At the end of this lecture, the students should be able to:

1)Explain the meanings corporate governance

2)Discuss the importance of corporate governance from an Islamic perspective

3)Explain the corporate governance requirements for companies in Malaysia

4)Explain the corporate governance requirements for Islamic financial institutions

MGA3033 AL-TADQIQ AL SHARI'IE

 Corporate
Governance
(CG)
 Definition: The way in which companies are governed

Practices and procedures for ensuring a company is

run in such a way that it achieves its objectives.

Aim to satisfy different needs of large number of

stakeholders.

Conflict of interests between stakeholder groups e.g.

employees want higher salaries but the company
cannot afford to cut dividends to shareholders.

Conflict of interests: Board of directors and its

individual directors (i.e. remuneration and bonus) vs
- other stakeholders such as shareholders (i.e.
dividends pay out) and employees (i.e. remuneration
and employment)
 A set of processes, policies, laws affecting the way
an organization is directed, administered &
controlled
Includes relationship amongst stakeholders, management
& board of directors, employees & customers.
Decision making process by which decisions are
implemented.

Corporate governance = Urus tadbir korporat

OECD (Organization of Economic Cooperation & Development):

What makes corporate governance necessary?

Put simply, the interests of those who have effective control over
a firm can differ from the interests of those who supply the
firm with external finance. The problem is due to separation of
ownership and controlcapital providers who lack of control

over the corporation will find it risky and costly to protect

themselves from the opportunistic behavior of managers and
controlling shareholders
 A system of structuring, operating and controlling a company to achieve:

- long term strategic goal of owners; shareholders value, dominant

market share, etc.

- interests of employees such as recruitment, training, working

environment etc.

- needs of environment and local community

- work to maintain excellent relations with customers &

suppliers

- maintain proper compliance with legal and regulatory

requirements

(Sheridan and Kendall, 1992)

 Main objective of corporate governance - to ensure that the
direction of the company is in line with its objectives, and there is
an element of control in the organization.

Many corporate scandals such as Enron (1999) and Lehman

Brothers (2007) in the US and in other countries are due to
mismanagement and frauds committed by the managers, directors
and even the external auditors.

Collapses of big corporations such in the US has led to more

stringent laws (e.g. Sarbannes Oxley Law).

Even with new regulations and policies, corporate failures are

becoming a norm worldwide due mainly to lack of integrity by
directors, managers, auditors

MGA3033 AL-TADQIQ AL SHARI'IE

 Corporate failures would be minimized if proper
corporate governance has been in place.

Corporate governance is the mechanism by which agency

problems of corporation stakeholders, including the
shareholders, creditors, management, employees,
consumers and the public at large are managed and
resolved.

Transparency, accountability and adequate disclosure

are 3 essential ingredients in corporate governance.
 Shareholders wealth = the amount of capital contributed and
invested in the company.
In return the shareholders earn dividend or bonus shares based
on the companys earnings for a particular financial period.

Shareholders theory by Friedman (1987) argues for maximizing

profits and shareholders wealth within the legal and basic human
rights framework.

Stakeholders theory = corporation owned by shareholders and

directors have fiduciary duty to act in best interest of
shareholders.
They are others who are affected by the corporation suppliers,
local community, employees = stakeholders
 CG &
Islamic
perspective
 Directors are appointed by shareholders at AGM.

At all times directors must uphold their integrity in

carrying out duties & responsibilities.

In Islam, Muslim directors must ensure that Shariah

law is strictly adhered to

They are accountable not only to shareholders and

stakeholders BUT ultimately to Allah SWT

MGA3033 AL-TADQIQ AL SHARI'IE

 Application of maslahah in stakeholder management by
companies.
Maslahah = seeking something useful or removing
something harmful

Managers only make useful decisions and not pander

in activities that would be deemed harmful for the
shareholders & stakeholders.

The principle of maslahah stresses on taking into account

public interests rather than individual interests.

