Q1: explain how information asymmetry and self interest contribute to agency problem?

What steps can be taken to manage this agency problem? Discuss this problem and its management in the context of Islamic financial institutions. ANSWER: Agency theory is based on the separation of the ownership of a company and control over the company‟s actions. The owners, as principal, appoint an agent, the management, to manage the company on their behalf. Thus, delegating the decision-making processes to them. Agency problem occurs when the interests of owners of the company are not perfectly aligned with those of management and/or when there exists information asymmetry to the advantage of management and on the expense of owners. Information asymmetry Information asymmetry is where one party to a transaction has more or superior information about the transaction than his counterpart, creating an imbalance of power in transactions which can cause a bad deal for one party. Information asymmetry exists due to the agency contract between the owners and management and separation of ownership and control. Self interest The problem of conflict of interests arises from the fact that shareholders and management may have different aims or interests that they wish to pursue: The shareholders want to increase their income and wealth over the long term. They are therefore, concerned not only about short-term profits and dividends; they are even more concerned about long-term profitability. The managers, on the other hand, have an employment contract and earn a salary. Unless they own shares, or unless their remuneration is linked to profits or share values, their main interests are likely to be the size of their remuneration package and their status as company managers. Thus, an agency problem occurs due to differences in the interests of owners and managers. The following steps can be undertaken to manage the agency problem:
 Calls for strong corporate governance measures  Corporate governance bestows a variety of duties on directors.  CG limiting the power of the BoD.  Board Structures  To appoint independent non-executive directors to the board of directors.  Will ensure that management is monitored for operational performance.      Compensation plans Ensure the provision of appropriate incentives so agents act in the way principals wish. Linkage between performance and incentive system Basic salary, accounting- based performance bonuses, performance-based share option schemes and long-term incentive plans. Agent is offered rewards that increase with seniority.

 Threat of Firing  Managers may be forced to take shareholder maximising actions simply in order to keep their jobs and in the process protecting the interests of shareholders hence reducing goal non-congruence between shareholders and management.  Increasing the quality and quantity of information related to the behaviour of the agent.  This can be done through increasing the level of management, physical surveillance and establishment of control mechanisms such as budgeting systems.

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However it is costly and most often impractical to address the information asymmetry problem. It may raise privacy and ethical issues and are not always suitable and most of the time not welcomed by the agent. The problems of adverse selection and moral hazard mean that fixed remuneration contracts are not always the ideal solutions to organize relationships between principals and agents

 Internal and External Auditing System  Disciplinary Take-overs  Will occur in response to breakdowns of internal control systems in companies with large levels of free cash flows.  Where managers fear that they may lose their jobs following takeovers, they may react by investing these free cash flows in more efficient investment projects.  Thus, take-over bids may be initiated not only for efficiency gains but also as a way of disciplining poorly performing management.

Discuss this problem and its management in the context of Islamic financial institutions,  BoD should be accountable to the shareholders ( please refer statutory duties of directors in the PES, (no page number found, just forth page 2 slide))  Regulatory agencies (E.g. BNM, international regulators) this is the most relevant solution that can be managed Further discussions please refer PES.

Question 2 : How is the principle of independence understood and applied in corporate governance framework?

NED: Non-Executive Directors

The UK Corporate Governance Code requires the board to identify in the annual report each NED it considers to be independent. Although this is a matter for the board’s judgement, the Code sets out circumstances in which independence would usually be questionable. The board would need to explain why it considers an NED to be independent in any of these circumstances: ■ The director has been an employee of the company within the last fi ve years. ■ The director has a material business relationship with the company (or has had such a relationship within the last three years). This relationship might be as a partner, shareholder, director or employee in another organisation that has a material business relationship with the company. ■ The director receives (or has received) additional remuneration from the company other than a director’s fee, or is a member of the company’s pension scheme, or participates in the company’s share option scheme or a performance-related pay scheme. ■ The director has close family ties with any of the company’s advisers, directors or senior employees. ■ The director has cross-directorships or has signifi cant links with other directors through involvement in other companies or organisations. A cross-directorship exists when an individual is an NED on the board of Company X and an executive director on the board of Company Y, when another individual is an executive director of Company X and an NED on the board of Company Y. ■ The director represents a signifi cant shareholder.

this should not be a reason to end his appointment if he is still making a valuable contribution to the board. The QCA added that this is particularly important for smaller quoted companies.’ On the other hand. but I would expect this to be the exception and the reasons explained to shareholders. there is no change in the number of independent NEDs required on the board – the requirement remains for just two. The nine-year rule on independence The provision in the UK Code (also in the King III Code) that an NED should not be considered independent after serving on the board for over nine years arises from the general view that the independence of an NED is likely to diminish over time. as the NED becomes more familiar with the company and executive colleagues. because effective NEDs are often diffi cult to fi nd and (unlike a larger quoted company). If the board considers that a director is still independent even after nine years’ service. . Even larger quoted companies appear reluctant to lose NEDs after nine years of service. The Higgs Report commented: ‘There will be occasions where value will be added by a non-executive director serving for longer. The risk is that the NED will take more of the views of executive colleagues on trust and will be less rigorous in his questioning. when a director ceases to be independent. These criteria of independence should be applied to the chairman (on appointment) as well as other non-executive directors. and the independence of NEDs should be kept under review. the Quoted Companies Alliance (QCA) commented (in a submission to the Financial Reporting Council in 2005) that if an NED ceases to be considered independent after nine years. Circumstances may change. It is therefore worth remembering that the UK Code is pragmatic in its approach to the nineyear rule.■ The director has served on the board for more than nine years since the date of his fi rst election. he may still be considered ‘independent’ for the purposes of the corporate governance provisions. due largely to a perceived lack of potential candidates with the suitable qualifi cations to be an effective NED.

consideration should be given to the benefi ts of ensuring that committee membership is refreshed (i. although other individuals may attend at the invitation of the committee. ■ The only individuals who are entitled to attend meetings of the nomination.Protecting the independence and effectiveness of board committees As a way of protecting the independence and improving the effectiveness of board committees. the UK Corporate Governance Code includes the following supporting principles. Source P .e. membership rotation) and that undue reliance is not placed on particular individuals. ■ When deciding the chairmanship and membership of board committees. remuneration and audit committees are the chairman and members of the committee.

