sayd farook, m. kabir hassan, roman lanis, (2011)

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Journal of Islamic Accounting and Business ResearchEmerald Article: Determinants of corporate social responsibilitydisclosure: the case of Islamic banks

Sayd Farook, M. Kabir Hassan, Roman Lanis

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Determinants of corporate socialresponsibility disclosure:the case of Islamic banks

Sayd FarookIslamic Capital Markets, Thomson Reuters, Manama, Kingdom of Bahrain

M. Kabir HassanDepartment of Economics and Finance, University of New Orleans,New Orleans, Louisianna, USA, and

Roman LanisSchool of Accounting, University of Technology, Sydney, Sydney, Australia

Abstract

Purpose The purpose of this paper is to develop and test a theoretical model of the determinants ofIslamic banks social disclosures. In testing the hypotheses, the level of social disclosure in Islamicbanks annual reports is gauged based on a benchmark derived from Islamic principles.

Design/methodology/approach Applying the principles of systems-oriented theories such aspolitical economy, legitimacy and stakeholder theories, as well as agency theory, hypotheses linkingIslamic social disclosure and its determinants are developed. The sample comprised 47 Islamic banksin 14 countries and the data related to the dependent (Islamic banks social disclosures) variable are

collected mainly from the annual reports, while data for the independent variables (determinants) arecollected from various sources. Regression analysis was conducted to test the hypotheses.

Findings Corporate social responsibility (CSR) disclosure by Islamic banks varies significantlyacross the sample. According to the regression results, variation is best explained by the influence ofthe relevant publics and the Shariah (SSB supervisory boards) corporate governance mechanismvariables. Using alternative variable measures, the regression results suggest that level of social andpolitical freedom and the proportion of investment account deposits to total assets are alsosignificant determinants of Islamic banks CSR disclosure.

Research limitations/implications The major limitation of this paper is the small sample size ofonly 47 Islamic banking institutions. Future studies may expand the sample size used here.

Practical implications The results indicate the significance of the SSB as a governancemechanism that may increase the CSR disclosure of Islamic banks. Thus, from a policy perspective,bodies that regulate Islamic banking should consider mandating the SSB for all Islamic banks.

Originality/value This research is the first to provide an a priori basis for CSR disclosure ofIslamic banks and to test using empirical data. The findings of this research should be of significant

value to regulators, shareholders and deposit holders of Islamic banks. In a more general context, thispaper is one of a few that has operationalised Gray et al.s conception of levels of resolution ofperception and empirically tested the concept using non-traditional organisations (Islamic banks) in anon-Western context. This adds further credibility to systems-oriented theories in explaining CSRdisclosures of non-Western organisations operating in non-Western cultures.

Keywords Islam, Banks, Corporate governance, Corporate social responsibility, Disclosure,Political economy, Legitimacy theory

Paper type Research paper

The current issue and full text archive of this journal is available atwww.emeraldinsight.com/1759-0817.htm

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Journal of Islamic Accounting andBusiness ResearchVol. 2 No. 2, 2011

pp. 114-141q Emerald Group Publishing Limited1759-0817

DOI 10.1108/17590811111170539


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1. IntroductionA combination of political, economic and demographic factors, including and notlimited to the impact of the Iranian revolution, a growing Muslim middle class, the riseof the Asian tigers, increased deregulation and the oil shocks of the 1970s, havestimulated the development of Islamic banks (Akacem and Gilliam, 2002).[1] Thereputation of Islamic banking gained after the recent global financial meltdown mustbe sustained through customer-oriented policies. Since the search for a new monetarysystem is underway globally, Islamic finance may be a suitable alternative mode offinance in the modern world. The growing recognition accorded to the Islamic financeproducts in some European and American financial and insurance institutions

following the post-financial crisis era attests to this projection. Islamic finance hasachieved a substantial growth in the past two decades, annualising a growth rate ofabout 14 percent over the past 15 years.

According to the Malaysian Securities Commission, the Islamic finance industrythat was currently estimated to be worth about USD1 trillion had made furtherheadway in the Islamic traditional markets such as Malaysia and the Gulf CooperationCouncil countries, while at the same time penetrating new markets in Europe andAfrica. It is expected to grow to USD2 trillion by 2016 (Hassan and Oseni, 2011; Zaherand Hassan, 2001).

Islamic banks should ideally operate in accordance with the principles laid down byIslamic law (Sharia)[2]. The primary contributing factor that hastened the need forIslamic banks is the prohibition of usury (riba)[3]. Ahmed and Hassan (2007) states thatthe prophet admonished riba in its all forms in his farewell pilgrimage speech.Referring to a debate by the modernists claiming that what is prohibited in al-Quran isthe form ofriba referred to the then prevailing practice of lending in the pre-Islamic era,they boldly ruled out the logic saying that any increase over and above the principalshould be riba, and as such it is unlawful. They stress on the point that any form ofribais strictly avoided in the Islamic banking system. Merged with this function is thesocial role of Islamic banks that entails social justice and accountability, requiring thebanks to disclose corporate social responsibility (CSR) information.

Usmani (2002, p. 113)asserts thatthe philosophy behind Islamicbanking wasaimedat establishing distributive justice free from all sorts of exploitation. According toIslamic principles, business transactions can never be separated from the moralobjectives of society (Usmani, 2002). As such, a number of scholars have developed anormative standard for reporting (Gambling and Karim, 1986, 1991; Baydoun andWillett, 2000; Lewis, 2001) and indeed social reporting for Islamic businesses based onIslamic principles (Haniffa, 2001; Maali et al., 2003). Governments in Muslim populated

countries such as Malaysia and international regulatory institutions such as theAccounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI)have also voiced their support for the development and adoption of such CSR reportingstandards, encouraged and propagated by Islam (Sharani, 2004; Yunus, 2004).

Recent ad hoc studies indicate that Islamic banks are not completely fulfilling theirsocial role in accordance with the prescriptions of Islam (Metwally, 1992; Aggarwal andYoussef, 2000; Maali et al., 2003). Usmani (2002, p. 116) emphasizes that Islamic banks:

[. . .] were supposed to adopt new financing policies and to explore new channels ofinvestment which may encourage development and support of small scale traders to lift uptheir economic level.

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He also call for Islamic banks to advance towards profit and loss sharing (musharakah)in gradual phases and to increase the size of musharakah financing. Unfortunately,very few Islamic banks and financial institutions have paid attention to this socialaspect. Usmani (2002) further highlights that in a number of Islamic banks, otherpermitted forms of financing are not effected according to the procedures required bythe Shariah.

Additionally, Aggarwal and Youssef (2000, p. 99) find that while Islamic banks areexpected to favour small entrepreneurs who do not have access to credit in theconventional banking system, they rarely offer finance to these segments of the market,contrary to Islamic injunctions to promote the development of the under-privileged

echelons of society. They infer thatthis is a rational response by Islamicbanks in the faceof severe agency problems in their attempts to provide funds to entrepreneurs. Thisleads them to conclude that economic incentives shape the structure of Islamic bankingmore so than religious norms (Aggarwal and Youssef, 2000, p. 99).

Maali et al.s (2003) rudimentary analysis also suggests that Islamic banks CSRreporting falls short of the benchmark for entities whose operations are founded onIslamic principles. Based on an Islamic perspective, they develop a pragmaticbenchmark for social disclosures that they would expect Islamic banks to provide.They find that there is considerable variation in the voluntary social reporting ofIslamic banks, with some banks reporting 35 percent of expected social disclosurewhile others disclosing almost no social information (Maali et al., 2003). In addition,they find that the annual reports of Islamic banks present elements in the process ofconstructing an Islamic reality (Hines, 1988; Maali et al., 2003). As such, Maali et al.(2003, p. 31) conclude that with a few exceptions, Islamic banks have a long way to goto meeting expectations of the Islamic community. However, they fail to provide an apriori basis to support their results. In addition, their sampling and statistical analysesare rudimentary leaving their conclusions theoretically inexplicable (Maali et al., 2003).

