to the society while in Islam its seen as a

duty which should be performed in order to purifies ones wealth and earn the pleasure of Allah.

3.0 Corporate Governance.

3.1 Definition.

The term “corporate governance” has gained prominence only during the last two decades.17 This

terminology clearly had its origin from a Greek word “kyberman” which means to steer, guide or

govern. This passed on from Greek to Latin word as gubernare and the old French “governer”,

but this word has been defined in different ways by different organizations or committees,

according to their own ideological concerns. The OECD has defined it as the “set of relationships

between a company’s management, its board, its stakeholders and other stakeholders18”. The

World Bank President has gone a step further by explaining that corporate governance needs to

be “fairness, transparency and accountability19”.

In the practical sense, corporate governance involves the nuts and bolts of how corporations

should fulfill their responsibilities to their shareholders and other stakeholders. Corporate

governance is the mechanism by which agency problems of corporation stakeholders, including

16 Reported by: Ibn Majah, 3: 2202

17 Zingales L. Corporate governance. The new Palgrave dictionary of economic and the law; 1997. p. 1.

18 OECD. OECD Principles of Corporate Governance; 2004.

19 Wolfensohn. Financial Times, 21 June (1999). Cited by the Encyclopedias of Corporate Governance in the Article

on “What is Corporate Governance”. (www.encycogov.com); 11 July 2001. p. 1.

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the shareholders, creditors, management, employees, consumers and the public at large are

framed and sought to be resolved. Transparency, accountability and adequate disclosure are three

essential ingredients in corporate governance”. Hence, therefore, it can be concluded here that

corporate governance is a set of mechanism that helps in confirming, with fair and just dealing to

all the stakeholders and to strengthening transparency and accounting20.

3.1 Principles of Corporate Governance.

The OECD Principles of corporate governance originally adopted by the 30 member countries of

the OECD in 1999 have became a reference tool for policy makers, corporations, institutional

and regulatory frameworks and others. It also provides practical guidance and suggestions for

stock exchange, investors, corporations and other profound organizations of the world other than

OECD member countries. The following are the main areas of the OECD principles and its

annotation:

Principle 1: Ensuring the basis for an effective corporate governance framework.

Annotation: The corporate governance framework should promote transparent and efficient

markets, be consistent with the rule of law and clearly articulate the division of responsibilities

among different supervisory, regulatory and enforcement authorities.

Principle 2: The right of shareholders and key ownership functions.

Annotation: The corporate governance framework should protect and facilitate the exercise of

shareholders’ rights.

Principle 3: The equitable treatment of shareholders.

Annotation: The corporate governance framework should ensure the equitable treatment of all

shareholders, including minority and foreign shareholders. All shareholders should have the

opportunities to obtain effective redress for violation of their rights.

Principle 4: The role of stakeholders in corporate governance.

20 Hakim Sam R. Islamic banking, challenges and corporate governance, LARIBA; 2002.

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Annotation: The corporate governance framework should recognize the rights of stakeholders

established by law or through mutual agreements and encourage active co-operation between

corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound

enterprises.

Principle 5: Disclosure and transparency.

Annotation: The corporate governance framework should ensure that timely and accurate

disclosure is made on all material matters regarding the corporation, including the financial

situation, performance, ownership, and governance of the company.

Principle 6: The responsibilities of the board.