In a statutory test of Insolvency Act 1986 refers to what would be expected of: ‘a reasonably diligent person having both: the general knowledge. The directors hold a position of trust because they make contracts on behalf of the company and also control the company’s property. and the general knowledge. he would not be expected to possess the technical skills of a scientist. with honesty and sincerity. Directors are also subject to a duty of care. or a majority of the shareholders. . skill and diligence to the company. duty of care. skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company. and could be personally liable for losses suffered by the company as a consequence of such negligence. skill and experience that that director has. If the finance director of a scientific research company is a qualified accountant. In such a situation. Since this is similar being a trustee of the company. 3) The transaction has not been made for the benefit of the company but for the personal benefit of the director or an associate.’ A director is expected to show the technical skills that would reasonably be expected from someone of his experience and expertise. The standard of skill and care expected of a director is the higher of the skill that he has or the skill that would objectively be expected of a director of the particular company. or a single controlling shareholder. A director has a fiduciary duty to avoid a conflict of interest between him or herself personally and the company. legal action could be brought against him by the company.Q3: What is fiduciary duty. and must not obtain any personal benefit or profit from a transaction without the consent of the company. a director has a fiduciary duty to the company (not its shareholders). A director would be in breach of his fiduciary duty in carrying out a particular transaction or series of transactions in any of the following circumstances. 2) The transaction is not carried out bona fide. 1) The transaction is not in any way incidental to the business of the company. but would be expected to possess some technical skill as an accountant. ‘the company’ might be represented by a majority of the board of directors. If a director were to act in breach of his fiduciary duty. which means in good faith. skills and diligence? How are these duties relevant to directors of companies? ‘Fiduciary’ means given in trust and the concept of a trustee (as established in US and UK law) is applicable. A director should not act negligently in carrying out his duties.

this requirement arises out of his job as a manager. Unless there are particular grounds for suspecting dishonesty or incompetence. However. If a director holds an executive position in the company. or whether important information is being withheld.66-67) . If the management appears honest. a director is entitled to leave the routine conduct of the company’s affairs to the management. This contract might call for full-time attendance at the company or on its business. not out of his position as a director. (Sources: Corporate Governance Coyle PDF. because he is an employee of the company with a contract of service. such as when the board meets. pg. It is not part of their duty of skill and care to question whether the information is reliable.The duty of skill and care does not extend to spending time in the company. but at other times is not required to be concerned with the affairs of the company. a different situation arises. A director should attend board meetings if possible. The duties of a director are intermittent in nature and arise from time to time only. the directors may rely on the information they provide. It is also not a part of the duty of skill and care to watch closely over the activities of the company’s management.

By discharging their responsibilities regarding the conduct of company‟s activity and management. . It could thus lead to a reluctance of collaboration that could affect the conduct and the efficiency of auditors‟ mission Auditor rotation a good practice? In my opinion auditor rotation is not a perfect practice because. control. studies have shown that audit failures are three times more likely in the first two years of an audit engagement. It also reduces the auditee’s incentive to make an advisable change in auditors if doing so would disrupt the normal rotation schedule. Mandatory audit firm rotation increases audit costs as the first year of an audit represents the steep part of the learning curve. Since every individual will feel uncomfortable by being screened and evaluated by an external individual. However. What are the constrains faced by auditors in discharging their roles and liabilities? Is auditor rotation a good practice? Internal and external auditor‟s functions are mainly related to control and evaluation of the effectiveness of risk management. changing auditors every three to five years is considered by many to be a nonprofit best practice. they advise management and the Board of Directors (or similar oversight body) regarding how to better execute their responsibilities. internal auditors are not responsible for the execution of company activities. and governance processes threw assessment of financials information and reports conducted by companies‟ executive management.4. auditors assume a „referee‟ position which mission is to highlight misstatement and non-compliant process undertaken by employees. The costs of audit firm rotation far exceed the potential benefits Mandatory audit firm rotation can also have a perverse effect on audit quality as it reduces the audit firm’s incentive to improve quality as the end of the firm’s tenure draws near. Internal auditing frequently involves measuring compliance with the entity's policies and procedures. Therefore some constraints can arise that can be attributed for instance to reluctance from executive management to disclose and provide information that could disqualify the effectiveness of their operations and could lead to sanctions or re-adjustment decision from board of director. the same feeling can overcome when dealing with employee perception of external audit. in addition     The linkage between auditor tenure and auditor competence is real.

its members are appointed by the supervisory board. Would it be any different for Muslim countries? Boards can be classified into two general categories: 1) unitary boards or 2) two-tier board 1. In a two-tier structure. It is led by the chairman of the managing board. by including representatives on the board. Two -tier boards have two separate boards: a) the management board and b) the supervisory board. 2. It focuses on major operational issues and is headed by the chief executive. He is responsible for making sure that the two boards work well together. The supervisory board is led by the company chairman. The supervisory board is responsible for general oversight of the company and of the management board. who is the chief executive officer. It advises the management board and must be involved in decision-making on all fundamental matters affecting the company. a minimum proportion of the supervisory board must consist of representatives of the employees. the chairman will effectively speak for the management at meetings of the .tier boards are effective relationship between the chief executive (head of the management board) and the chairman (head of the supervisory board). It also has responsibility for risk management and for the preparation of the annual financial statements b) The supervisory board deals with the strategic decisions and oversees the management board. The management board is responsible for managing the company. Supervisory boards consist exclusively of non-executive directors.Q6. except that in public companies with more than 500 employees. The chairman of the company sits on the supervisory board. The audit committee consists entirely of supervisory board members. a) The management board generally includes only executives. and the chairman of the supervisory board plays a key role. The chief executive officer reports to the supervisory board chairman. Two. If the relationship between these two works well. and the most powerful individuals in the company are the chairman of the supervisory board and the chief executive officer who is in charge of the management board. and is responsible for implementing the agreed strategy. such as employees or environmental consultants. Its members are elected by the shareholders. Unitary boards include both executive and non-executive directors and make decisions as a unified group.The unitary and two-tier model of corporate governance reflects difference in socio economic orientation of societies and what they consider to be their goals. in co-operation with the supervisory board. The supervisory board is often used as a way to represent various stakeholder groups. these include ‘decisions or measures which fundamentally change the asset. financial or earnings situations of the enterprise’ (German Corporate Governance Code). there has to be a functional relationship between the management board and the supervisory board. It develops strategy for the company.

