Name:

Mubashir Hassan Khan

SAP ID:
20441
Subject:
Corporate Governance
&
Business Ethics
Topic:
Distinct Features of Conventional
and Islamic Foundations Of
Corporate Governance (Summary)
Submitted To:
Sir Ikram Ullah

Riphah School Of Leadership

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CORPORATE GOVERNANCE- WESTERN VS ISLAMIC:
WESTERN & CONVENTIONAL Perspective:
 In modern corporate literature, the principal-agent problem arises when
ownership and managerial control are separated. The separation can be
problematic if the management acts according to their best interest instead of
doing the best interest to maximize the shareholders’ wealth.
 Corporate governance issues arise in the corporation in two situations
namely whenever there is an agency problem or conflict of interest involving
members of the organization such as board of directors, managers and
shareholders and cost of business are such that agency problem can not be
dealt with through a normal contract.
 The rationale of the existing corporate governance systems of the Anglo-
Saxon, the European and other models are undeniably due to these two
issues that need to be dealt with effectively. Each system has its own
features, represents different corporate structures and diverse aims of
corporation.
 The Anglo-Saxon model of corporate governance which is also known as
market based systems or shareholder-value system or principle-agent model
is considered as the most dominant theory championed by the United States
and the United Kingdom. Market-based system of the United Kingdom and
the United States are characterized by arm’s length relationship between
corporations and investors who are said to be concerned primarily about
short-term returns.
 For instance, a manager might not be interested to spend much money in the
company’s staff training, which will potentially increase operational cost
and reduce profit - including his salary - in the short run. On the other hand,
this type of investment has potential to increase profit for all shareholders in
a longer run. Yet, the manager might not be in his position anymore in a
long run. Therefore, it is obvious that conflict of interest potentially occurs
between the owner and the management. This point of view represents the
Shareholder Model or the Anglo-American Model of Corporate
Governance largely used by many corporations today, especially those in the
US and the UK.
 In contrast, emphasizes is given more to other stakeholder, or stakeholders
other than shareholders. This point of view represents the Stakeholder
Model or Eurpeon Model of Corporate Governance. Specifically, the

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 stakeholder model proposes that society is entitled to get positive
contribution from firms, especially big firms that have great economic and
social power, in return for ‘granting’ the firms their legal status in the
marketplace. Nevertheless, some puzzles exist in the model. It is not clear
who or what is a legitimate stakeholder, to what each stakeholder is entitled,
or how managers should balance competing demands among a range of
stakeholders. The European model or stakeholder theory rejects the three
main propositions of the American model namely all stakeholders have a
right to participate in corporate decisions that affect them, manager’s
fiduciary duty to protect the interest of all stakeholder and the corporation’s
objective to promote the interest of stakeholder and not only shareholders
 In the Conventional Models, a company objectives can be varied i.e. either
to maximize the shareholders’ profit or to maximize the stakeholders’
wealth.
 The contracts are stipulated in forms of legal law and regulation.
Nevertheless, because the western models are based on human perspective,
they tend to change overtime depends on the situation. The Sarbanes-Oxley
Act 2002 for instance, was enacted just after the Enron scandal discovered.
It designs accounting practices to prevent financial misreporting and holds
management more responsible for accurate financial reports and strengthen
the power and responsibility of board audit committees.
 The shareholder model believes that the major player whose interests are
emphasized is the shareholder or capital provider. The stakeholder model, by
contrast, places the same amount of interests (at least in theory) on
protecting the interests of other stakeholder.
 According to the conventional model, depositor is not shareholder because
their funds are insured and guaranteed. This implies that no corporate
governance mechanism is required for them.

ISLAMIC Perspective:
 Islamic perspective on corporate governance, to some extent, resembles to
the stakeholder model.
 Indeed, it provides a more solid justification regarding who can qualify as a
stakeholder and what are the rights and responsibilities that both firms and

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 their various stakeholders may assume. This framework is firmly established
in Islamic principles of property rights and contracts.
 Although all the Islamic economists or Muslim jurists agree on the concept
of Tawhid as one of the philosophical pillars of Islamic economic5 , it is
observed that little is written on the Tawhid epistemological methodology to
the issue of corporate governance.
 An Islamic corporation is “a legal entity where the principle and
proportionate of the firm’s shares owned by the shareholders based on equity
participation and profit sharing ratios and deals with legal and organizational
structures that control the internal governance of a firm with an objective to
define and attain an objective criterion by way of understanding the relations
between variables supported by policies, programs and strategic coalition” .
 A stakeholder is defined as the one whose property rights are at stake or at
risk due to voluntary or involuntary actions of the firm. This implies that a
firm is expected to preserve property rights of not only the shareholders, but
also those who have participated in the process of acquiring the firm’s
property and those who could be threatened as a result of its operation. They
also posit that any group/individuals with whom a firm has any explicit and
‘implicit’ contractual obligations qualifies as a stakeholder although the firm
may not have formal contracts with them through mutual bargaining.
 Islam also believe that a person’s daily activities and transaction should be
based on the values of truthfulness, firmness, fairness, respect for the law,
kindness, forbearance, tolerance and uprightness, instead of deceit,
haughtiness, class consciousness, ostentation, insubordination, envy,
jealousy, backbiting and self-aggrandizement. These should also naturally be
manifested in individuals’ involvement in business activities and operations
as well as their relationships with all their respective stakeholders.
 Overall, the Islamic view of corporate governance is more comprehensive
than the stakeholder view and closely related to the ethical values in Islam.
 In Islamic perspective, the main goal is clearly stated: everyone has a unity
purpose in his/her that is to serve Allah SWT. One of the consequences
would be, at least normatively, that the Islamic society will avoid having
conflicting interest among member of the society. This will inevitably lead
to a society whereby every member will cooperate with each other rather
than compete, as success in life is to obtain the ultimate happiness (falāh).
Such philosophical considerations do not exist in the conventional literature.