Our paper contributes to the existing literature in several important ways. First, wemeasure the annual report social disclosure levels of Islamic banks based on abenchmark derived from Islamic principles. Second and more importantly, we ascertaina priori the determinants of Islamicbanks social disclosures which will subsequently betested utilising the disclosure measures obtained. In particular, tests for thedeterminants of social disclosure from a legitimacy and political economyperspectives are to be performed (Gray et al., 1995; Williams, 1999). Departing fromprevious research, this study also tests for the relationship between corporategovernance mechanisms and CSR disclosure. We provide empirical evidence on thenature and determinants of social disclosure by Islamic banks.

2. Prior research on CSR and Islamic bankingDespite the growth of Islamic banks in size and complexity, few researchers haveaddressed the issue of social responsibility in the context of Islamic banks. While anumber of papers have explored Islamic accounting and corporate reporting of Islamicinstitutions and banks, they have generally been either normative or analytical innature and lack the empirical analysis of disclosure practices of Islamic organisations.

Gambling and Karims (1986) seminal work developed a theoretical foundation forthe analysis of Islamic accounting elaborating on its peculiarities and analysing itssocial orientation. Hamid et al. (1993), Karim (1995), and Lewis (2001) subsequently

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detailed the intricacies of the influence of Islam on all areas of accounting from practicethrough to disclosure, paving the path for developing a conceptual framework forIslamic accounting and disclosure requirements particularly for Islamic banks.Sadeghzadeh (1995) enhances the structure of an Islamic perspective of socialresponsibility and sustainability accounting by giving it theoretical depth andcontrasting it with conventional theories relating to the area. Baydoun and Willett (2000)supplement Sadeghzadeh (1995) by developing normative Islamic reporting comprisingof value-added statements following thetwo complementary principlesof full disclosureand social disclosure based on Islamic ethical values. The studies above provide theoverall theoretical framework and practical application of Islamic accounting.

Farook (2008) stresses that IFIs are meant to be socially responsible for twointerrelated reasons: their status as a financial institution fulfilling a collective religiousobligation and their exemplary position as a financial intermediary. Based on theconceptualisation of maslahah (public good or welfare) by pre-modern andcontemporary scholars, he proposes that the guidelines of institutional socialresponsibilities follow a dichotomous framework of essentials on the one hand andcomplementarities and embellishments on the other.

Hasan and Hassan (2011) explains that corporate and Shariah governance isconsidered as one of the most significant topics in Islamic finance recently. Soundcorporate governance, especially within an Islamic paradigm, is very imperative as ittends to encourage honesty, integrity, transparency, accountability and responsibilityamongst all stakeholders in an organisation. Meanwhile, Shariah governance is thevery essence of Islamic finance in building and maintaining the confidence of the

shareholders as well as the other stakeholders that all transactions, practices andactivities are in compliance with the Shariah principles.Dealing specifically with Islamic banks, Archer et al. (1998) detail the contractual

basis of Islamic banksand the special need for corporate governance and disclosure dueto the monitoring weaknesses inherent in the Islamic banking system. They recommenda number of solutions ranging from tighter ex ante contractual conditions to improvingtransparency of financial reporting and monitoring. Their analysis is a significantattempt to extrapolate the various contracting issues inherent in Islamic banks.

The only noteworthy exceptions to the normative and analytical papers in the areaof Islamic corporate reporting and social reporting are the works of Askary (2001),Maali et al. (2003) and Haniffa and Hudaib (2007). Askary (2001) draws on researchexamining the influence of culture on accounting to classify accounting practices indifferent Muslim countries according to cultural variables developed by Hofstede(1980), Gray (1988) and Perera (1989). He compares the actual disclosure practices of

companies in Muslim countries to the benchmark of Islamic accounting practices asmeasured by those cultural variables. However, his research focuses on all companiesin Muslim countries rather than on Islamic banks specifically and he measures overalldisclosure rather than CSR disclosure.

Maali etal. (2003)make a significant attempt to substantiatethe actual social disclosurepractices of Islamic banks. They utilise a sample of 29 Islamic banks from a number ofdifferent countries and compare CSR disclosure to a pragmatic benchmark based onIslamic values. They find that Islamic banks aredisclosingCSR informationfar below theexpected level. However, their rudimentary analysis makes only vague inferences as towhat may drive the social disclosure practices of these banks. They conjecture


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as to a number of possible explanations from the CSR literature (Maali et al., 2003).Alluding to economic incentives that may drive CSR disclosure, Maali et al. (2003) alsosuggest that Islamic banks may only disclose CSR information to construct an Islamicreality while not subscribing to that reality and its resultant obligations.

Haniffa and Hudaib (2007) examined the ethical identity of Islamic banks in the Gulfregion. Based on published annual report, they measured the level of ethical identityfor seven Islamic banks in the Arabian Gulf Region based on ideal versuscommunicated ethical identity framework. They find the gap between ideal andcommunicated ethical identity for Islamic banks to be wide. In their study, they usedeight dimensions of ethical identity namely:

(1) mission and vision statement;

(2) board of directors and top management;

(3) products and services;

(4) zakah, charity and benevolent funds

(5) commitments towards employee;

(6) commitment towards debtors;

(7) commitment towards society; and

(8) Shariah supervisory board.

Hassan and Mamunur examines the ethical identity of Islamic banks in Bangladesh,Malaysia and Arab gulf states based on eight distinctive dimensions to explore thedifference between ideal and communicated ethical conducts via annual reportsfollowing the methodology by Haniffa and Hudaib (2007). Banks in the Gulf region arefound to maintain a high standard of reporting in all dimensions. However, theyperformed poorly in information regarding board of directors and top management, andcommitments towards debtors. Banks in Bangladesh did not clearly indicate the statusand role of board of directors and top management. Hassan et al. (2011) show evidencethat some dimensions of ethical identity are over-communicated while some others areunder-communicated in the annual reports of Islamic banks in Bangladesh. They find asignificantly positive relationship between the ethical identity index and the marketvalue of banks. They make a number of recommendations for improvements in Islamicbanks communication of their ethical identity through the annual reports.

3. Theoretical framework and hypothesis development3.1 Theoretical framework

A review of accounting research indicates that theory development related to CSRdisclosure in general is fragmented and rudimentary, while almost no theorydevelopment has occurred in relation to CSR disclosure of Islamic banks (Maali et al.,2003; Sadeghzadeh, 1995). At most, the literature on Islamic banks suggests that apriori there are two major influences on the Islamic banks CSR disclosure:

(1) socio-political context within which the banks operate; and

(2) economic opportunities available to Islamic banks.

In the CSR literature, the former influence is related to systems-oriented theories suchas political economy, legitimacy and stakeholder theories (Wilmhurst and Frost, 2000;

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Deegan, 2002; Campbell et al., 2002). The political and social contexts have been foundto be important determinants of the decision to disclose CSR information (Roberts,1992; Williams, 1999). The economic incentives viewpoint is consistent with researchthat explains CSR disclosure in the context of agency theory (Cowen et al., 1987;Adams, 2002; Campbell, 2000). Thus, the theoretical framework development here willincorporate both influences.

3.1.1 Systems theories, social responsibility and Islam. Systems-oriented theoriessuch as political economy, stakeholder and legitimacy propose that individuals,institutions and organisations seeking to preserve their own self-interest, will attempt tooperate and interact within the system through various relationships with others(Williams, 1999). The theories also emphasize that the actors, whether they areindividuals or organisations, in this system have the right to pursue their own goals andself-interests (Williams, 1999, p. 211). However, these rights to self-interest aremoderatedby the social and political environment in which theyinteract (Williams,1999).