some independent supervisory board directors might well be senior managers of other companies. and in particular a good working relationship between the company chairman and the head of the management board. On the other hand. It can therefore be difficult to reconcile the differing views of employee representatives and representatives of major shareholders. As such. shareholders may be unable to voice out their expected goals of the company as their interests differ though they all expect a yield in the forms of dividends and growth in the company’s share price. Unfortunately.  . and large numbers can result in inefficient meetings. In addition. The supervisory board consists entirely of NEDs. The supervisory board NEDs are therefore not necessarily independent. Disadvantage: Supervisory boards are too big. The two-tier system encompasses a clearer. These individuals might therefore sympathise with the views of the management board. German supervisory boards include a large number of employee representatives. the two-tier system may produce certain advantages. The two-tier system also takes into accounts of the need of other stakeholders. there is a risk that the supervisory board could take a lenient and easy-going view of what management are doing.supervisory board.  Such issue can be resolved by separation of the supervision and management function as characterized by the two tier system.  It has been common to appoint retired former managers of the company to the supervisory board. without antagonizing the executives on the management board. where they are management board members. the supervisory board will be responsible for supervising and ensuring the management board to establish company’s goals on behalf of the shareholders and to identify the common interest of shareholders. where there is a large number of former executives on the supervisory board. workers’ representatives often lack the competence to consider strategic issues or are not independent from the company Advantage  For companies with a dispersed share structure. having up to 20 members. formal separation between the supervisory body and those being ‘supervised’. The management board consists entirely of executive directors.  With a dispersed share structure (outsider system). particularly employee representatives. The success of corporate governance depends on a good working relationship between the supervisory board and the management board. and these individuals might be tempted to retain some influence over the actions and operational decisions of their successors  Companies with more than 500 employees are required to have workers’ representatives or trade union representatives on the supervisory board.

the Governance Committee shall not be treated as just another Board Committee. (iii) It would be preferable for an independent non-executive director to chair the Governance Committee. the Governance Committee shall be accorded a special attention by the supervisory authorities. In Muslim world two tier boards could be more relevance since it takes into account various stakeholders such as employees. but should also be able to coordinate and link the complementary roles and functions of the Governance Committee and the Audit Committee. . Islamic framework unlike conventional does not lay too much emphasis on maximizing profitability followed by shareholder’s wealth. The Chairman of the Governance Committee should not only possess the relevant skills such as ability to read and understand financial statements.Islamic Perspective 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 IIFS’s accountabilities to various stakeholders. society etc. It is evident that recent failures in Islamic financial governance framework were due to lack of understanding between the Sharia board and products of an institution (Goldman Sachs Sukuk default). A two tier broad could help strengthen the work force environment within the firm. environment. (ii) It is necessary to include a Shari`ah scholar who is an SSB member for the purpose of leading the Governance Committee on Shai`ah-related governance issues (if any). It must be emphasized that. Instead. as the primary objective of the Governance Committee is to protect the interest of stakeholders other than the shareholders. Having a representative from each department can help in overcoming these sorts of issues. According to IFSB Governance Committee may comprise. It can help ensure better transparency between the functioning of various departments and their progression towards achievement of common goal within the best interest of all the stakeholders. and also to coordinate and link the complimentary roles and functions of the Governance Committee and the SSB. for example: (i) A member of the Audit Committee.

Rewards punished action against good practice or breaches of ethics code. . .Format document.7.Made clear to employees that they should comply with the code. public and stakeholders who was made to understand that company is responsible to future of company‟s stakeholders. . .Level of commitment and support from directors‟ input. .Code of ethics should be outlined.Adopted by board of directors.Disclosed to employees. What condition must be in place for ethical codes and practices to be part of corporate culture? . approved by the board and implemented by integrity. .Practice should be monitored and any breach of ethical conducts should be punished. .Code of ethics been adopted based on existing legislation and includes serial obligation that output to fulfill. (Top management) . .

and which guide decisions and behavior of its employees. even in the absence of regulation or resource taxes. Too many companies have lost sight of that most basic of questions: Is our product good for our customers? Or for our customers’ customers? such as refocusing on the fundamental need for better nutrition. improving value in one area gives rise to opportunities in the others. and equal treatment in the workplace. redefining productivity in the value chain. better housing. and pay down debt. working conditions. less environmental damage. Efficient use of resources . it is about expanding the total pool of economic and social value. Redefining Productivity in the Value Chain A company’s value chain inevitably affects—and is affected by—numerous societal issues. Shared value. Nor is it about “sharing” the value already created by firms—a redistribution approach. they are the greatest unmet needs in the global economy. was able to address both issues by reducing its packaging and rerouting its trucks to cut 100 million miles from its delivery routes in 2009.it recognizes that societal needs. such as natural resource and water use. define markets. Provide pertinent examples. then. Excess packaging of products and greenhouse gases are not just costly to the environment but costly to the business. Shared values are Explicit or implicit fundamental beliefs. help for the aging. Arguably. is not about personal values. There are three distinct ways to do this: by reconceiving products and markets. and members. Many so-called externalities actually inflict internal costs on the firm. health and safety. and principles that underline the culture of an organization. In business we have spent decades learning how to parse and manufacture demand while missing the most important demand of all.Q9 Shared values What are shared values? If you are responsible to manage ethics program. Excess packaging of products and greenhouse gases are not just costly to the environment but costly to the businessWal-Mart. devising ways to help utilities harness digital intelligence in order to economize on power usage. for example. Opportunities to create shared value arise because societal problems can create economic costs in the firm’s value chain. improved nutrition. Innovation in disposing of plastic used in stores has saved millions in lower disposal costs to landfills. Companies can create economic value by creating societal value. concepts. what measures would you recommend to the board to ensure such a program yields sound corporate governance practice. Reconceiving Products and Markets Society’s needs are huge—health. manage credit. saving $200 million even as it shipped more products. and building supportive industry clusters at the company’s locations. greater financial security. Each of these is part of the virtuous circle of shared value. management. Instead. developing a line of products and tools that help customers budget. not just conventional economic needs.