Annotation: The corporate governance framework should ensure the strategic guidance of the

company, the effective monitoring of management by the board, and board’s accountability to

the company and the shareholders.21

3.2 Issues with Corporate Governance in the west.

The way and matter the term corporate governance is being brandish in journals and different

academic materials in the past few decades one will want to come to a conclusion that we have

come to the end of business failures, some see it as a perfect strategy to ensure that companies

are run in the most effective and efficient ways. Also the most prestigious schools where MBA

degrees are being awarded corporate governance is one of the most talked about courses. The

thinking is that we have come to the end of business failures as a result of negligence and

compliance to codes of conduct and ethics, however, the number of failed companies keeps

increasing as it were from WorldCom, Anderson, Merrill Lynch, Enron, Martha Stewart, Global

Crossing, Qwest Communications, Tyco International, Adelphia Communications, Computer

Associates, Parmalat, Putnam, Boeing, Rite Aid, Xerox ... Falling stock markets, corporate

failures, dubious accounting practices, abuses of corporate power, criminal investigations

indicate that the entire economic system upon which investment returns have depended is

showing signs of stress that have undermined investor’s confidence.

21 OECD. OECD Principles of Corporate Governance; 2004.

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Some corporations have grown dramatically in a relatively short time through acquisitions

funded by inflated share prices and promises of even brighter futures (many of these corporations

have now failed). In others, it seems as if the checks and balances that should protect shareholder

interests were pushed to one side, driven by a perception of the need to move fast in the pursuit

of the bottom line. While some failures were the result of fraudulent accounting and other illegal

practices, many of the same companies exhibited actual corporate governance risks such as

conflicts of interest, inexperienced directors, overly lucrative compensation, or unequal share

voting rights22.In the face of such scandals and malpractices, there has been a renewed emphasis

on corporate governance.

The major problem and issues with the current set of corporate governance principles is that it

lack ethical value, that is, it’s not structured ethically and the people who are meant to implement

the rules, law and policies are lacking in ethical values, in place where these so called values are

in place its based on human logic and reasons as oppose to a divinely inspired values which is

the hull mark of Islamic principles and teachings, thus any law or principles that is not in line

with the guidelines of the creator will fail though it might seem like its successful but in the long

run it will be a failure.

3.3 The Islamic approach to corporate governance.

Islamic corporate governance model in Islam has its own unique features and presents distinctive

characteristics in comparison with the western concept of corporate governance as exemplified in

the OECD Principles of corporate governance. The Islamic approach combines the element of

Tawhid, Shura, Shari’ah rules and maintains the private goal without ignoring the duty of social

welfare. Though from Islamic perspective corporate governance does not differ much with the

conventional definition as it refers to a system by which companies are directed and controlled

with a purpose to meet the corporation’s objective by protecting all the stakeholders’ interest and

right. Uniquely, in the context of corporate governance within the Islamic paradigm it presents

distinct characteristics and features in comparison with the conventional system as it refers as a

22 Anderson G. and M. Orsagh (2004), “The Corporate Governance Risk”, Electric Perspectives, 29(1), pp 68.

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special case of a broader decision-making theory that uses the premise of Islamic socio-scientific

epistemology which is premised on the divine oneness of God23.

4.0 Islamic ethics – the missing link.

There are no doubts that the world economy is in shambles, from the most advanced continent –

Europe to the most developed country and the acclaimed super power of the world – USA, the

story is the same, the world economy is nose diving and there are no imminent solutions in the

horizon. The economic down turn of the 2008-2009 is still very fresh in our memories, the heart

of the problem which is well known to everyone is due to greed and non-ethical behaviors of

some few CEO’s that snow ball to the financial/ economic crisis that griped the United States

and had a ripple effect on the entire world economy.

At the hearth of capitalism which is the philosophy upon which the world economy is being

managed is immoral and unethical where CEOs get ever-larger pay rises and bonuses while the

asset values of their companies slump. Pension rules are unilaterally changed without consulting

those who will lose out, and insurance companies and financial institutions that are supposed to

offer protection try to escape from their obligations through legal loopholes embedded in the

small print of their contracts which most offent than not is not visible to the customer.