MGA3033 AL-TADQIQ AL SHARI'IE

Source: Asyraf (2008)

MGA3033 AL-TADQIQ AL SHARI'IE

 Daruriyyat (essentials) strive for preservation and protection of
the essential needs (religion, life, intellect, posterity and property) of
their stakeholders and public interests
Eg: welfare or basic needs of employees

Hajiyyat (complementary) beneficial to remove difficulties

Managers who have fulfilled there essential levels may want to further
extend their social responsibility commitment
Eg: provide training to staff

Tahsiniyyat (embellishments) corporations are expected to

discharge their social responsibilities activities that lead to
improvements and attainments of perfections of public life
conditions
Eg: charity, donations, provide clear information or advertisement about
products to customers
 Users of financial statements (i.e. accountants,
financial analysts, capital market investors,
shareholders) expressed concern about business
failure and accuracy of financial information prior to
failure.

Users look towards BOD for more efficient and

effective corporate governance.

Directors who follow Shariah strictly will be able to

carry out their tasks and responsibilities diligently to
ensure that there is no manipulation of accounting
numbers.

MGA3033 AL-TADQIQ AL SHARI'IE

CG requirements
for companies in
Malaysia
 Malaysian Code of Corporate Governance
(MCCG) (1999) regulates corporate practices in
Malaysia. MCCG 2007

MCCG 2012 effective on 31 December 2012.

Prescribes the role of directors, the right of
This new amendments code on CG focuses on:
shareholders,
Clarifying the the
role offunction
the board inof accountability
providing leadership, and
audit, and other
enhancing boardrelevant requirements.
effectiveness through strengthening
its composition and reinforcing its independence.
It also encourages companies to put in place corporate
All disclosure
companies listed
policies that in the principles
embody Bursa Malaysia
of good are
disclosure.
required to comply with MCCG.
Companies are encouraged to make public their
commitment to respecting shareholder rights.
Other companies are advised to observe the MCCG
(not compulsory).
 Finance Committee Report
(Malaysian Code of Corporate Governance, 1999)

Enhancing
Strengthening of legal Corporate Code of Corporate
and regulatory Governance
framework
Governance

Enhancing enforcement
(SSM (ROC), SC and BNM) Education and Training

Promoting Shareholder
Activism
A. Directors
I The Board
Every listed company should be headed by an effective board which
should lead and control the company

II Board Balance
The board should include a balance of executive directors and non-
executive directors (including independent non-executives) such that
no individual or small group of individuals can dominate the boards
decision making.

III Supply of Information

The board should be supplied in a timely fashion with information in a
form and a quality appropriate to enable it to discharge its duties.

IV Appointments to the Board

There should be a formal and transparent procedure for the
appointment of new directors to the board.

V Re-election
All Directors should be required to submit themselves for re-election
at regular intervals and at least every three years.
B Directors Remuneration
I The Level and Make-up of Remuneration
Levels of remuneration should be sufficient to attract and retain
the Directors needed to run the company successfully. The
component parts of remuneration should be structured so as to
link rewards to corporate and individual performance, in the case
of Executive Directors. In the case of non-Executive Directors, the
level of remuneration should reflect the experience and level of
responsibilities undertaken by the particular non-executive
concerned.

II Procedure
Companies should establish a formal and transparent procedure
for developing policy on executive remuneration and for fixing the
remuneration packages of individual directors.

III Disclosure
The Companys Annual Report should contain details of the
remuneration of each Director
C Shareholders.
I Dialogue between Companies and Investors
Companies and institutional shareholders should each by ready,
where practicable, to enter into a dialogue based on the mutual
understanding of objectives.

II The AGM
Companies should use the AGM to communicate with private
investors and encourage their participation.
D Accountability and Audit
I Financial Reporting
The Board should present a balanced and understandable
assessment of the companys position and prospects.