For example. The opportunities apply to all resources.Heightened environmental awareness and advances in technology are catalyzing new approaches in areas such as utilization of water. and packaging. Better resource utilization—enabled by improving technology—will permeate all parts of the value chain and will spread to suppliers and channels. raw materials. Landfills will fill more slowly. Coca-Cola has already reduced its worldwide water consumption by 9% from a 2004 . as well as expanding recycling and reuse. not just those that have been identified by environmentalists.

Available to all staff members on our intranet. In this case. suppliers. In analogy. the code of ethics is the soul while corporate governance is the body. The code is comprehensive in nature. Do you agree? Justify your position. Reporting of any unethical or harmful behaviour. . Disclosure of any gifts offered or received and which must be within prescribed financial parameters. 3. the company would act like a zombie that is soulless and would eat it the flesh of its own people. We cannot separate the soul to the body. 4. Compliance with all of the Group‟s standards and procedures. To corporate governance.10. 2. There is a strong relation between the two. it forms an integral part of the induction programme and all new employees agree to subscribe to the code. including the computer usage policy. A comprehensive code of ethics is sufficient to ensure good corporate governance of a company since the board has adopted a code aimed at creating a culture of the highest standards of ethics and uncompromising honesty among all employees throughout the company and its groups. shareholders and society at large. impartiality. It is because the code is founded on the principles of integrity. Separating between the code of ethics to corporate governance would cause collapse to the company. In the real life the code of ethics is like culture in a company which represent the soul of the company. Conformance with all laws and regulations. clearly outlining the full obligations of every member of staff in their dealings with fellow employees. Sound processes are in place to manage any deviations from this code. “A comprehensive code of ethics is not sufficient to ensure good governance of a company”. It requires inter alia: 1. Good corporate governance is sufficed by a comprehensive code of ethics. And no donations are made to political parties. Disclosure of any direct or indirect conflict of interest. code of ethics is the substance while the corporate governance is the form. 5. and 6. customers. between the form and the substance cannot be separated to each other. good faith. that no bribes be accepted or proffered. If it is separated. competitors. openness and accountability.

. he or he seeks advice about improper behavior or reports improper behavior.’It can act as an early warning system to the employer about improper or illegal behavior within the organization. where it is not possible to resolve the individual’s concerns through discussions with colleagues or line management. This might be the company secretary or internal audit. . crime. in good faith. breach of legal obligation.   (source : Corporate Governance Coyle pg 223) Process to ensure that whistle blowing is effectively executed  Clear documentation The internal whistle blowing procedures should be documented and a copy should be given to every employee. Malicious reporting should not be tolerated. danger to health and safety or to the environment and dangerous or illegal activity that he is aware of through his work. such as the person to whom employees should report their suspicions or concerns. Authority or personnel in charge It should set out the key aspects of the procedure.Question 11 . Whistle blowing policy is one of the anti-fraud programs.Principle and process that must be in place for whistle blowing to be useful and effectively executed are: Principle: A company might state its policy on whistle blowing in the following principle. Employer statement of commitment   . Protection to whistle blower The company will not tolerate any discrimination by employees or management in the company against an individual who has reported in good faith their concerns about illegal or unethical behavior. the public or the organisation’s own reputation.  Report improper behavior. (source : Corporate Governance Guide – Bursa Malaysia) . danger or other serious risk that could threaten customers. raises a concern about a possible fraud. How is „whistle blowing‟ viewed from Islamic perspective? ‘Whistleblowing is the popular term used when someone who works in or for an organisation. colleagues. (source : Corporate Governance Coyle pg 222) Whistle blowing is when employee speaks up about genuine concerns in relation to criminal activity. Disciplinary action will be taken against any employee who knowingly makes a false report of illegal or improper behavior by someone else.Term „whistle blowing‟ What do you understand by the term whistle blowing? Discuss the principles and processes that must be in place for whistle blowing to be useful and effectively executed. shareholders. An employee is acting correctly if.

(Although positive proof might not be required. Victimization for raising a qualified disclosure should be a disciplinary offence. An external whistle blowing route should be offered. then has to be either a duty on a Muslim or a right.       It should contain a statement that the employer takes malpractice or misconduct seriously. Islamic perspective of whistle blowing Whistleblowing being lawful in Islam. where as in the latter it can be ignored depending upon the choice of the person concerned. one can not ignore it. then whistleblowing is a "duty" because the purpose of whistleblowing is the same as that of 'enjoining goodness and forbidding wrongdoing'. (enjoining goodness) Wal Nahyi an Al Munkar (and forbidding wrongdoing) or from the point of view of Shahada (witness attestation) which is mandatory upon Muslims. In the former. However. Confidentiality Whistleblowers should be promised confidentiality. a whistleblower should be able to provide good reasons for his concern. whistleblowers will be informed about the outcome of their allegations and the action that has been taken. Outcome of investigation There should be an undertaking that. as far as this is possible. and is committed to a culture of openness in which employees can report legitimate concerns without fear of penalty or punishment.) Procedures of investigation The document should set out the procedures by which an allegation will be investigated. as far as possible. - . It should make clear that no employee will be victimized for raising a genuine concern. Clear guidelines of misconduct It should give examples of the type of misconduct for which employees should use the procedure and set out the level of proof that there should be in an allegation. if we look at it from the angle of Amru bil Maaruf . as well as an internal reporting procedure. Consequences of false allegation It should make clear that false or malicious allegations will result in disciplinary action against the individual making them.