Although there has been a lot of talks are regards ethics in the management of the business

outlook, most MBA degree teaches ethics in the management of business, but alas most of the

CEO of collapsed companies do have MBA degrees from ivy league schools but have failed to

use what they learnt in the management of their companies but have succeeded in running it

aground. The ethics taught in these Ivy League schools are essentially socially derived, relative

and secularist rather than being based on religious moral authority. It is often difficult enough to

ensure that national laws are enforced in business, but business ethics, which promotes codes of

good conduct over and above the legal minimum, lacks any enforcement mechanism, and instead

relies on individual moral conscience. In the absence of a higher moral authority and religious

23 Choudury, M,A. and Hoque, M.Z. 2004, An Advanced Exposition of Islamic Economics and Finance, New

York, Edward Mellen Press.

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guidance, personal conscience cannot determine social standards but merely results in

individuals determining their own rules, moral uncertainty and even chaos.

The Muslims are in a vantage position because the religion of Islam teaches about guidance of

ethics in business and financial dealings; belief in Allah provides not merely the motivation, but

the imperative for adhering to shariah law, which is to be applied in all spheres of life including

financial and business dealings. For Muslims moral conduct in their daily lives is part of their

devotion. Revealed teaching provides moral certainty, and a set of standards to which the entire

community of believers can adhere.

Thus the practice of financial dealing in Islam cannot and should not be devoid of ethics as this is

the edifice of the entire Islamic way of life rests on absolute ethical values. One cannot be a true

Muslim unless one adheres to these values. Justice and equity, honesty, integrity, veracity,

leniency, compassion, tolerance, selflessness, benevolence, cooperation, mutual consideration,

sacrifice and harmlessness, are the guiding values in all walks of life, business being no

exception. Muslims are ordered truly to observe these values in whatever position they are:

whether employer or employee, landlord or peasant, trader or customer, ruler or ruled, officer or

subordinate, transporter or passenger, depositor or fiduciary, relatives or strangers, neighbours or

fellow-workers, nobody is allowed to disregard these values at any time. To recognize these

values as binding is a concomitant of true faith; to neglect them in practical life means a serious

lapse these values are laid down and emphasized in the Qur'an and reinforced in the sayings of

the Prophet Muhammad (SAW)24. Thus the implementation of corporate governance without the

face of Islamic ethics will be a total failure as we are witnessing today.

24 S. M. Hasanuzzaman (2003). Preface of Islam and Business Ethics, published by the Institute of Islamic Banking

and Insurance, London, UK 2003

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5.0 References.

AbdulGafoor(1995), Interest Free Commercial Banking. Publisher: APPTEC Publications (May

1995) Language: English; ISBN-10: 9080235415.

Anderson G. and M. Orsagh (2004), “The Corporate Governance Risk”, Electric Perspectives,

29(1), pp 68.

Baumann, Mary. 1987. “Ethics in Business.” USA Today. She was citing data from the

Conference Board.

Cherrington, J. O. and Cherrington, D. J. 1993. “A Menu of Moral Issues: One Week in the Life

of the Wall Street Journal.” Journal of Business Ethics, 11, pp. 255-265.

Choudury, M,A. and Hoque, M.Z. 2004, An Advanced Exposition of Islamic Economics and

Finance, New York, Edward Mellen Press.

Hakim Sam R. Islamic banking, challenges and corporate governance, LARIBA; 2002.

OECD. OECD Principles of Corporate Governance; 2004.

S. M. Hasanuzzaman (2003). Preface of Islam and Business Ethics, published by the Institute of

Islamic Banking and Insurance, London, UK 2003

Siddiqui, Ataullah. (1997). Ethics in Islam: Key Concepts and Contemporary Challenges.

Journal of Moral Education, 26 (4), 423- 431.

Solomon, Robert. C. (1984). Morality and the Good Life. New York: McGraw-Hill.

Wolfensohn. Financial Times, 21 June (1999). Cited by the Encyclopedias of Corporate

Governance in the Article on “What is Corporate Governance”. (www.encycogov.com); 11 July

2001. p. 1.

Zingales L. Corporate governance. The new Palgrave dictionary of economic and the law; 1997.

p. 1.