This idea is consistent with Islam where the concept of Unity (Tawhid) prevails.According to this concept, God is the creator, owner and source of all things (Maali et al.,2003)[4]. In light of Gods ownership of everything, it is believed that God has entrustedmankind to the use of resources[5]. Thus, in return for the use of the physical universe,mankind agrees to be accountable for how the universe is used (DeLorenzo, 2002). Thisposition of trust is the source of accountability for individuals and consequentlyorganisations[6]. The trusteeship requires a total commitment to the will of God andtherefore involves both submission and a mission to follow the Shariah in all aspectsof life (Baydoun and Willett, 2000, p. 80), including economic aspects.

However, Islam does not deny individual rights to self-interest. Enjoyment ofself-interest is only conditioned by the permanent needs of greater society (Umma)(Sadeghzadeh, 1995). As such, individual freedom is sacred only as long as it does notconflict with the larger societal interest or as long as the individual does not transgressthe rights of others (huqquq-al-ibad). Some practical examples of this concept aredemonstrated by the forbiddance of a number of activities such as drinking alcohol,adultery and gambling because of their contributory effects to families and societies.The conceptual basis of this implicit contract between the individual and greatersociety are emphasized in great lengths in the Quran and the teachings of ProphetMuhammad.

Similarly, defined by the proponentsof political economy, stakeholderand legitimacytheories, the relationshipbetween individuals, organisations and society is consequentlyviewed as a social contract (Ramanathan, 1976; Deegan, 2002; Williams, 1999).Organisations themselves play a significant role in society and have responsibilities

assigned to them based on their status in society. As such, they [. . .

] exist only to theextent that the particular society considers that they are legitimate (Deegan, 2002,p. 292). Organisations continually seek to ensure that they operate within the boundsand norms of their respective societies (Deegan, 2002). In this context, CSR is definedbroadly as including the concern for the impact of all of the corporations activities onthe total welfare of society (Bowman and Haire, 1976, p. 13).

The concept of CSR in Islam likewise emerges from this social contract thatneccesarily has to do with the congruency of the value system of the organisation to thelarger value system of an Islamic society[7]. In Islam, organisations are similarly, if notmore so, accountable to society as are individuals. As Lewis (2001, p. 113) elaborates,


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theimplications forbusiness enterprises is thatboth managers and providers of capital,are accountable for their actions both inside and outside their firms; accountability inthis context means accountability to the community to establish socio-economic justicewithin their own capacity. A number of commandments in the Quran and the traditionof the Prophet Muhammad stipulate what must be done in order to establishsocio-economic justice and therefore be socially responsible. Some examples of these arethe obligatory payment out of income and wealth (zakah), philanthropic trusts (waqf),alms, charity (sadaqa), interest-free loans (qard-ul-hassan) (Sadeghzadeh, 1995). Theforbiddance ofriba also stems out of principles of socio-economic justice in Islam in thatthe objective is to disallow any unjust distribution of wealth through forced or

undeserved loss to one party or unearned gain to the other party (fixed interest). Againstthat background, it is reasonable to concludethat Islamic business values and norms areconsistent in general with the definition of CSR.

3.1.2 CSR disclosure as a means of legitimation . To discharge their CSR, politicaleconomy, legitimacy and stakeholder theories proponents argue that corporations(management) provide CSR information as part of the dialogue between the corporationand greater society (Gray et al., 1995). Even if the organisation is complying withsocietys expectations, organisational legitimacy can be threatened if it has failed tomake disclosures that show that it is complying with societal expectations (Newson andDeegan, 2002). Hence, managers need to demonstrate that they are complying with thesocial contract by disclosing information in line with societys expectations(Lindblom, 1994)[8][9].

Although different obligations and responsibilities are due to different types oforganisations in different contexts, the overall general framework for socialresponsibility and accountability in Islam is derived from Islamic teachings embodiedin the detailed jurisprudence outlined in the Quran and the teachings ofProphet Muhammad. Hence, the expectations of an Islamic populace towards anyorganisation that claims to be Islamic are unambiguous. Islamic banks are expected todisclose relevant CSR information to discharge their responsibility and to earnlegitimacyfor their continued existence (Sadeghzadeh, 1995; Baydoun and Willett, 2000;Haniffa, 2001; Lewis, 2001; Maali et al., 2003). However, the expectation to disclose isonly a necessary condition for disclosure.

The disclosure of CSR information by Islamic banks will depend on a number of otherfactors necessarily focussing on the role of information and disclosure in therelationships (Gray et al., 1996, p. 45) between the organisations, the state, individuals,groups and particularly the Islamic society (Umma). In light of this, two factors fromsystems-oriented theories are identified that will directly influence the level of CSR

disclosure by Islamic banks. Extracted from political economy theory, the first factorfocuses on the broader social and political environments in which organisations interactand is capturedby thepolitical rights and civil liberties (PRCL)variable (Williams, 1999).The second factor, proxied by the relative size of Muslim population variable, is derivedfrom legitimacy theory and attempts to capture the concept of the relevant publics fromwhich the organisation requires legitimation to exist (Newson and Deegan, 2002).

3.2 Hypothesis development3.2.1 Political economy. It has been suggested that Islamic banks are also driven byeconomic realities within which they operate. According to Archer et al. (1998),

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Islamic banks are an efficient means of contracting for investors and fund userswishing to comply with the laws and principles of Islam. The aggregate investmentportfolio of an Islamic bank is financed by investment account holders (IAH) funds(Gray et al., 1995)[10], shareholders equity and other sources of funds available to thebank (Archer et al., 1998). The banks management acts as an agent not only for theshareholders, but also for IAHs as the mudarib. The Islamic bank then investsthese funds in Sharia permissible activities[11].

The main problem is that the two types of principals (the IAH and shareholders)have inferior information to that possessed by management, particularly about theapplication of Islamic laws in relation to the banks operations. Islamic banks are underan implicit contractual obligation to both their shareholders and IAH to functionaccording to the laws and principles of Islam. Bakar (2002, p. 76) states thatSharia compliance is the very essence of an Islamic bank and its banking business.

Another agency problem is the fact that investment accounts are not a liability witha fixed claim on the companys assets and hence are only given a residual claim to thebanks earnings or assets pari passu with that of shareholders (Archer et al., 1998). TheIAH has no formal right to show their disapproval of management actions except tovote with their feet (Archer et al., 1998). Archer et al. (1998) explain that in that case,due to the inherent benefits of higher returns from funds invested by IAH, shareholdersmay vicariously monitor for their other counterparts: the IAH. They state that therelationship between IAH and shareholders:

[. . .] exhibits some features of bilateral dependency, in that the IAH depend on shareholdersfor monitoring while the shareholders depend on IAH as a source of profits via the mudarib

share (Archer et al., 1998, p. 164).

The IAH, if it is comprised of Islamic investors, would also be interested in the level ofcompliance of the bank with Islamic laws and principles. Consequently, the extent ofShariah compliance by an Islamic bank will depend on the level of monitoring in placeto limit the divergence of interest between the principals who are particularlyinterested in Shariah compliance of the bank and the agent which is the banksmanagement. Karim (1990) broadly classifies the three main types of shareholders ofIslamic banks: management; Islamic investors[12]; and economic investors[13].

The same categorisation could be used for classifying IAH perhaps with theexclusion of management shares. The segment most interested in the bankscompliance with Islamic laws and principles within this categorisation would be theIslamic investors. The greater the level of monitoring by Islamic investors, the greaterthe compliance of the Islamic bank with Islamic laws and principles. Hence, the extent

of CSR disclosure could arguably depend on the level of monitoring by the Islamicinvestor group. Two major determinants of the level of monitoring are identified in theliterature: monitoring mechanisms and ownership structure.