particularly if their voting intentions at an AGM may be influenced by the non-compliance: In the UK. Refer to Page26. 34. The law applied to all public companies in the USA and also to all non-US companies that had shares or debt securities registered with the Securities and Exchange Commission (SEC). On the other hand. whereas an “apply or explain” regime shows an appreciation for the fact that it is often not a case of whether to comply or not. For example. and a view that the detailed provisions must be followed without considering whether the provisions might actually be appropriate or a suitable way of applying the governance principles in the actual circumstances. For this reason some countries have adopted what they call an „apply or explain‟ rule (or approach).12. A second approach is to establish laws and other regulations for corporate governance that companies must obey (principles-based approach). lawmakers and regulators try to prescribe in great detail exactly what companies must and must not do to meet their obligations to shareholders and clients. which says that when a company is in breach of one of its provisions. the explanation for non-compliance should be clear. the Listing Rules require listed companies to comply with the UK Corporate Governance Code or explain any non-compliance. In rules-based approaches. 40 of “CORPORATE GOVERNANCE” by BRIAN COYLE There are two different approaches to establishing a system of best practice in corporate governance. following a number of financial scandals and corporate collapses in 2001–2002 involving major corporations such as Enron. but rather to consider how the principles and recommendations can be applied. The King Code III (the governance code for South Africa) gives its reasons for doing this: ‘The “comply or explain” approach could denote a mindless response to the King Code and its recommendations. Shareholders may wish to discuss the situation with the company. and invite (or expect) companies to comply with them (rules-based approaches). not a „comply or explain‟ approach.‟ . What is the difference between rule based and principle based approaches to corporate governance? What is the difference between „comply or explain‟ and „apply or explain‟ in corporate reporting? Provide examples to support your answer. In other countries there is a view that the word „comply‟ will encourage companies to follow the provisions of a code in all its details. the UK Corporate Governance Code adopts a principles-based approach. The USA took a regulatory approach to dealing with the problems. Rules-based system was taken in the Sarbanes-Oxley Act 2002(“SOX”). a principles-based approach is designed to move away from this so called „rigid method‟ and allow for the flexibility of principles that have the potential to improve over time. without giving proper consideration to the principles that underpin the code. One approach is to establish voluntary principles and guidelines. and a number of corporate governance measures were included in SOX. This encourages a box-ticking approach.

they can use a combination of staffs from BNM and external consulting companies to evaluate the performance of the others. but may hand the responsibility for conducting the review to the senior independent director. The following questions that may provide a useful basis for assessment of board performance are set out below. Companies may also use the services of specialist external consultants.13. As for the other members of the organ. e. in other words. One approach is for the chairman to carry out the reviews personally. the potential value of external consultants has been recognised. the company should use specialist external consultants at least once every three years. directors. 1) Has the SSB properly endorsed the product? 2) Has the SSB properly approved the product before the product launch? 3) Has the SSB properly validated the operations and operation manual? 4) How often do they update the fatwa? 5) Do they keep proper record of the fatwa? 6) How often do they conduct meetings with the other organs of governance? 7) How often do they appraise the junior members of the SSB? . So in a similar note Malaysia can have the SAC member come to a firm and evaluate the SSB. and should act on the findings of the review. the chairman may be responsible for deciding on the process that should be used for the performance review. employees.103-105 For the SSB. The evaluation of the board of FTSE companies should be „externally facilitated‟ at least every three years. ■ Does the board have any specific performance objectives. and the UK Code now states that for the evaluation of the board as a whole. shariah committees and individual member of shariah committee. skills and/or background)? Are changes needed? ■ How well does the board communicate with management. key questions for evaluation include the following. possibly with advice and assistance from the company secretary. In the UK. Discuss the criteria that can be adopted to evaluate the performance of the board.g. in terms of business performance or dividend payments? How well has the board performed against any such targets? ■ What has the board contributed to the development of strategy and what has the board done to oversee the implementation of strategy and achievement of strategy targets? ■ What has the board contributed to ensuring that the company has a robust and effective risk management system? ■ Is the board concerning itself with the appropriate issues? Is the list of matters reserved for the board suitable or should it be amended? ■ Is the board an appropriate size and is the mix of members suitable (in terms of spread of experience. Alternatively. knowledge. shareholders and other stakeholders? Ref p.

and to ensure progressive refreshing of the board. so as to maintain an appropriate balance of skills and experience within the company and on the board. e. These discussions should take place well in advance of any fi nal decision about the appointment. A supporting principle in the UK Corporate Governance Code states that: ‘The board should satisfy itself that plans are in place for orderly succession for appointment to the board and to senior management. but the contract may be extended at the . If the board intends to breach the governance code by appointing the current CEO as the next chairman. A smooth succession is desirable to avoid disruptions to the company’s decision-making processes or changes in policy or direction. it would be advisable for a suitable representative of the board (e.’ Succession planning should be delegated to the nomination committee. the successor might be an existing executive manager who has been groomed for the role.g. because the individual has reached retirement age or has come to the end of a fixed-term contract. In the case of a departing CEO. The succession can also be planned well in advance. with a replacement lined up to take the place of the departing individual. The board of directors should try to ensure a smooth succession. NEDs are typically appointed in the UK for a fi xed period of three years. There should also be succession planning for NEDs. In the case of a departing non-executive chairman. The individuals holding these positions will retire or resign at some time. the chairman of the nomination committee or the senior independent director) to discuss the reasons for their choice with major shareholders and representative bodies of the institutional shareholders. so that the newly appointed individuals will have an opportunity to learn about their new role before the actual succession occurs. the successor might be an external appointment.Question 15: Why should the board be concerned about succession planning? NED: Non-Executive Directors The key positions on the board of directors are the chairman of the board and the CEO. As stated above.g.

The board should be continually refreshed. 99 – Corporate Governance. It was explained in the previous chapter that an NED is generally considered ‘not independent’ if he has been with the company for nine years or more. The nominations committee may recommend the re-appointment of an NED at the end of his fi rst year term. . when the second three-year term ends. but should be more inclined to terminate the appointment after six years. Over time. Refreshing the board calls for succession planning.end of that time for another three years and so on. The UK Code states that there should be ‘progressive refreshing of the board’. and the nomination committee should be aware when a vacancy is expected to arise and should plan in advance to appoint the type of person it considers would improve the balance of skills and experience on the board. The UK Code also includes a provision any term beyond six years for an NED should be subject to particularly rigorous review. Source P. an NED may lose some of his independence. and this is achieved by appointing a new NED when the three-year term of an existing NED reaches its end.

