Ethical disclosure in the Shari’ah annual reports of Islamic banks: discourse on Shari’ah governance, quantitative empirics and qualitative analysis

DOIhttps://doi.org/10.1108/CG-01-2020-0037
Pages175-211
Date14 December 2020
Published date14 December 2020
Subject MatterCorporate governance,Strategy
AuthorHarun Sencal,Mehmet Asutay
Ethical disclosure in the Shariah annual
reports of Islamic banks: discourse on
Shariah governance, quantitative empirics
and qualitative analysis
Harun Sencal and Mehmet Asutay
Abstract
Purpose As an essential componentof Islamic governance for ensuring religiouscompliance, Shari’ah
annual reports (SARs) play an importantrole in providing communication between Shari’ah board (SB)
members and stakeholders.This paper aims to determine the ethical disclosurein SARs to identify how
close the Shari’ah disclosureto the standards set by AAOIFI and also substantive moralityof Islam. The
researchalso aims to examine the factors determining disclosureperformance.
Design/methodology/approach Two disclosure indices are developed to generate data from
the SARs: the AAOIFI standards for Shari’ah governance index for form related app roach, an
Islamic ethicality augmented index reflecting on substantive moralit y approach. The sample
consists of 41 Islamic banks from 15 different countries for the period of 20072014. Sampled
305 SARs were examined through disclosure analysis in line with the two indices developed for
this study. The econometric analysis was run to identify the factors determining disclosure
performance.
Findings The findings suggest that AAOIFI guidelines have an influence on the level of disclosure,
even if Islamicbanks have not adopted them. However, the level of disclosurefor the ethically augmented
index is found to be very limited with reliance on general statements in most of the cases. As part of
determining factors,the popularity of Shari’ah scholars issignificant for both indices, while the existence
of an internal Shari’ah auditing department holds some explanatory power. The adoption of AAOIFI
standards at the country level, the regulatory quality and the duration of Sharīʿah-compliance are
particularlydeterministic factors in termsof complying with AAOIFI standards for SARs.
Originality/value Although SB is themost crucial division of corporate governancein Islamic banks in
terms of securing the ‘‘Islamic’’ identity of these institutions, their most important communication
instrument, namely, SAR, has not been explored sufficiently, alongside an insufficient attempt to
constitute Islamiccorporate governance. Initially, this studyattempted to constitute an Islamic corporate
governance framework as a theoretical construct, which provides context for the empirical part of the
research and this should be considered a novel approach. Second, the empirical part of the research
aims to fill the gap observed inthe literature such as small sample size and index construction-related
matters. Thisresearch is conducted with a larger sample size as comparedto the available studies in the
literature and it has developed two indices for disclosure analysis along with developing an Islamic
morality-basedindex beside an index based on AAOIFIstandards.
Keywords Islamic banks, Disclosure analysis, Ethical disclosure, Islamic corporate governance,
Shari’ah annual report
Paper type Research paper
1. Introduction
Corporate governance (CG) has been an emerging research agenda highlighted by an
increased interest during the past decade mainly due to its essential role in the financial
Harun Sencal is based at
the Department of
Economics, Istanbul 29
May University, Istanbul,
Turkey. Mehmet Asutay is
based at the Durham
Centre for Islamic
Economics and Finance,
Durham University
Business School, Durham
University, Durham, UK.
Received 27 January 2020
Revised 3 July 2020
29 September 2020
10 October 2020
13 October 2020
18 October 2020
Accepted 29 October 2020
DOI 10.1108/CG-01-2020-0037 VOL. 21 NO. 1 2021, pp. 175-211, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 175
system and the globalisation of the economy. By playing a crucial role in the working
mechanisms of the economy, theoretical and empirical explorations of CG from different
perspectives have emerged, offering theories on the types of corporate governance
systems including outsider and insider systems (Dignam and Galanis, 2016),
information disclosure (Hermalin and Weisbach, 2012) and explanations the role of CG in
bank failures (Berger et al.,2016).
With the emergence of Islamic banks (IBs) following the 1970s, CG models in conventional
systems were studied from an Islamic perspective to explore possible conformity with
Islamic principles and viability in IBs with the objective of locating and/or developing a
distinctive GC structure for these institutions in line with Islamic operational principles (Abu-
Tapanjeh, 2009;Alam Choudhury and Ziaul Hoque, 2006;Muneeza and Hassan, 2014).
Although IBs’ CG is similar to the conventional CG in its structural and functional nature, an
essentialisation of Islamic norms, values and forms, as part of its construct, makes Islamic
corporate governance (ICG) distinct, particularly, in terms of Shari’ah governance and
accounting practices with a specific emphasis on a holistic approach intrinsic to Islam,
articulated through transparency, environmental concerns, the rights of stakeholders and
social justice (Choudhury and Hoque, 2004;Kamla et al.,2006;Kamla, 2009;Haniffa and
Hudaib, 2011;El-Halaby and Hussainey,2015a, 2015b). Thus, despite the fact that a
majority of the IBs follow shareholder CG in their operation, tempered by some twists of
Shari’ah compliancy ameliorated via the input of Islamic law or fiqh due to the realism of
market conditions, ICG is considered to be a product of Islamic Moral Economy (IME) by
essentialising the substantive morality inherent within Islam in relation to incorporating the
larger stakeholders’ interests.