As Islamic banks operate in a broader social and political environment, theinterplay ofpower affecting the rights and responsibilities of all actors within this environment willdetermine the flow of information and dialogue. One factor that may influence theinterplay of power is the PRCL in a country. Gastil (1981) points out that as political andcivil repression increases, the influenceand effectiveness of social interest bodies decrease.Within countries exhibiting limited PRCL, societal interest groups, whether Islamic orotherwise, lack the capacity to voice their concerns regarding organisational conduct.


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Under such repressive regimes, organisations may face lower social expectations andpressure(Williams,1999). On theother hand,organisations and particularly Islamic banksoperating in relatively open communities with greater freedom may need to providefurther justification to legitimize their existence and hence disclose CSR information. Wethen can hypothesize that a significant negative relationship is expected between thelevels of CSR disclosure presented by Islamic banks and the extent of political and civilrepression:

H1. There is a negative association between the level of political and civilrepression and the level of CSR disclosure presented in annual reports of

Islamic banks.

3.2.2 Relevant public.3.2.2.1 Relative size of Muslim population. While the broader social and political

environment may affect the flow of information and the effectiveness of social interestgroups in a particular country, the relative size of the Muslim population as a proxy forthe Islamic society will contemporaneously determine the level of CSR disclosurepresented by Islamic banks. Newson and Deegan (2002) point to the crucial factor thatis directly relevant to management: the relevant publics to which the organisation isaccountable. As articulated in the theory development section, it could reasonably be

justified that the main relevant public in the case of Islamic banks is the Islamicsociety. Applying Newson and Deegans (2002) concept, while there may be limitedexpectations about social responsibilities within a particular country, if an Islamicbank relies on support from the Islamic public, then it must demonstrate adherence to

the expectations thereof.Newson and Deegan (2002) elaborate that while there may be national differences

across countries with regards to disclosure, perhaps attributed to cultural and otherfactors, their notion of a global culture and Islamic culture in this study, should workagainst the differences in CSR disclosure policies. Reiterating this point, Maali et al.(2003) indicate that Islamic banks claiming to follow Islamic principles are required tomake certain universal voluntary disclosures regardless of local standards, because theneed to report such items is based on accountability to the Islamic public or society.

However, the extent to which Islamic banks comply with these universalexpectations of CSR disclosures depends on the relative power of the relevant publicto influence the activities of Islamic banks. Given that the relevant public in the case ofIslamic banks is the Islamic society, the proportion of population in a country thatadhere to the principles of Islam or in other words, the relative size of the Islamicsociety could arguably represent the influence of the relevant public for Islamic

banks (Karim, 1990). If the relevant public comprise a larger proportion of the overallpopulation, there will be increased pressure on the Islamic banks to legitimize theiractions to this constituency who enjoy a relatively stronger position in the social andpolitical environment within which Islamic banks operate (Roberts, 1992). Hence, asignificant positive relationship is expected between the proportion of adherentMuslims and the level of CSR disclosure presented by Islamic banks:

H2. There is a positive association between the proportion of adherent Muslims ina country and the level of CSR disclosure presented in annual reports ofIslamic banks.

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3.2.3 Monitoring mechanism.3.2.3.1 Governance by the Sharia supervisory board. A number of Islamic banksemploy a special form of monitoring to limit the divergence of interest between Islamicinvestors and the management of the Islamic bank. Shariah supervisory boards (SSB)assure investors of the compliance of Islamic banks with Islamic laws and principles.The demand fortheservicesof an SSBarises out ofa perceived needto constantly checkinnovations in banking practice [as well as in accounting] against the principles ofIslamicorthodoxy (Karim,1995, p. 287). It is not mandatory for an Islamic bank to haveits own SSB. However, the AAOIFI requires both the SSB and the financial auditors ofIslamic banks to report on compliance with Shariah doctrines (AAOIFI, 2003).The AAOIFI standards explicitly state that the Shariah supervision is intended toinvestigate to what extent the financial institution has adhered to Shariah rules andprinciples in all its activities (Bakar, 2002, p. 81). The investigation would includeexamination of the banks memorandum and articles of association, its contracts [. . .]its financial reports and various other reports [. . .] (Bakar, 2002, p. 81). Karim (1995,p. 35)stresses that in most cases, SSBsauthority is equalto those of external auditors.

Ideally, one would expect the SSB to represent orthodox Islamic laws and principlesmore so than management. The Islamic credentials of the members of the SSB areconsidered to be impeccable (Karim, 1990). If an SSB is employed to ensure complianceof the Islamic bank to Islamic laws and principles, it can be deduced that it may play arole in mandating CSR activities and also CSR disclosure. However, the extent to whichthe SSB influences CSR disclosure depends on the function of the SSB in monitoring onbehalf of investors.

The extant literature suggests two competing viewpoints: the impact of internalgovernance mechanisms on corporate disclosures may be complementary orsubstitutive (Ho and Wong, 2001). A greater magnitude of disclosures would beexpected if it is complementary as more governance mechanisms will strengthen theinternal control of companies and provide an intensive monitoring package for a firm toreduceopportunistic behavior and information asymmetry (Hoand Wong, 2001, p. 143).Islamic banks would thereby be under greater pressure from the SSB to comply withIslamic laws and principles and hence disclose more CSR information. This view isconsonant with the role and function of the SSB described above.

Alternatively, corporate governancemechanisms may be substitutive and may resultin lower disclosures (Ho and Wong, 2001). Where there is an additional governancemechanism installed that leads to greater monitoring, the need for disclosure as a form ofmonitoring then decreases (Ho andWong, 2001).The SSB may see no need to emphasizeadditional CSR disclosures if the banks activities are complying with Islamic laws and

principles and investors are assured of that through the Shariah compliance report(Maali et al., 2003). If information asymmetry can be reduced because of existingmonitoring packages such as the SSB, the need for installing additional monitoringthrough greater CSR disclosures to assure Islamic investors of the banks commitment toIslamic laws and principles should be lower (Ho and Wong, 2001).

Nothwithstanding, it is expected that the former explanation holds true. This isbecausethe nature of compliance with Islamic laws and principles from an Islamic pointof view entailsnot onlyassuranceof compliance throughissuing the Shariah report, butalso greater involvment in CSR activities including CSR disclosures. The SSBs functionas stated by the AAOIFI also concurswith this rationale. Hence, it is generally expected


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that the existence of an SSB in an Islamic bank would lead to greater levels of CSRdisclosures.

However, while the existence of an SSB may lead to greater monitoring and therebygreater disclosures of CSR information, the degree to which the SSB would influenceCSR disclosures may also depend on the characteristics of this corporate governancemechanism (Haniffa and Cooke, 2002; Ho and Wong, 2001). Hence, a multitude offactors that relate to the SSBs characteristics may determine how effectively the SSBconducts its function and subsequently the level of CSR information disclosed byIslamic banks. A number of characteristics are elaborated upon, after which ahypothesis is formulated.

3.2.3.2 Number of board members. An increase in the number of SSB members maylead to higher levels of CSR disclosure as the capacity for monitoring increases. Withregard to the minimum number of members of any SSB, the AAOIFI standards haverequired at least three members. This is a common requirement in many Islamic banks.The greater the number of members in an SSB, the greater the amount of monitoring,implying a greater level of compliance with Islamic laws and principles. The SSBwould be able to allocate its functions across a larger group of members, allowing theSSB to review more aspects of the banks activities and hence ensure greatercompliance. One aspect of this compliance is more CSR disclosure. Further, synergiescould also be present in boards with a large number of members pooling their ideasand perspectives to derive better applications of Islamic law, particularly with regardsto disclosure. The AAOIFI recommends a number of different people from differentprofessions to sit on the SSB, including bankers, economists and full-time member(s)

(AAOIFI, 2003). This allows for the implementation of diverse perspectives on theapplication of the Shariah. To enable this to happen, a large SSB would be required torepresent these sectional professions. The above analysis suggests that the size of theSSB should have a positive relationship with CSR disclosure.