The Board should consider not only the financial performance but the impact of the company’s operations on society and environment. fairness and transparency. society and the environment. http://services. social and environmental issues in their core business strategy. (Sources: Corporate Governance King 3 PDF. accountability. The Board should ensure that the company’s ethics are managed effectively. Informal culture- “living” practices and language usage.pdf ) . Corporate citizenship and sustainability require business decision makers to adopt a holistic approach to economic.co.Q16: How is ethical leadership exercised by the board in the context of King III? Ethical leadership & corporate citizenship in King III: 1. Increasingly. To provide this. Such a culture consists of both formal and informal culture systems. 3. the leadership should direct the strategy and operations to build a sustainable business.bowman. Good CG requires that the Board takes responsibility for building and sustaining an ethical corporate culture in the company. A code of conduct and ethics related policies must be implemented and its implementation measured and adherence rewarded. The company’s ethics performance should also be reported and disclosed. and taking into account the company’s impact on internal and external stakeholders. Responsible leadership is categorized by ethical values of responsibility. companies view economic. while doing business ethically and considering the short and long-term impacts of the strategy on economy. The Board should provide effective leadership based on ethical foundation. A cultural approach to governing and managing the company’s ethics would ensure that ethical standard infuse both formal and informal cultural elements. Eg. responsible leadership. Good corporate governance (CG) is essentially about effective. The Board should ensure that the company is and is seen to be a responsible corporate citizen. 2. social and environmental responsibility and other social initiatives as central in doing business. Formal culture- selection and reward system.za/Brochures/OnlineServices/CorporateGovernance/CorporateGovernance-King-3.

Differences between governance and management . The management is accountable to the governing body which is in turn accountable to the owners. It is the governing body that oversees the overall function of an organization. Governance consists of a governing body. company or any institution. or the interest group of people.17. Management is the group of people who are given the authority by the governing body to achieve the desired results. which directs the management on all aspects of a company. Governance represents the will of these interest groups who manage the company. who represent a firm. How is governance is different from management? How are they similar? How are they exercised in practice? Governance can be said to be representing the owners.

and manage risks in the face of uncertainty. reduce or control risks. 2) Risk identification and assessment= especially for significant risks. forming a more robust conceptualization and tool for management.. designed to PROVIDE REASONABLE ASSURANCE regarding the achievement of objectives. internal audit is one method of monitoring the internal control system How is it similar with and/or different from enterprise risk management ****I could not find accurate answer about this question.. US (COSO) defines “internal control as a process. What do you understand by the term internal control system? How is it similar with and/or different from enterprise risk management. How are they beneficial to IFIs  This is challenging answer also. affected by an entity‟s board of directors. Committee of Sponsoring Organizations of the Tread way Commission. This enterprise risk management framework encompasses internal control.. 3) Internal controls= implemented to eliminate. and is integral to value creation and preservation.” These objectives are:  Effectiveness and efficiency of operations (through operational controls)  The reliability of financial reporting (through financial controls)  Compliance with relevant laws and regulations (through compliance controls) The COSO Framework identified FIVE elements to a system of internal control: 1) A control environment= awareness of (and attitude to) internal controls in the organization. but at least this is the starting point*** Enterprise risk management enables management to identify. management and other personnel. Risk management and internal control systems are an integral part of enterprise risk management. How are they beneficial to IFIs? An internal control system consists of a „control environment‟ and control procedures.Q18. I asked the Prof. assess. but he replayed “simply there is no such difference between ” Im sorry to not the second question fully because im still doing assignments! . 4) Information and communication= all employees who are among risk management should receive information that enables them to fulfil this task 5) Monitoring= risk controls and control system should be monitored regularly.

remuneration and nomination.Q19 Differentiate between shareholder model.org/corporate-governance/id3173/index. Single Tier Board Two tier Board Continental European model where a Supervisory Board consists solely of non-executives and a lower level management board consists of full-time managing directors. Anglo-Saxon model where executive and nonexecutive directors sit together Chairman works closely with CEO. long term growth. France and a few other European countries. especially public Seek profitability and efficiency Look for survival.iccwbo.html . The answer I got it from http://www. and there are board committees for audit. Supervisory Board totally independent from management board. enlightened shareholder model and the stakeholder model which is applicable in the case of Islamic organization of corporate governance? Shareholders model Stakeholders model Maximise shareholder value and look after shareholder interests Look after all stakeholder interests. Eastern Europe. and stability Hard-nosed and commercial Less concerned with profit than value for money Narrow Ownership Ownership concentrated in a few hands with strong power over management sometimes through an executive chairman Minority shareholders poorly protected and need independent director support Widely Held Ownership scattered with managers given a great of freedom but subject to market forces such as takeovers and proxy fights All shareholders need protection with close attention to management actions Another difference arises from the boards' traditional structures: the single tier board going usually hand-in-hand with the shareholder model and the two tier board more common in Germany.

In turn. the strategic dialogue with stakeholders leads companies towards the need to integrate sustainability into their business models In other words.pdf There is a table number 2 that I couldn’t copy and other useful diagrams ) . • Eco-efficiency and respect for the environment. one must understand the expectations of the different stakeholders which influence and are influenced by the company. • A licence to operate from and acceptance by the communities among which it operates. • Involvement with the community and strategic philanthropy. For this model: • The main objective is to maximize shareholder value. • Employee satisfaction. a synthesis of the advantages and limitations of the shareholder and stakeholder model is made. who wish to buy its products and services. • Satisfied suppliers through being treated as business partners.The Enlightened Shareholders model This model arose from the basic premise that the two models presented above are not incompatible or mutually exclusive. and act accordingly with the expectations of the main stakeholders of the company. from which the Enlightened Shareholder Model arises.suste+sam(ENG1). Thus. this means that companies should take into account aspects such as: • Ethics. ( for more details please check http://www. who wish to do the jobs available.pt/pdf/doc. • Working conditions. • Quality of products and services and customer satisfaction. • Motivated employees. The model thus attributes critical importance to companies defining relationships with their strategic stakeholders.Therefore this model starts from the principle that for the company to be successful it must have: • Satisfied customers.sustentare. • It is assumed that to create value for shareholders. • Strategic relationships with suppliers.

Audit committee approved seriously misleading accounts. Review management performance. Examples Executives encouraged misleading accounting treatment of transactions. Set company‟s values and standards. Describe the roles of the various board committees. Factors Lack of clear expectations. No enforcement. Set organization‟s strategic aims. Ensure financial and human resources are in place to meet company objectives. What factors can prevent these committees from discharging their responsibilities effectively. . Ensure company‟s obligations to shareholders are understood and met. responsibility and authenticity. Standards are not defined. Lack of leadership. Give examples. Individuals profited personally from transactions made with company that employed them. Unsound governance framework. Lack of accountability. Unstructured process and systems.20. Roles Provide entrepreneurial leadership within framework of prudent and effective risk management.

