The effects of Shariah board composition on Islamic equity indices' performance

• Author: Federica Miglietta,M. Kabir Hassan,Josanco Floreani,Andrea Paltrinieri
• DOI: http://doi.org/10.1111/beer.12185
• Published date: 01 July 2018
• Date: 01 July 2018

ORIGINAL ARTICLE

The effects of Shariah board composition on Islamic equity

indices’performance

M. Kabir Hassan

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Federica Miglietta

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Andrea Paltrinieri

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Josanco Floreani

3

1

Department of Economics and Finance,

University of New Orleans, New Orleans,

Louisiana

2

Department of Economics, Management

and Business Law, University of Bari, Bari,

Italy

3

Department of Economics and Statistics,

University of Udine, Udine, Italy

Correspondence

M. Kabir Hassan, Department of Economics

and Finance, University of New Orleans,

New Orleans, LA 70148.

Email: mhassan@uno.edu

Based on a sample of 54Islamic indices over the period 2007–2014, we investigate the effect of

Shariah board members’educational background on Islamic indices’risk and return characteristics

via the screening criteria. Using a capital asset pricing model benchmark analysis, we assess the

sensitivity of Islamic indices to their conventional peers in terms of beta and derive a measure of

return (Jensen’s alpha). First, we observe that the higher the number of members in common

among the boards, the higher the risk–return profile of Islamic indices. Second, commonalities

among board members leadto standardization of the screening criteriaand to similar Islamic indi-

ces’performance. Third, we show that different betas across providers depend on the screening

criteria, while the economic educational background of board members affects performance in

terms of Jensen’s alpha. Our study aims at contributing to the governance literature related to

board composition and its importance as a possible driver of performance. In addition, given the

impressive growth that Islamic financehas experienced during the lastdecade, this topic is of great

interest to theasset management industry.

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INTRODUCTION

The impact of board composition on screening criteria and, through

them, on index performance is a question of paramount importance in

the Islamic finance asset management industry, since the activities of

Islamic financial institutions (IFIs) reached $1.89 trillion at the end of

2016 (IFSB Stability Report, 2017). In particular, Islamic funds, which

exclude fromthe investment portfolio thosestocks that are not compli-

ant with Shariah (Islamic Law), are experiencing an impressive growth.

Islamic funds track as benchmarks (actively or passively, as in the case

of Islamic Exchange Traded Funds) Islamic equity indices, whose risk

and return profile are analyzed in the present work. During the eco-

nomic downturn and the recent financial crises, we have witnessed

Islamic equity indices outperforming their conventional counterparts

due to different composition and construction mechanisms (IFSB Sta-

bility Report, 2016). These different results raise many questions

related not onlyto the construction mechanism, butalso to the choices

made by the ShariahBoard.

As a specific governance body in each IFI (Ullah, Jamali, &

Harwood, 2014),the Shariah Board must certifythat a financial product

or activity complies with the precepts andrequirements of Islamic law,

thus exerting substantial influence and control over IFIs. In the asset

management industry, each Islamic index provider has to hire eminent

Shariah scholars to sit in the Shariah Board entrusted with the

responsibilityto certify the Islamic indexmethodology. For this reason,

the Shariah board members’decisions have a direct influence on the

composition of Islamic indices. In fact, basing their judgment on their

expertise and knowledge of Islamic Law, the Shariah board members

decide whichexclusion screens and criteriahave to be imposed on con-

ventional indicesin order to derive the correspondentcompliant Islamic

one. For this reason, in our study, we wonder whether the subjective

characteristicsof the board members, such as their education(BA, MSs

or PhD in law or economics), can influence thedecisions related to the

exclusion screens, leading to a different index profile in term of risk

and return. Should the different education background of the board’s

members be able to influence the risk–return profile of the Islamic indi-

ces, mutual fund managers, who use them as benchmarks in their

investment decisions, could have an additional important set of

information.

Building on this proposition, at first, we focus on the composition

and education of the Shariah board members and, then, move to ana-

lyze if and how the board members’educational background (speciali-

zation in economics or law) can affect the performance and risk of

Islamic equity indices, through the screens.Each Shariah board member

has to be skilled both on Shariahand financial issues and, unfortunately,

this is not a common pairingof expertise. As a result, many scholars sit

on multiple boards and this shortage of suitable scholars leads to a

Shariah boardconcentration issue (Bassens,Derudder, & Witlox, 2011).

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C2018 JohnWiley & Sons Ltd wileyonlinelibrary.com/journal/beer BusinessEthics: A Eur Rev. 2018;27:2 48–259.

Received:29 March 2017

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Revised: 26 February2018

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Accepted:12 March2018

DOI: 10.1111/beer.12185