3.2.3.3 Cross-memberships. Cross-memberships of SSB members may also lead tohigher disclosure of CSR information (Dahya et al., 1996). The literature suggests thatcross-directorships increase transparency for two reasons: first, members withcross-directorships can make comparisons from knowledge gained in other companies;and second decisions at one board become part of the raw material for decisions atother boards (Haniffa and Cooke, 2002, p. 321). SSB members with cross-membershipswill be exposed to more discussions about the application of Islamic law in banking.This increased experience should enhance their knowledge about the application ofIslamic principles to corporate reporting and in particular to CSR disclosure.

3.2.3.4 Secular educational qualifications. In the extant literature, the directors

education has been proposed to influence the level of disclosure. Hambrick and Mason(1984) indicated that the more educated the director, the more likely he/she is to adoptinnovative activities and accept ambiguity. The level of education of the SSB membersmay influence the level of CSR disclosure. Bakar (2002, p. 79) states that:

[. . .] ideally a Sharia adviser (board member) must be able to understand not only Shariaissues but also issues pertaining to law and economics, because such issues in many cases areoverlapping.

SSB membersusually comprise scholars of Islamic lawwho maynot be highly educatedin secular studies. SSB members who are not highly educated may be undermined

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in their abilities to fully apply theoretical Islamic laws and principles because of theirlack of practical commercial knowledge (Bakar, 2002; Bokhari, 2002). Hence, scholarswith a doctorate degree in business and economics are arguably better informed of thecurrent implications of Islam for financial institutions, particularly with regards to CSRdisclosure.

3.2.3.5 Reputable scholars. Some Shariah scholars have a significant amount oftacit knowledge about the application of Islamic law. However, they may not haveformally recognised qualifications from secular educational institutions. Hussain andMallin (2003) report that the factors influencing the appointment of directors inBahraini companies are relevant skills, business experience and reputation. Following

that reasoning, it is expected that reputation is a proxy for industry knowledge andhence reputable scholars with relevant degrees in Shariah and business and who arerepresented in many Islamic banking and financial institutions Shariah boards, aremore likely to understand the current implications of Islamic banking, particularlywith regards to disclosure. Hence, reputable scholars are more likely to emphasize CSRactivities and the subsequent disclosure of CSR information.

3.2.3.6 IG-score. A number of previous studies have combined corporate governancefactors into an index which attempts to capture their aggregate effect. Gompers et al.(2001) and Hanlon et al. (2003) combine a number of variables proxying for governancefactors to produce a g-score. Applying the same reasoning, this study develops anIslamic governance score (IG-SCORE). In particular, a score is constructed based on theexistence and characteristics of the SSB as detailed above. The score sums the value ofthe dichotomous characteristics of the board, namely the existence of the SSB, thenumber of SSB board membe rs , t he e xi st ence of SSB membe rs w it hcross-memberships, the existence of SSB members with doctoral qualifications andthe existence of reputable scholars presiding on the SSB board. The method iselaborated in the research design. A positive relationship is expected between theIG-SCORE and the level of CSR disclosure presented by an Islamic bank:

H3. There is a positive association between the IG-SCOREs and the level of CSRdisclosure presented by Islamic banks in their annual reports.

3.3 Ownership structure3.3.1 IAHs rights. The structure of ownership also determines the level of monitoringand thereby the level of disclosure (Jensen and Meckling, 1976). A number of priorstudies look at the effect of ownership structure on voluntary disclosure (Ruland et al.,1990; Eng and Mak, 2003; El-Gazzar, 1998; Mitchell et al., 1995; McKinnon andDalimunthe, 1993; Schadewitz and Blevins, 1998).

As elaborated above, Islamic investors determine the extent of compliance withIslamic principles and consequently the level of CSR disclosures. Islamic investors aremore likely to invest their funds as IAH rather than as shareholders since Islamicinvestors are primarily interested in the services that Islamic banks offer rather thanshare ownership of the Islamic banks per se. Further, investment accounts with Islamicbanks are generally more accessible than shares of Islamic banks. While the IAH donot have any formal voting rights, they nevertheless influence the level of monitoringof management vicariously through shareholders (Archer et al., 1998). This is due tothe fact that the profits of shareholders are determined by the profits earned throughthe utilisation of IAH funds.


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If the IAH are more interested than the shareholders in the banks compliance withIslamic laws and principles, then the relative influence of the IAH will determine theextent to which the bank complies with Islamic laws and principles and consequentlythe level of disclosure presented by the bank. This suggests that CSR disclosure ispositively related to the relative size of IAH funds as a proportion of shareholder funds:

H4. There is a positive association between the proportion of IAH funds toshareholder funds and the level of CSR disclosure presented by Islamic banksin their annual reports.

4. Data and research design4.1 Sample and data descriptionIn order to test the hypotheses, annual reports (Gray et al., 1995)[14] of fully fledgedIslamic banks from a number of countries were collected during 2000s. Islamic banksare classified as any financial intermediary that claims to operate according to the lawsand principles of Islam (IAIB, 2001). Therefore, the sample of Islamic banks containsservice banks, investment banks, mortgage companies and leasing companiesoperating as either publicly listed companies, private companies or asgovernment-owned institutions. The structure of the banks and the types of servicesthey offer are not significant in determining CSR disclosure as the expectation todisclose CSR information is based on the fact that the banks claim to be Islamic. Hence,mission statements and/or information on their web sites are used to verify the banksclaim to operate according to Islamic laws and principles.

The initial sample population for the study comprised all Islamic banks in the world

derived from a comprehensive list compiled by Archer and Karim (2002). These werecross-checked with the International Directory of Islamic Banks and Institutions issuedby the IIBI (2000) in London and the relevant stock exchanges. Approximately, 187fully fledged Islamic banks in 29 countries were identified. The annual reports forIslamic banks were primarily obtained from their web sites and the relevant stockexchange web sites. Approximately, 33 banks annual reports were collected in thismanner. To enlarge the sample size, another 48 banks were identified in the sample forwhich mailing addresses were available. In total, 14 Islamic banks annual reports werereceived giving an overall response rate of 29.8 percent. This is somewhat lower thanthe response rates achieved for studies in which Islamic banks annual reports wereused. Maali et al. (2003) achieved a response rate of 37.5 percent with an initial sampleof 88 banks. The final sample consists of 47 banks from 14 countries with thedistribution as follows: Bahrain (6), Bangladesh (5), Egypt (1), Iran (4), Jordan (2),Kuwait (5), Malaysia (2), Pakistan (8), Qatar (2), Saudi Arabia (5), Sudan (1), Turkey (2),

United Arab Emirates (3), and Yemen (1).

4.2 Research designOrdinary least squares regression is used to examine the relationship between CSRdisclosure and the explanatory variables[15]. The regression equation is as follows:

CSRDIS a b1 PRCL b2 MUSPOP b3 IGSCORE b4 IAH b5 SIZE 1

CSRDIS is the CSR disclosure index score of the bank. Table I provides a summary ofthe operationalisation of the independent variables.