Failure to perform duties of loyalty. Board ignores complaints of whistleblowers. Greed and consolidations of power. care and diligence. skills. .- Board was ineffective in supervising actions of senior executives.

This tension heightens the importance of gatekeeper independence. Those investments were advertised as a way to diversify and thus reduce risk. Similarly. There will always be a tendency. ensure that they are free of conflicts of interest that could affect their ratings' independence. And it is critical that credit rating agencies. Gatekeepers Intermediaries or gatekeepers provide important services that benefit investors--for instance. for senior management to listen to those who generate profits rather than those who caution against excessive risk taking. market confidence suffers. credit rating agencies that evaluate a company's creditworthiness.Q21 Who are gatekeepers of the company and how do gatekeepers contribute to sound corporate governance of companies? 1. Underwriters packaged risky subprime loans into products that carried top credit ratings issued by the leading credit rating agencies. securities analysts need to provide disinterested assessments of a company's prospects not unduly influenced by their firms' investment banking activities. and securities analysts who assess its business prospects. They play crucial roles in our capital markets because they are far better equipped to gather information about companies than most investors. investors rely on them to objectively assess a company's financial statements. though frequently compensated by the issuers they rate. outside auditors who provide independent assurance that its financial condition is portrayed fairly. Consider the role credit rating agencies played in the 2008 market crisis. When their independence and integrity become compromised. particularly when times are good. and their investors trust and rely on them. while their true risks were often poorly understood and far greater than their credit ratings suggested. After all. although auditors work for issuers and report to management. Credit rating . One of the most important roles gatekeepers must play is as a check on management's tendency to focus on short-term profits at the expense of long-term shareholder value.

I got it from http://www. The proper functioning of our capital markets depends on good corporate governance--and good corporate governance depends on gatekeepers who serve directors and investors with honesty and integrity.html .forbes.agencies thus may have facilitated excessive risk taking by management.com/2010/06/21/shareholders-risk-gatekeepers-elisse-walter-leadershipgovernance-ethisphere. much to the detriment of shareholders.

such as a contract for the shareholder's company to perform renovations to the corporation's offices. For example. it could also be manage through a prudent and transparent approach by declaring interest in any transaction involving related party . . would be deemed a related-party transaction. or a company that is manufacturing tires and form a subsidiary that supply it with rubber sap will be deemed as related party transactions In transacting with the company there could be potential conflict of interest such as charging high prices or selling the company undesirable products Related party transaction can be manage through a clear define process on how the company will interact with related party in business and proper disclosure. a business transaction between a major shareholder and the corporation.Q 22 Related third party transactions What is a related party? When and how related party transactions undermine the principles and practice of governance? How can they be managed for the best interest of the company and its shareholders? A business deal or arrangement between two parties who are joined by a special relationship prior to the deal.

scope of duties and responsibilities of the SC and to define relationship and working arrangement between the SC and the SAC The Bord of Directors (BOD) shall appoint the members of the SC and the tenure shall be valid for a renewable term of two years but subject to the approval of the BNM The member of the SC shall at least either have qualification or possess necessary knowledge. Shari‟ah governance system as defined by The IFSB Guiding Principles on Shariʼah Governance System in Institutions Offering Islamic Financial Services (IFSB-10) refers to a set of institutional and organizational arrangements to oversee Shari‟ah compliance aspects in Islamic Financial Institutions (IFIs). What measures can be taken to further improve the effectiveness of Shariah committees in the case of Islamic banks? Give examples familiar to you. IFIs are not allowed to appoint any member of the SC in another IFI of the same industry To ensure that the SC would be able to function effectively.23 Critically evaluate existing standard codes of Shariah governance in the case of Islamic financial institutions. Shari‟ah Governance System in Malaysia The BNM has issued the BNM/GPS 1 that regulates the governance of SC of Islamic financial institution. the SC shall at least consisting of a minimum three members in which will be coordination by the Shari’ah secretariat of the respective IFIs . expertise or experience in Islamic jurisprudence or Islamic law of transaction With purpose of mitigating the risk of potential of conflict of interest and confidentiality issues.No. regulations and procedures in the establishment of the SC. majority of IFIs have established their own Shari‟ah board and some of them even have set up a dedicated internal Shari‟ah review unit or department to support Shari‟ah board in performing its function. to define the role. This indicates a positive development on the aspect of Shari‟ah governance system in IFIs. The objective of BNM/GPS 1 is to set out the rules. In this regard.

GCC Countries and the UK can be classified into two namely regulated via legal and supervisory requirements as in the case of Malaysia. budgeted. UAE and Qatar as minimalists approach. Malaysia is identified as a strong proponent of regulation-based approach.kyotou. 2. Each committee should identify specific tasks to be accomplished within its area of responsibility. Kuwait. 4. Management should enter into commitments for timely action on committee recommendations. Each task should be scheduled. the committee should determine whether top management is setting an appropriate Islamic ethical tone. Improve effectiveness of SC AAOIFI expects to strengthen the effectiveness of Sharia committees by facilitating evaluation of emerging financing instruments and by aiding in the implementation of Islamic ethics. UAE and Qatar or through self regulation such as in the case of Saudi Arabia and the UK. 3. Saudi Arabia as passive approach and the UK as reactive approach. Bahrain. Committee members may examine “surrogate” measures relative to compliance with . and assigned to a specific committee member. Kuwait. that is.htm) 1. based on that member‟s skills and availability. The internal auditors should be assigned the task of monitoring compliance with ethics related policies. Some of the ways improve Sharia Committees (pls refer to http://www.- The SC is legally required to produce a Shari’ah report expressing their observation on IFIs‟ compliance with Shari’ah principles (pls read http://www. Within its areas of expertise. The internal auditors should follow up on committee recommendations. Bahrain.pdf to read the other codes of shariah gov in Malaysia) The Shari’ah governance system in Malaysia.kantakji. noncompliance. should be regularly and systematically reported to the committee.ac.asafas. In term of classification from regulatory perspective.com/fiqh/Files/Accountancy/368. Open matters.jp/kias/1st_period/contents/pdf/kb3_2/07zulkifli.

