Challenging the IBF model - III

Let's briefly discuss each of these three areas individually, in the sequence they are mentioned, while keeping in mind that in reality all three are interconnected in their practical impact, and thus may necessitate cross-disciplinary research:
Islamic corporate governance theory and practice The author admits that some research work has been conducted by Muslim as well as some non-Muslim scholars on this topic. Nevertheless, this work has not moved much beyond stating the obvious; for example, the idea that Islamic corporate governance model is a stakeholder model that caters to the concerns of all stakeholders and not just the interests of an organization's equity investors.
To start with, a truly distinct and meaningful Islamic corporate governance framework would be based on the proposed mechanism of an Islamic stock market, as presented earlier. There is a need to devise a new research agenda aimed at addressing practical concerns of the equity investors of the business regarding transparent information sharing and accountability of business managers. To illustrate, a few topics on this research agenda could be: how to make board processes more transparent, how to strip away the elitist status accorded to the boards and hold them fully accountable to equity investors, how to ensure regular and substantial dividend declaration, how to ensure truthful and accurate financial disclosures, how to make managers move from the short term "compliance-with-standards" mentality to potential competitive advantage in the long term that comes only with implementing a strong corporate governance mechanism in its real spirit, etc.
Also, there is a need to challenge prevalent corporate governance standards set by the West, rather than accepting them at face value. For example, Western corporate governance standards seem to present independent directors as a panacea to many lacunae in board functioning and decision-making, without any conclusive evidence about their effectiveness in fraud prevention at the board level, as depicted by many corporate scandals in the West. Therefore, Islamic corporate governance scholars could perhaps question Western pre-occupation with research on board composition, and concentrate more on discovering mechanisms that prevent negligence or wrongdoing by board members.
Islamic ethical thought Muslims need to develop their own ethical theory and moral thought philosophy based on Islamic teachings. Since Islamic principles of ethics are based on the reality of human nature and not some utopia, this research should be practice-oriented. Unless ethical principles are implemented successfully, the whole exercise of ethics research becomes akin to needless hair splitting and hopeless sermonizing. For example, according to Islamic teachings, a seller must always disclose the defects of his product while selling it. In the prevalent scenario of rampant deception even by the buyers themselves, and the competitive constraints placed on the seller by other sellers who are not following this teaching, Muslim businessmen and traders need informed guidance on how to be honest and truthful sellers and still earn a decent return on their business.
One way to illustrate the practicality of ethics in Islam is the concept of accountability given by the Holy Quran and Sunnah. On the one hand, Islam stresses upon the rich to engage in regular charity and holds them accountable for it; on the other hand, it encourages the needy, and in fact holds them accountable too, for working hard to climb out of the abyss of poverty so as to become a giver rather than a receiver of charity. Thus, Islam places a lot of emphasis on individual accountability regardless of one's economic and social status. This Islamic principle of accountability extends to business settings as well, where not just the rich business owners but also their employees at all hierarchical levels are held accountable for safeguarding each other's justified interests. The same principle of accountability could guide in designing and instituting a mechanism of checks and balances to make equity finance more transparent for the benefit of equity investors.
Therefore, while it should be explored how the ethical thought given by Islam, with justice as its cornerstone, is different from the prevalent Western theories of ethics like deontology, (rule-based ethics), consequentialism (consequences of actions is all that matters), and moral relativism (moral judgments vary depending on the situation) etc, the research focus must be on making Islamic ethical principles the realistic foundation for all business decisions and transactions in a Muslim society.
Islamic accounting In the author's view, the practice of 'creative accounting', also called 'aggressive accounting', is a major flaw in the Western accounting principles and methods which must be removed to reduce the moral hazard in equity finance. Creative accounting refers to using excessively complicated and innovative methods in accounting so as to present a largely untrue picture of the financial position of a company. The idea is to inflate profit for the company's equity holders and creditors, and to understate profit for tax purposes. Essentially speaking, creative accounting is legal as it follows existing accounting rules in their form; however, it deviates from their spirit.
While it is crucial to have a strict internal audit function, and a strong fraud prevention mechanism implemented across an organization, the author opines that an essential step to reducing moral hazard in equity finance would be to reconsider the whole Western accounting system, including its principles and methods, from an Islamic perspective, and to identify and eliminate loopholes that allow creative accounting. The accepted practice of presenting different financial figures to different types of users must also be questioned, since it creates the need as well as the opportunity to deceive.
The Islamic accounting principles and methods should be based on Islamic ideals of transparency, accountability, simplicity, and ease of understanding of the real performance of a business entity by all, be they sophisticated financial experts or common men belonging to any field of professional endeavour. This ease of understanding of financial statements, and their truthfulness, will likely attract more equity investors to a stock market based on profit-loss sharing model.
To conclude, the steps as proposed above may appear radical and idealistic in nature, however, it must be kept in mind that moral hazard has become a major problem for all economies and societies today, and the search is on to find a solution to this global epidemic. Therefore, presenting the moral hazard in equity finance as an insurmountable obstacle, as done by IBF proponents, should be unacceptable to Muslims with strong belief and a deep understanding of their faith. It is hoped that the proposals in this article would help in creating an ethical and transparent business environment in a Muslim society, and initiate the process of presenting the true, equity/profit-loss sharing-based economic and financial system of Islam to the world as a stable, just and equitable alternate to the prevalent unstable, unjust and debt-based one.
(Concluded) (The writer is a former Commonwealth Scholar for UK, and Fulbright Scholar for USA, in the field of Management with special interest in corporate governance, business ethics and sustainable business. She can be reached at [email protected]. The views expressed in this article are not necessarily those of the newspaper)