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HypothesisIndependentvaria

bles

Operationalisation

Sourceofinformation

Socio-politicalcontext-Politicaleconomy

H1

PRCL

Politicalrightsand

civilliberties

OverallcombinedindexscoresofPRCLbasedon

workofGastilforthegivennation:1(freedom)to

14(repression)

Freedomhousefre

edomintheworldIndexwww.

freedomhouse.org/r

atings/allscore04.xls

Socio-politicalcontext-relevantpublics

H2

MUSPOP

ProportionofMuslim

popula

tion

RatioofMuslimpopulation

tototalpopulation

CIAWorldFactboo

k(2004)www.odci.gov/cia/

publications/factbook/geos/

Corporategovernance-S

hariasupervisoryboard

H3

IG-SCORE

Islamicgovernance

score

ExistenceofSSB

numbe

rofSSB

members

crossmembers

hips

doctorate

qualificationofSSBmember

reputablescholars

onSSB

Derivedfromsub-v

ariablesbelow

SSB

ExistenceofSSB

Dichotomous;yes/no

Bankannualreport

NUM

NumberofSSB

members

Dichotomous;1forbanksw

ith7ormoremembers

and0otherwise

Bankannualreport

CROSS

Cross-memberships

Dichotomous;ifanySSBm

emberwithcross-

directorship:1,otherwise:0

Bankannualreport

PHD

Doctor

alqualification

ofSSB

member

Dichotomous:ifanySSBm

emberwithdoctorate

qualification:1,otherwise:0

Bankannualreportandwebsite

REP

Reputablescholarson

SSB

Dichotomous:ifanyreputa

bleSSBmember:1;

otherwise:0.Reputablesch

olarisonethathasa

positionintheSSBoftheA

AOIFIandatleasttwo

Shariaboardmemberships

AAOIFIstandards

andbankannualreport

Corporategovernance-ownershipstructure

H4

IAH

Investmentaccount

holders

Ratiooftotalamountofinvestmentaccountfunds

topaidupcapitalinshareholdersequity

Bankannualreport

Control

SIZE

Size

Naturallogofbookvalueofassetstranslatedinto

USD

Bankannualreport

Table I.Summary of the source

and operationalisation ofindependent variables


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4.2.1 Dependent variable. The dependent variable was constructed using an index ofexpected CSR disclosure of Islamic banks operating in Muslim countries. The indexwas derived from Maali et al. (2003) and contains 32 items (Maali et al., 2003)[16].Following Inchausti (1997) and Maali et al. (2003), each item in the disclosure index wasgiven the same weight (Barrett, 1997). Items disclosed were given a weight of 1 whileundisclosed items were weighted 0. The annual report of each bank was reviewed anda judgment made by the author as to which items were relevant to each bank.Irrelevant items were not considered as part of the overall score for the respective bank.For instance, some banks are required by law to pay zakah, while others are not. Hence,the CSR disclosure score was constructed as a ratio of the actual score achieved by thebank to the maximum possible value for each bank from the 32 disclosure items(Maali et al., 2003). The CSR disclosure index of 32 items in nine broad categoriesrepresents a replication of the Maali et al. (2003) index with two extra items addedunder other aspects of community involvement. The appendix provides the 32 itemsused in constructing this variable. The following are the explanations for including thetwo additions to the index.

The banks role in creating avenues of credit for small entrepreneurs is seen as oneof the more important facets of developing society, it seems necessary to include this inthe disclosure index. Further, it is evidenced by the current study that a number ofbanks in the Middle East and South Asia have embraced this facet of socialresponsibility in their operations as an application of true Islamic principles.

While Maali et al. (2003) discuss the basis of charitable and social activities, Islam inits application has a much wider spectrum of duties for its adherents. For example,

Islamic banking should be actively involved in assisting the poor and disadvantagedclasses in society to come out of their plight by helping them establish their ownincome streams, instead of only financing their needs through charitable funds. This isreiterated by a number of Islamic finance scholars (Aggarwal and Youssef, 2000;Hassan, 1999). Neinhaus:

[. . .] argues that Islamic banks in conformity with the welfare principles of Islam, shouldfocus on the disadvantaged classes of the society by channeling their loans and advanceswith a view of making them self-reliant.

In light of these, Islamic banks should actively make an effort to alleviate the conditionof the poorer and disadvantaged classes in society and disclose their accountability ofthis important facet. Hence, the banks role in enhancing the condition of poor familiesis deemed as another important dimension to be included.

4.2.2 Independent variables. The independent variables are categorised into three

groups: socio-political context, corporate governance and control. Since a number of thevariables were never considered in previously published research on disclosure andparticularly CSR disclosure, the appropriateness of these variables was discussed withand confirmed by a managing director and a Shariah supervisory board member of anIslamic bank in Australia.

4.2.3 Control variables. Firm size (SIZE) log of total assets. This measure has beenconsistently found to influence CSR disclosure (Belkaoui and Karpik, 1989; Roberts,1992; Williams, 1999; Patten, 1991). The arguments for larger firms disclosing higherlevels of CSR flow from a number of different theoretical perspectives. Agency andpositive accounting theories predict that managers use CSR disclosure as part of their

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overall strategy to reduce agency costs and in particular political costs (Watts andZimmerman, 1978). Large firms are more politically visible and therefore disclose moreinformation. The legitimacy theory argument is that the more social exposure a firmreceives by being larger, the greater the need to legitimize its existence to its relevantpublics (Patten, 1991). Hence, a significant positive relation is expected between firmsize and voluntary disclosure.

4.2.3.1 Alternative definitions of explanatory variables. There are a number ofalternative definitions for the explanatory variables stated above. Therefore,sensitivity testing is carried out, the results of which are reported subsequent in themain regression model.

5. Empirical results5.1 Descriptive statisticsTable II provides descriptive statistics of sample variables. The mean CSR disclosurefor the 47 banks in the sample is approximately 16.8 percent of expected disclosure,representing an increase from Maali et al. (2003) who reported a mean disclosure of 13.3percent. This is perhaps due to the fact that there are more banks in the sample used inthis study. The maximum reported disclosure was 48.3 percent of expected disclosure,still falling significantly below expectations of the banks Islamic stakeholders or anyIslamic society. In fact, a number of the banks provides no CSR disclosures.

Table III provides correlation statistics. The Pearson parametric and Spearmannon-parametric correlation tests indicate that CSR disclosure is significantly related tosize (SIZE), the IG-SCORE and IAHs rights. Size is also significantly related

Panel A: descriptive statistics: CSR disclosure index (CSR DIS)a

Mean 0.168 Skewness 0.827SE mean 0.019 S.E. skewness 0.347SD 0.128 Kurtosis 20.144Minimum 0.000 SE kurtosis 0.681Maximum 0.483

Panel B: descriptive statistics on independent variablesb

Variables Minimum Maximum Mean SD PRCL 7.00 14.00 10.66 1.87MUSPOP 0.60 1.00 0.93 0.10IG-SCORE 1.00 4.00 2.60 1.36IAH 0.00 51.29 9.81 11.27SIZE 6.10 10.16 8.59 1.00

Notes:

a

Shows the descriptive statistics for the dependent variable in a sample of 47 firms;

b

shows thedescriptive statistics for the independent variables in a sample of 47 firms; where: PRCL politicalrights and civil liberties index scores from Freedom House ranging from 1 (highest amount of PRCL) to14 (lowest amount of PRCL); MUS POP proportion of Muslim population to total population of thegiven nation; IG-SCORE (SSB NUM CROSS PHD REP); IAH proportion of investmentaccount holders funds to paid up capital; SIZE natural log of the banks total assets; CSR DIS CSRdisclosure index score of firm; IG-SCORE consists of: SSB 1 for Islamic banks with Shariasupervisory boards and 0 otherwise; NUM 1 for Islamic banks with 7 or more SSB members and 0otherwise; CROSS 1 for Islamic banks with one or more cross-members and 0 otherwise; PHD 1 forIslamic banks with one or more members with doctorate qualifications and 0 otherwise; REP 1 forIslamic banks with one or more reputable scholars as members of the SSB and 0 otherwise

Table II.Descriptive analysis


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to the IG-SCORE and IAHs rights. This is intuitively appropriate since larger bankswould have better monitoring mechanisms in place and would be funded to a greaterextent by IAHs rather than shareholders. The proportion of Muslim population(MUSPOP) is significantly related to the level of PRCL in a country.