Implementation of Islamic norms and values in the IBs essentialises the “Islamic identity” of
these institutions, which renders them as a separate sector, namely, the Islamic banking
sector, within the existing capitalist financial system. However, the practice evidence that
convincing the customers of Sharīʿah-compliance of IBs is more important for them than
providing Sharīʿah-compliant products and services or managing the IBs in line with the
normative expectations of the ICG principles. To assure Sharīʿah-compliance of an IB, as
well as, its products, services and operations and ensure customers’ trust in Sharīʿah-
compliance, IBs incorporate Shari’ah Boards (SB), an institution of larger ICG, in various
forms and titles, as a distinct division compared to conventional CG (Malkawi, 2013). Thus,
ICG has been relegated to the operation of SBs in a functional sense before even
attempting to constitute the ICG, as IBs aim to secure efficiency by only adopting elements
of a form-based Islamisation, thereby, ensuring Sharīʿah-compliance at the expense of
ICG’s essentialised objectiveof equity and stake-holding.
The SB constitutes one of the most important and distinguishing features of ICG in IBs. The
role of an SB is to assure those operations undertaken by IBs comply with Shari’ah rules
and principles through directing, reviewing and supervising activities within an IB (Malkawi,
2013). To provide customers with confidence in the Sharīʿah-compliance of products and
services offered by IBs, as the AAOIFI (the Accounting and Auditing Organisation for
Islamic Financial Institutions) standards identify, SBs are expected to issue an annual
Sharīʿah-compliance report to disclose the necessary information to assure stakeholders
that the operations of IBs are conducted according to Shari’ah rules and principles.
Although an SB’s annual report provides the most important intermediary between the SB
and stakeholders, the extent of disclosure by SBs varies amongst the IBs considerably
being determined by individual SB’s efforts and transparency. As a standard-setting body
for Sharīʿah-compliance in Islamic financial institutions, the AAOIFI does not possess
enforcement powers while theirstandards are form or fiqh oriented rather than reflecting the
substantive morality of Islam.
To fill the identifiable gaps in the literature, the study explores SAR disclosure levels and
performance of Islamic banks through an index developed by virtue of the application of
PAGE 176 jCORPORATE GOVERNANCE jVOL. 21 NO. 1 2021
AAOIFI standards in relation to Shari’ah governance. In addition, as mentioned above, this
study adopts a critical approach towards evaluating AAOIFI standards and constructs a
more demanding and extended index based on an ICG framework developed through the
ethical positioning of IME. This is rationalised on the grounds that IBs’ Islamic compliance
should not be limited to “legal and form” matters, and should also integrate “substance”, as
Islam promotes a comprehensive and integrated view of the world. Thus, the Islamic
morality augmented index essentialises a more detailed level of disclosure due to its
emphasis on ethical outcomes such as transparency, along with other features based on
the substantive morality argument of IME. This constitutes a significant and critical
conceptual contribution of this study to the existing body of knowledge. Consequently, this
research examines the content of SARs and their level of disclosure for 41 Islamic banks
from 15 different countries for the periodof 20072014, by applying two different indices.
An econometric analysis of SARs is conducted by examining the factors affecting such
disclosure through analysing bank-level and country-level variables, through the disclosure
data generated from the sampled banks. The empirical contribution is also significant as
this study provides the largest sample size for SAR-based disclosure analysis available in
the literature along with examining the data generated through two different sets of indices.
Finally, a brief qualitative analysis of SAR reports is attempted to render further evidence
qualifying the Shari’ah governance issues affecting IBs.
The rest of the paper flows as follows: Section 2 presents a literature review by referring to
the empirical studies available on the theme, while Section 3 provides a critical discussion
on essentialising a distinctive CG, namely, ICG, which aims at rationalising an extended
index based on IME used in this study. Section 4 discusses variables and hypothesis
development, while Section 5 presents the methodology of the study and data generation.
In Section 6, the empirical findings of disclosureand regression analysis are presented and
Section 7 culminates with the concluding remarks.
2. Rationalising the study
The existing body of knowledge demonstrates that the literature regarding good
governance and ethical disclosure, as an articulation of it, is growing in size and quality,
particularly after the corruption scandals of big corporations (e.g. Enron) and failures of
banks (e.g. Lehmann Brothers). Elmagrhi et al. (2016), for instance, explored the UK
publicly listed firms during the post-financial crisis period (20082013) in terms of their
compliance with the good governance principles and to what degree they disclose such
information. Their findings suggest that the firms differ in fulfilling the requirements and
disclosure of good governance, which can be attributed to several factors such as board
size, independent outside directors and director diversity. A similar study was conducted
by Jizi et al. (2014) to investigate the level of CSR disclosure of large US commercial banks
following the financial crisis (20092011) to reveal the impact of corporate governance
through particular characteristics on disclosure level. They also find that independent
boards of directors and larger board sizes have a positive influence on the level of
disclosure. Similar studiesto analyse the corporate governance features of IBs and the level
of their disclosure are also conducted (Azam et al.,2019;Dalwai et al.,2015;Ghosh, 2017;
Nawaz, 2017;Shehata, 2015). However,the existent paucity of literature indicates that most
of the available studies regarding the disclosure of IBs neglect to analyse SARs issued by
SBs and mostly focus on the level and determinants of disclosure of CSR or other aspects
of CG in IBs (Al-Baluchi, 2006;Darmadi,2013;Farook et al., 2011;Hameed and Sigit, 2005;
Rahman et al.,2010;Hassan and Syafri Harahap, 2010;Aribi and Gao, 2010;Mallin et al.,
2014).
As a peculiar feature of corporate governance in IBs, investigation of SAR is crucial from
both good governance and IME perspectives. Literature, where it exists, focussing on the
level of disclosure in SARs is scarce and rudimentary. For instance, Md Rahin (2009)
VOL. 21 NO. 1 2021 jCORPORATE GOVERNANCE jPAGE177

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