II Internal Control
The Board should maintain a sound system of internal control to
safeguard shareholders investment and the companys assets.

III Relationship with the Auditors

The Board should establish formal and transparent arrangements
for maintaining an appropriate relationship with the companys
auditors.
I Shareholder Voting
Institutional shareholders have a responsibility to make
considered use of their votes.

II Dialogue between Companies and Investors

Institutional investors should encourage direct contact with
companies including constructive communication with both
senior management and board members about performance,
corporate governance and other matters affecting shareholders
interest.

III Evaluation of Governance Disclosures

When evaluating companies governance arrangements,
particularly those relating to board structure and composition,
institutional investors and their advisers should give due weight
to all relevant factors drawn to their attention.

IVExternal Auditors
The External Auditors should independently report to
shareholders in accordance with statutory and professional
requirements and independently assure the board on the
discharge of its responsibilities under D.I and D.II above in
accordance with professional guidance.
 CG for Islamic
Financial
Institutions (IFIs)
The recent effort by Islamic Financial Services Board
(IFSB)

IFSBsGuidelines on Risk Management and Capital

Adequacy (2005)

Companies are different in many aspects from Banks

and financial institutions

Accounting and Auditing Organization for Islamic Financ

ial
Institutions AAOIFI Governance Standards
MGA3033 AL-TADQIQ AL SHARI'IE
Main Players:
Board of Directors
Management
Internal Auditor
External Auditor
Shariah Advisory Committee

Main Stakeholders:
Shareholders
Investment Account Holders (Mudarabah Investors)
Customers of Islamic financial services
 Statements of Principles
Rationales of the Principles
Proposed Structures and Processes
Recommended Best Practices
Part 1: General Governance Approach of IIFS

Principle 1.1: IIFS shall establish a comprehensive

governance policy framework which sets out the
strategic roles and functions of each organ of governance
and mechanisms for balancing the IIFSs accountabilities
to various stakeholders.

Principle 1.2: IIFS shall ensure that the reporting of their

financial and non-financial information meets the
requirements of internationally recognized accounting
standards which are in compliance with Shariah rules and
principles and are applicable to the Islamic financial
services industry as recognized by the supervisory
authorities of the country.
Part 2: Rights of Investment Account Holders (IAHs)

Principle 2.1: IIFS shall acknowledge IAHs right to monitor

the performance of their investments and the associated
risks, and put in place adequate means to ensure that
these rights are observed and exercised.

Principle 2.2: IIFS shall adopt a sound investment strategy

which is appropriately aligned to the risk and return
expectations of IAHs (bearing in mind the distinction
between restricted and unrestricted IAH), and be
transparent in smoothing any returns.
Part 3: Compliance with Shariah Rules and Principles

Principle 3.1: IIFS shall have in place an appropriate

mechanism for obtaining rulings from Shariah scholars,
applying fatawa and monitoring shariah compliance in
all aspects of their products, operations and activities.

Principle 3.2: IIFS shall comply with the Shariah rules and
principles as expressed in the rulings of the IIFSs
Shariah scholars. The IIFS shall make the rulings
available to the public.
Part 4: Transparency of Financial Reporting in respect
of Investment Accounts

Principle 4: IIFS shall make adequate and timely disclosure

to IAH and the public of material and relevant
information on the investment accounts that they
manage.
 Take note that the IFSBs Guiding Principles on Corporate Governance were issued in
December 2006.
Will the IFSB corporate governance principles be adopted by regulators in Muslim
countries as principles/ standards/ rules for their IFIs? What are the challenges? What
are the benefits?
Will adoption of corporate governance principles necessarily improve accountability?
performance? efficiency? risk management? or just cosmetics/PR exercises?
More importantly, will corporate governance alleviate risks? mismanagement?
inefficiency?
Are religious values, ethics and morality more important? or need to be practiced in
parallel with good corporate governance practices?

All the above questions and issues need further study.