5.2 Main regression model

Table IV shows the results of the multivariate regression analysis. The model isstatistically significant at the 1 percent level and has an adjusted R2 of approximately0.393, indicating that the model explains a significant amount of the variation indisclosure. Although SIZE and PRCL variables are both in the predicted direction, theyare found to be statistically insignificant. The proportion of MUSPOP variable is in thepredicted direction and statistically significant at the 5 percent level (p-value 0.027).This indicates that the size of the relative publics proxying for their ability to influenceand apply pressure on Islamic banks is a significant factor in determining the level ofCSR disclosure presented by these banks. One of the corporate governance factors issignificant at or below the 5 percent level. The combination of the SSB characteristics(IG-SCORE) is highly significant at the 1 percent level and in the predicted direction(p-value 0.001) while the IAH s rights (IAH) variable is in the predicted directionbut only marginally significant at the 10 percent level (p-value 0.061). The highlysignificant IG-SCORE indicates that the SSB and its characteristics are important in

influencing CSR disclosures. IAH variable is consistent with H4, implying that IAHsexert pressure for more information disclosure. Overall, the preliminary resultssuggest that the relevant publics and monitoring mechanisms such as the SSB increasethe level of CSR disclosure by Islamic banks.

5.3 Sensitivity testingSince there is a degree of arbitrariness in selecting the proxies for the model variables,sensitivity tests are conducted to ensure the robustness of the results and to furtherenhance the empirical model. Replacing the measure of PRCL with a relatively simplerindex ranking countries from free (1) to partially free (2) to not free (3), increases

PRCL MUSPOP IG-SCORE IAH SIZE CSR DIS

PRCL Correlation coefficient 1.000 0.303 * 20.064 20.242 20.046 20.029Sig. (two-tailed) . 0.038 0.670 0.101 0.759 0.849

MUSPOP Correlation coefficient 0.373 * * 1.000 20.097 20.280 20.140 0.136Sig. (two-tailed) 0.010 . 0.515 0.056 0.346 0.363

IG-SCORE Correlation coefficient 20.174 0.001 1.000 0.004 0.476 * * 0.549 * *

Sig. (two-tailed) 0.242 0.993 . 0.979 0.001 0.000IAH Correlation coefficient 20.102 20.235 20.010 1.000 0.375 * * 0.252

Sig. (two-tailed) 0.493 0.112 0.949 . 0.009 0.088

SIZE Correlation coefficient 0.0562

0.035 0.373

* *

0.451

* *

1.000 0.472

* *

Sig. (two-tailed) 0.708 0.817 0.010 0.001 . 0.001CSR DIS Correlation coefficient 20.050 0.195 0.595 * * 0.309 * 0.444 * * 1.000

Sig. (two-tailed) 0.740 0.190 0.000 0.034 0.002 .

Notes: Correlation is significant at: *0.05 and * *0.01 level (two-tailed); this table shows the Pearsonand Spearman correlation indices for all variables; where: upper half is the parametric Pearsoncorrelation; lower half is the non-parametric Spearman correlation

Table III.Pearson and Spearmancorrelation matrix

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the adjusted R2 from 0.393 in the original model to 0.452 and the variable PRCLbecomes significant at the 5 percent level (p-value 0.042). Since size was found to bein the predicted sign but insignificant, a relative measure of size was used by dividingthe total assets of the bank by the gross domestic product of countries and then loggingthe value. While this was done to adjust for the relative differences in size betweencountries, we find again this variable to have expected positive sign, but notstatistically significant.

Two alternative measures of IAH were utilised. The first measure utilised was theratio of total IAH s fund to totalassets. The IAH variable increases in significance to the5 percent level (p-value 0.029) and theadjustedR2 increases from 0.393 in the originalmodel to 0.411. The second measure utilised is the ratio of the total IAHs funds to total

shareholders equity. The IAH variable loses its significance using this measure and theR2 decreases from 0.393 in the original model to 0.348. There are no significant changesin the other variables. Further, to ensure that the significant correlation between IAHrights and size is not introducing noise into the regression model, tests were conductedby excluding either IAH rights or size from the model. While each of the variablesincreases in significance when one of them is excluded from the model, excluding IAHfrom the model reduces the total R2 more than excluding size, indicating that the IAHcontributes more significantly in explaining disclosure than SIZE. Hence, it may beinferred that the significance of the SIZE variable in the test conducted without IAH wasonly capturing the effect of an omitted correlated variable.

Independent variables Predicted sign Coefficients t-statistics p-value VIF

Intercept 20.517 22.457 0.018PRCL 20.001 20.105 0.917 1.148MUSPOP 0.373 2.298 0.027 * 1.168IG-SCORE 0.046 3.625 0.001 * * 1.376IAH 0.003 1.927 0.061 1.362SIZE 0.023 1.258 0.215 1.591SE 0.100

F-value 6.950

Sig. F (p-value) 0.000R 0.677R2 0.459Adjusted R2 0.393

Notes: Coefficient is significant at: *0.05; * *0.01 levels (two-tailed); this table displays the regressionresults for the determinants of CSR disclosure; the coefficients are based on the following equation:CSRDIS a b1 PRCL b2 MUSPOP b3 IG SCORE b4 IAH b5 SIZE 1; variabledefinitions: PRCL political rights and civil liberties index scores from Freedom House rangingfrom 1 (highest amount of PRCL) to 14 (lowest amount of PRCL); MUS POP proportion of Muslimpopulation to total population of the given nation; IG-SCORE (SSB NUM CROSS PHD REP); IAH ratio of investment account holders funds to paid-up capital; SIZE natural log of the banks total assets; CSR DIS CSR disclosure index score ofbank; IG-SCORE consists of: SSB 1 for Islamic banks with Sharia supervisory boards and 0otherwise; NUM 2 for Islamic banks with 7 or more SSB members and 1 otherwise; CROSS 1 forIslamic banks with one or more cross-members and 0 otherwise; PHD 1 for Islamic banks with oneor more members with doctorate qualifications and 0 otherwise; REP 1 for Islamic banks with one or

more reputable scholars as members of the SSB and 0 otherwise

Table IV.Regression analysis main

model


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Since theIG-SCORE attempts to combinethe effectof five differentsub-variables, it isnot informative as to the effect of each sub-variable. Tests are run excluding each one ofthe sub-variables oneat a time from the IG-SCORE to reviewthe consequent effect on thesignificance of the IG-SCORE and the adjusted R2 of the total model. The IG-SCOREvariable drops in significance and the R2 is vastly reduced at every instance asub-variable is dropped except for when the sub-variable NUM is dropped indicatingthat the number of scholars is not an important factor in contributing to higher CSRdisclosure.

5.4 Optimal regression modelBased on the sensitivity analysis conducted above, an optimal regression model isformed utilising two alternative measures derived from the sensitivity testing. Theoriginal PRCL variable is replaced by the measure elaborated earlier. The IAH variableis replaced by the alternative IAH rights measure based on the ratio of total IAH fundsto total assets. The results are reported in Table V. The model provides an adjusted R2

of approximately 0.471 recording a significant increase from the original model whichhad an adjusted R2 of approximately 0.393. All variables are significant with PRCL(p-value 0.034) and IAH (p-value 0.039) being significant at the 5 percent leveland MUSPOP (p-value 0.005) and IG-SCORE (p-value 0.007) being significant atthe 1 percent level. SIZE variable has predicted sign but not significant.