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  The unity of purpose in Islamic point of view marks the existence of
implicit contract, a type of contract unique to Islamic business transaction.
 The implicit contract is actually a Divine contract that requires man to
manifest the covenant (almithaq) through his submission in absolute true
willingness as prescribed by the Divine Law of Shari’ah. Indeed, the very
foundation of the Shari’ah is covenant between God and man which imposes
on man the duty of being faithful to his Lord. Failure to fulfill these
obligations means he or she has breach the Divine contract, thus equivalent
to betrayal with all the attending consequences in this world as well as in the
hereafter.
 The Islamic model is based on the Divine will and the Holy Quran that do
not change overtime. One verse of the Quran (QS 2:282), for instance,
specifically mentioned the guideline for ethical accounting practices: “…let
a scribe write down faithfully as between the parties…let him incurs the
liability dictate, but let him fear his Lord God and not diminish aught of
what he owes…let neither the scribe nor witness suffer harm…and God is
well acquainted with all things”.
 Islamic perspective shares some similarity to the stakeholder’s view, i.e. to
protect the interest of the stakeholder rather than the shareholder only, the
primary stakeholder in the case of IFIs is the God and Islam itself. If the
banks do not perform well, those who assume the Islamic system to be out
of tune with the modern world may try to blame Islam and the Divine Will
for the poor performance although they have nothing to do with that.
 In the Islamic perspective, the definition of shareholder should include the
depositors’ role. In particular, Investment Account Holders (IAHs) that
participate in PLS arrangements should act like the shareholder in the
conventional practice.

Conclusion:
 Main differences are found with regard to philosophical aspects which
include objectives of the company, types of contract involve, key players in

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 the corporate governance practice as well as the relationships between the
players.
 The difference rooted from the fact the Islamic perspective sees the
corporate governance practice as Muslim’s obligation to God, thus leads to
the existence and obedient of the ‘implicit’ contract with God and explicit
contract with humans. In the end, these placed God and Islam itself as key
players in the corporate governance practice. This is in contrast to the
conventional point of view that focuses on the material aspects.
 The design of corporate governance model in Islam has its own unique
features and presents distinctive characteristics in comparison with the
western concept of the Anglo-Saxon and the European model. The study
summarizes the diversities of these three models and classifies them into
four aspects namely the episteme, the corporate objective, the nature of
management, the management board and the capital-related ownership
structure.
 Nevertheless, as IFIs deal with more complicated financial transactions and
must comply with Shari’ah rules, it requires relatively stronger internal
control. Unfortunately, most of the tools are not being practiced yet by IFIs
either because less supporting infrastructure or insufficient human resources
are available. These constitute the main challenges for IFIs in the near
future.

As Per My Understanding:
 Although Islam as a way of life has always promoted good ethics, strong
morals, unshakeable integrity and honesty of the highest order, it is not easy
to incorporate such ethical values into an ‘Islamic’ corporate governance
standard and implement it.
 Consequently, in practice, most of ‘Islamic’ companies use the conventional
corporate governance standard which may not be consistent with the Islamic
values.
 Main differences are found with regard to philosophical aspects, including
objectives of the company, types of contract involve, key players in the
corporate governance practice as well as the relationships between the
players.
 The difference rooted from the fact that Islamic perspective sees the
corporate governance practice as Muslim’s obligation to God, thus leads to

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 the existence and obedient of the ‘implicit’ contract with God and explicit
contract with humans.
 In the end, these placed God and Islam itself as key players in the corporate
governance practice. This is in contrast to the conventional point of view
that focuses on the material aspects. In practical field, the differences are
minor. The mechanism and tools for the effective implementation of
corporate governance are relatively the same.
 Nevertheless, as Islamic financial institutions deal with more complicated
financial transactions and must comply with Shari’ah rules, it requires
relatively stronger internal control.
 Most of the tools are not being practiced yet by Islamic financial Institutions
either because less supporting infrastructure or insufficient human resources
are available. These constitute the main challenges for IFIs in the near
future.