1

Abdur Rashid Mirza

University of Lahore

School of Accountancy & Finance Subject Name: Corporate Governance Transparency and Risk

Management Lecture no.04

Operation of CG and CSR in the Institutions Offering Islamic Financial

Services

Definition of OECD

Organization for Economic Cooperation and

Development

Established in 1961, Head Quarters Paris France.

Corporate Governance is the system by which business

corporations are directed and controlled. The corporate

governance specifies the distribution of rights and

responsibilities among different participants in the corporation,

such as the board, managers, shareholders and other

stakeholders, and spell out the rules and procedures for making

decisions on corporate affairs. By doing this, it also provides

the structures through which the company objectives

are set, and the means of attaining those objectives and

monitoring performance. (OECD, 2004)

Principles of Corporate Governance

The concept was properly articulated only in

the early 1990s with the Cadbury Report

(1992). Subsequent reports continued to

improve the Cadbury report, eventually taking

shape as the OECD Principles of Corporate

Governance 2004. These Principles were so

sound that they were straightaway adopted by

the EU, World Bank, USA and other OECD

and non-OECD countries (Morck, 2005).

It provides guidance for stock exchanges, investors, corporations, and other parties that have a role in the process of developing good corporate governance.

OECD Principals

Ensuring the basis for an effective corporate governance framework:

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.

OECD Principles 1

(ii) The rights of shareholders and key ownership functions: The corporate governance framework should protect and facilitate the exercise of shareholders’ rights.

(iii) The equitable treatment of shareholders: The

corporate governance framework should ensure the equitable treatment of all shareholders, including minority (equity holder of a firm who does not have voting right) and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.

OECD Principles 2-3

(iv) The role of stakeholders in corporate governance: The corporate governance framework should recognize the rights of stakeholders established by law or through mutual agreements and encourage active cooperation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.

OECD Principles 4

(v) Disclosure and transparency: 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.

Principles 5

(vi) The responsibilities of the board: The corporate governance framework should ensure the strategic guidance of the company, effective monitoring of management by the board, and the board’s accountability to the company and the shareholders.

Principles 6

The above six OECD principles of corporate governance are based on the following three basic principles:

(i) The mechanism of decision-making and its transparency

(ii) Accountability in roles and responsibilities

(iii) Adequate disclosure of results

Basis of Principles

While as a term ‘corporate governance’ is relatively new, what it names is not unfamiliar in Islam.

Islam stresses the practice of justice and equality, truthfulness and transparency, and protection of minorities, accountability and adequate disclosure, just as it prohibits all forms of exploitation, in all walks of life, including business dealings: in Islamic law. The three underlying principles (transparency, accountability and adequate disclosure).

Corporate Governance and Islam

Islam strongly advocates all forms of positive governance. Rules of corporate governance derive from the underlying principle of assuring the economic well-being of the whole community on the basis of universal brotherhood, justice, mutual accountability, truthfulness and transparency, Islamic values have always advocated good corporate governance. “Islam always encouraged trade and commerce as long as it is conducted within the framework of Qur’an, and the word of Allah as revealed to His Prophet Muhammad” (Lewis, 2005).

Islam and Corporate Governance

Besides the implementation framework, Islam is very clear on the principles of corporate governance:

And consult them on affairs [of moment]. Then, when you have taken a decision, put your trust in Allah. (Al [Imran, 3:159)

Abu Hamzah Anas ibn Malik (RA), who was the servant of God’s Messenger (PBUH) reported that he said: None of you truly believes [in God and in His religion] until he loves for his brother what he loves for himself. (Reported in al-Bukhari and Muslim).

Islam and Corporate Governance Decision-making

Disclosure and transparency

The Qur’an, in verses 282 and 283 of Surah al-Baqarah, makes an explicit and detailed requirement in respect of good practice:

O you who believe! When you contract a debt for a fixed period, write it down. Let a scribe write it down in justice between you...

You should not become weary to write your contract down,

whether large or small, for its fixed term, that is more just with God, more solid as evidence, and more convenient to prevent doubts among yourselves… Take witnesses whenever you enter into a commercial contract.

Disclosure and transparency

O ye who believe! Fulfill [all] obligations.

(al-Ma’idah, 5:1)

The Qur’an requires the honest fulfillment of all contracts (5:1) irrespective of whether these are written or oral, explicit or implicit; it prohibits the betrayal of trusts

Accountability

The rules for corporate governance therefore do not apply only to the Board of Directors (BOD), and senior management but also to every person connected to the organization.

By contrast, OECD rules make senior management accountable to the BOD and the BOD to shareholders. Islam makes the responsible people accountable not only to stakeholders, but also to God – the Ultimate Authority. Again, the OECD rules make persons accountable for all written and defined obligations; Islam requires accountability of oral promises too.

Islam and OECD Principles

Comparing Islamic Corporate Governance and the OECD Principles

We can now set out the comparison between corporate governance in Islam and OECD Principles in the form of a table, as follows:

Basis of Difference OECD Principles Islamic Principles

Authority

OECD: Directors have authority for decision making.

They follow the principles of OECD.

Islam: Sole authority belongs to Almighty God; all decisions are to be made by keeping in view Shari[ah.

Comparing Islamic Corporate Governance and the OECD Principles

Decision-making OECD

Decision-making rests with the CEO and senior management.

Voting is required just for the selection of a BOD and few other decisions.

Islam

Consultation and consensus are required for every decision from concerned stakeholders.

Goal OECD

Maximization of profits and shareholders’ value. Islam

Commitment to equity, fair distribution of wealth, and consideration for

the whole community.

Comparing Islamic Corporate Governance and the OECD Principles

Accountability OECD

Senior management accountable to shareholders.

Islam

Accountability not only to shareholders but also to God.

Ethics OECD

Transparency, accountability and disclosure.

Islam

Justice, equity, truthfulness, transparency, protection of minorities, wider accountability, written as well as oral disclosure.

Application OECD

Principles are not equally applicable all over the world.

Islam

Equally applicable all over the world.

Comparing Islamic Corporate Governance and the OECD Principles

The OECD recommended a set of very effective corporate governance principles a decade ago and these principles have been efficiently implemented. The Islamic principles of good practice, in place for fourteen centuries, are very similar if not the same, but have not been efficiently implemented. The comparative study in the foregoing pages found that the OECD Principles cover six different issues and rights related to corporate governance, whereas the Islamic principles necessarily have a wider horizon, and place obligations beyond shareholders, financiers, suppliers, customers, and employees. They make reference to the well-being of humanity as a whole, not just material well-being and not just the Muslim community.

Finally, the Islamic principles rest accountability ultimately on God, whose knowledge and authority are absolute.

Conclusion

Thank you