Independent variables Predicted sign Coefficients t-statistics p-value VIF

Intercept2

0.4122

2.092 0.043PRCL 20.072 22.187 0.034 * 1.448MUSPOP 0.481 3.091 0.004 * * 1.231IG-SCORE 0.035 2.823 0.007 * * 1.547IAH 0.096 2.136 0.039 * 1.333SIZE 0.020 1.166 0.250 1.629SE 0.093

F-value 9.187Sig. F (p-value) 0.000

R 0.727R2 0.528Adjusted R2 0.471

Notes: Coefficient is significant at: *0.05 and * *0.01 levels (two-tailed); this table displays the optimalregression model derived from the sensitivity tests conducted utilising alternative measures of PRCLand IAH rights; the co efficients are ba sed on the following equatio n:

CSRDIS a

b1 PRCLb2 MUSPOP

b3 IG

SCOREb4 IAH

b5 SIZE

1; variabledefinitions: PRCL political rights and civil liberties index scores from Freedom House. 1: for

countries classified free, 2: for countries classified partially free, 3: for countries classified not free;MUSPOP proportion of Muslim population to total population of the given nation; IG-SCORE (SSB NUM CROSS PHD REP); IAH ratio of investment account holders funds to totalassets; SIZE Natural log of the banks total assets; CSR DIS CSR disclosure index score of bank;IG-SCORE consists of: SSB 1 for Islamic banks with Sharia Supervisory boards and 0 otherwise;NUM 1 for Islamic banks with 7 or more SSB members and 0 otherwise; CROSS 1 for Islamicbanks with one or more cross-members and 0 otherwise; PHD 1 for Islamic banks with one or moremembers with doctorate qualifications and 0 otherwise; REP 1 for Islamic banks with one or morereputable scholars as members of the SSB and 0 otherwise

Table V.Optimal regression model

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6. ConclusionIslamic banks have grown in size and significance in the past four decades. In line withIslamic principles, Islamic banks should fulfil an ethical role inherent in their characteras an Islamic bank. The objective of this study was to measure the CSR disclosurelevels of Islamic banks and subsequently ascertain the likely determinants of thatdisclosure. Contrary to expectations of full disclosure and accountability, it was foundthat the majority of Islamic banks disclose significantly less than expected, withapparent differences in the levels of disclosure. To explain these differences, a numberof hypotheses were derived and subsequently tested.

The significance of the variable PRCL suggests that the extent of political and civilrepression influences the level of CSR disclosure by Islamic banks. This gives weight tothe view consistent with Williams (1999) that organisations operating in relativelyrepressed societies face lower social expectations while organisations operating inrelatively open communities need to provide further justification to legitimize theirexistence. The significance of the variable MUSPOP lends weight to the hypothesis thatthe level of CSR activities and consequently disclosure will depend on the extent ofinfluence that the relevant publics have on the organisation. The combined results ofthese two hypotheses demonstrate the theoretical significance of applying levelsof resolution of perception to understand the complex interactions betweenorganisations and society in the broader socio-political environment.

The significance of the corporate governance variables lends support to the viewthat Islamic banks are also driven by economic realities. In particular, the existence ofShariah board members with cross-memberships, doctorate qualifications and/or

international reputation results in greater monitoring and hence greater compliancewith Islamic laws and principles, an output of which is higher levels of CSR disclosure.This implies that skilled scholars are required to decipher Islamic law to apply it tomodern Islamic banks, particularly with regards to CSR disclosure. Further, thesignificance of IAH rights in influencing CSR disclosures imply that Islamic banksdisclose CSR in order to bond their activities to their Islamic investors.

Overall, the results suggest that there are a number of factors whichcontemporaneously influence CSR disclosure of Islamic banks includingsocio-political pressures and economic incentives. The results here have a number ofpotential policy implications for Islamic banks and regulators. While socio-politicalfactors may restrain the level of CSR disclosure presented by Islamic banks, increasingthe level of monitoring within the banks, such as the installation of an SSB can counterthat and lead to greater CSR disclosure. As highlighted in the literature, these resultsfurther emphasize the need for Islamic banks to invest more in monitoring mechanisms,

such as greater training of SSB members to increase the confidence of the Islamicinvestors and society (Bakar, 2002). Furthermore, these results also give weight to thecontention that uniform accounting standards and Shariah rulings across the globeneed to be implemented in order to ensure a uniform level of disclosure by Islamicbanks(Dudley, 2004; Karim, 2001).

A numberof limitations, however, exist about theresultsof this paper. The samplesizeof 47 observations in 2007 is one such limitation. Further, this study only uses Islamicbanks annual reports to measure CSR disclosure. It is likely that Islamic banks also useother forms of media to communicate with investors and greater society such as companywebsites, press releases, annual general meetings, special booklets and pamphlets


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detailing their contributionto society.Using a larger sample and a larger setof informationor variables about the operating environment and individual characteristics of Islamicbanks, future research can attempt to further generalise these results and enhanceknowledge about the effect of other factors not theorised in this study, particularlyregarding transparency and social responsibility and the ensuing CSR disclosures.

Notes

1. In this paper, Islamic banks are synonymous with Islamic Financial Institutions namelycommercial banks, investment banks, and Modaraba companies.

2. The Sharia is the law of Islam derived from the Muslim holy book (Quran), the sayings anddeeds of the Prophet Muhammad (Sunnah), consensus (ijma), reasoning by analogy (qiyas),and public interest (maslaha).

3. Riba is translated strictly as usury; however Islamic scholars equate it as being equivalent tointerest.

4. Ali, 1989, The Holy Quran 2: 116; 2: 107; 3: 189; 5: 17; 18: 40.

5. Ali, 1989, The Holy Quran 33: 72. Vicegerency (istikhlaf) or trusteeship is similar to theconcept of Stewardship in Christianity.

6. Ali, 1989 The Holy Quran 102: 8.

7. Ali, 1989, The Holy Quran 22: 40.

8. Dowling and Pfeffer (2002) and Lindblom (1994) elaborate on the number of strategies thatorganisations undertake to maintain or create congruence between social values implied bythe organisations operations, and the values embraced by society, all of which require

disclosures and all of which may not be genuine attempts at social responsibility.9. Level of resolution of perception refers to the varying levels of perception through which the

social system can be analysed (Gray et al., 1995). For brevitys sake, we have concentrated ontwo levels of resolution, the broader political economy within which the organisationsinteract and the specific relevant publics with whom the organisations interact.

10. IAH funds usually comprise a mix of unrestricted and restricted mudarabah contracts.The IAH who use unrestricted mudarabah authorise their mudarib to invest their funds at itsdiscretion including co-mingling the IAHs funds with those of the shareholders. Therestricted mudarabah IAH, on the other hand specify to the bank the type of investment inwhich their funds should be invested, e.g. real estate, currencies or leasing.

11. An Islamic bank is not allowed to invest in activities that are associated with gambling,alcohol, pork and generally encouraged to invest in social development activities.

12. Islamic investors invest in Islamic banks primarily for religious reasons but also foreconomic reasons.

13. Economic investors invest in Islamic banks purely for economic reasons.

14. Annual reports may not be the only means by which Islamic banks communicate their CSRinformation. They may utilise other means such as advertising, public relations and internetsites to convey social information. Notwithstanding, Gray et al. (1995) state that the annualreport is the only document produced regularly to comply with regulatory requirements andmore importantly is central to the organisations construction of its own external image.Hence, this study only considers the information disclosed in annual reports.

15. A number of tests were conducted to confirm the normality of the distribution. Normalprobability plots and histograms of the distribution of the dependent variable (CSRDIS) andscatter plots of standardized residuals against standardized estimates of CSRDIS were

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reviewed on all models to verify that the normality and homoscedasticity assumptions werevalid. Multicollinearity tests are also conducted on all models. The variance inflation factors(VIF) range from 1 to 2 and eigenvalues and condition indices were checked to ensure therewas no excessive multicollinearity. However, caution must nonetheless be drawn ingeneralising from these results as sample size may limit the significant findings in thisstudy. Further, an expert statistician from the University of Technology, Sydney wasconsulted to ensure that the data did not violate any assumptions that are usually sacrificedwith small sample sizes.

16. Refer to Maali et al. (2003) for details on the construction of the disclosure index.

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