. and legal actions brought against the institution. These include violations noted by regulatory bodies.Islamic ethics.

Conducts meetings independently and separately from time to time with in house shariah committee or Internal Shariah Compliance Unit. Endorsing and validating relevant documentation for new products and services. An effective Shariah committee / board should be critically aware of its responsibilities.Question 24 What is the role of a Shariah committee? When is a Shariah committee effective? Discuss the measures that can be adopted by boards of directors of IFIs and regulators to ensure their Shariah committees are effective. Understands the Shariah’s risks and the Shariah control systems aimed at addressing those risks. as needed. agreements or other legal documentation used in the IIFS’s business transactions. any opinion that it gives on Shari`ah-related issues. Overseeing the computation and distribution of zakat and any other fund to be channeled to charity. • Overseeing Shariah report in financial reporting. ii. Varies the duration of time spent for meetings. and the manner of ensuring operational compliance with any decision of the Shari`ah board. v. iv. Measure that can adopt by the board to ensure Shariah committee or board effectiveness:       Conducts its own affairs efficiently and responsibly and reviews its own performance annually. including contracts. auditor or other consultants. • Evaluating the internal and external Shariah review process. Advising the BOD on Shari`ah-related matters. and • Reviewing conflict of interest situations and related party transactions (documentation wise and product). fully understand and embrace them and recognize what is necessary to fulfill them. upon request. For this purpose. Actively engages in the appointment. iii. Ensures effective communication among those involved with the Shariah committee. Assisting and advising relevant parties that serves the IIFS. Role of Shariah board are: i. in order to meet changing and often increasing demands. . Reviewing and endorsing Shari`ah-related policies and guidelines. Shariah committee / board should assume four fundamental responsibilities to be effective: • Assessing the Shariah risks if any and Shariah control environment. replacement or re-appointment of the head of Internal Shariah Compliance Unit . vi. in written form. the conduct of meetings of the Shari`ah board. the IIFS should also have a Shari`ah Process Manual which specifies the manner in which a submission or request for Shari`ah pronouncements/resolutions should be made to the Shari`ah board. such as its legal counsel. Put on record.

.     Evaluates and assesses the performance of head of Internal Shariah Compliance Unit. Determines the Shariah review plan and adequacy of the Shariah review scope. functions and resources and that the Internal Shariah Compliance Unit has the necessary authority to carry out its work. and Ensures management is responsive to Internal Shariah Compliance Unit recommendations. Evaluates the performance of the Internal Shariah Compliance Unit. Uses Internal Shariah Compliance Unit to review the way management manages Shariah risks as well as how the risks are managed to enhance shareholder value.

Refer to IFSB No. 2. Confidentiality  Shariah board members should ensure that internal information obtained in the course of their duties is kept confidential. with adequate capability to exercise objective judgement on Shariah-related matters. it is not for sufficient for effective Shariah governance. Independence  The Shariah board should play a strong and independent oversight role. confidentiality and Consistency. It should ensure that its Shariah board strictly observes the said framework and. 1. the Shariah board should be provided with complete. Whatever best practices individual IFIs adopted. wherever possible. it is necessary for the Shariah governance system as entire industry level to have sound legal framework to resolve the issue of conflict of laws. independence. The issue of conflict of law refers to the environment where the legislative framework consists of mixed jurisdictions and mixed legal systems causes conflict of law as every transaction. products documents and operation must comply with the Shariah principles as well as other laws that are not Shariah based. What would be the key best practices of Shariah governance for IFIs as given by IFIs and other regulatory bodies? Are they sufficient for effective governance? Discuss. Competence  The IIFS shall ensure that any person mandated with overseeing the Shariah Governance System fulfills acceptable fit and proper criteria.25.  There should be a formal assessment of the effectiveness of the Shariah board as a whole and of the contribution by each member to the effectiveness of the Shariah board. adequate and timely information prior to all meetings and on an ongoing basis. The followings are the principle of Shariah governance based on ISFB.  The IIFS shall facilitate continuous professional development of persons serving on its Shariah governance. In order to fulfill their responsibilities. One is the issue of conflict of law and another issue is the difference of Shariah resolution.10 and Text from 6-24 to 6-29 The key best practices of Shariah governance for IFIs are competence. It creates the risk that the end users will . 4. The issue of difference of Shariah resolution refers to the diversity and flexibility of Shariah opinion among many Shariah scholars. In the countries of mixed legal systems as in Malaysia or in a non-Islamic legal environment such as the UK. promotes convergence of the Shariah governance standards. 3. Consistency  The IIFS should fully understand the legal and regulatory framework for issuance of Shariah pronouncements/resolutions in the jurisdiction where it operates.

To solve this issue. providing legal provision on the final authority of rulings of the Shariah board at national level. issuing universal Shariah prudential standards.be frustrated with the Islamic financial products available in the market. . there are few approaches such as establishing the Shariah board at national level.

the commoners are ignored and left in destitude. That is for Him to decide. One‟s action is accountable to the stakeholders. When the true khalifah abides by the religion. it is advisable to not point out other people‟s weaknesses. for they will not give zakat. Keep clean record of everything (disclosure) and act wisely and leave the rest to Allah. Nominate judges based on wisdom and justice. The general public (the greater stakeholders) will judge you based on what you act and also what the other rulers did in the past. Also monitor their performance. . he is the true defender of justice for the commoners. Also stay away from those that are miserly. so they need to act with care. Once everything is clear then take action with confidence. and restraint.Sayyidina Ali The key point in addition to this is that not to abuse power. If they bow to the elites. In addition. And give them good compensation that is in line with their skills and efforts. To be a fair and just ruler. one needs to show restraint and patience. justice. Use the power responsibly and always be aware that it is Allah that is the one in control of everything. We are not the one‟s to judge people‟s intention. which will disrupt the social order (hurting the greater stakeholders). The rulers are khalifas. They need to be careful how to place priority. Keep away from people who point out the weaknesses of others. Maintain good urf or custom that is good for society. Act with caution and think before you act. These people tend to hinder betterment of society (in the case of companiescorporate governance).

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