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AAOIFI Governance Disclosure in Islamic Banks: Its Determinants and Impact on Performance

Tawida Elgattani
By Tawida Elgattani
3 weeks ago
AAOIFI Governance Disclosure in Islamic Banks: Its Determinants and Impact on Performance

Fiqh, Gharar, Islam, Islamic banking, Maqasid, PLS, Riba, Salam, Shariah, Sunnah, Takaful, Zakat, Provision, Sales

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  1. AAOIFI Governance Disclosure in Islamic Banks : Its Determinants and Impact on Performance Tawida Elgattani The thesis is submitted in partial fulfilment of the requirements for award of the degree of Doctor of Philosophy in Accounting at the University of Portsmouth Portsmouth Business School University of Portsmouth December 2018
  2. Surah Ash-Shuraa (36)
  3. Abstract This thesis investigates the level , determinants and consequences of the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) governance disclosure in Islamic Banks (IBs) that mandatorily adopt AAOIFI standards. The aims of this thesis are as follows: first, to measure the level of AAOIFI governance disclosure; second, to identify the determinants of AAOIFI governance disclosure; and finally, to examine the impact of AAOIFI governance disclosure on bank performance. The study uses the manual content analysis approach to measure the level of disclosure for 126 bank-year observations. The study constructed an AAOIFI governance index which includes 56 items based on AAOIFI governance, 2010. To examine the determinants and impact on the performance of AAOIFI governance disclosure, for a sample of IBs, the study used ordinary least square (OLS) regression analysis. The analysis showed that the level of AAOIFI governance disclosure is very low (about 33%) in the sample of IBs. Using CG mechanisms as potential determinants of AAOIFI governance, this research found a significant positive relationship between AAOIFI governance and audit committee size (ACs). However, it showed an insignificant relationship among AAOIFI governance disclosure and other variables (board size, board meeting, CEO, board independence and audit committee meeting (ACM)). With regard to the consequences of AAOIFI governance disclosure, the study investigated the influence of AAOIFI governance disclosure on bank performance. The study used two measurements of bank performance, return on asset (ROA) and return on equity (ROE), and the analysis showed an insignificant relationship among AAOIFI governance disclosure and bank performance. The study highlighted the implications of AAOIFI governance disclosure for users of annual reports in IBs. One of these implications is that the regulatory council and policymakers might identify the minimum level of AAOIFI governance that every bank should disclose in an annual report. Furthermore, the AAOIFI organisation should be cooperative and work closely with the central banks in the countries that mandatorily adopt AAOIFI standards, to encourage IFIs in these countries to comply with CG standards. Keywords: AAOIFI Governance, content analysis, disclosure level, Islamic Banks, Bank Performance 1
  4. Declaration “Whilst registered as a candidate for the above degree, I have not been registered for any other research award. The results and conclusions embodied in this thesis are the work of the named candidate and have not been submitted for any other academic award” Tawida Elgattani Date: 20/01/2019 2
  5. Acknowledgements In the name of Allah , the Lord of Mercy, the Giver of Me, and may His blessing and peace be upon our beloved Prophet Mohammed and His family. I thank Him for the blessing and for giving me the patience and assistance for me to fulfil this thesis successfully. The Prophet (PBUM) said: “He who does not thank the people is not thankful to Allah.” I have benefited from plenty of people help, encouragement and direction. I want to take this opportunity to thank all of those who have driven me to output this work. I would like to express my gratitude, and heartfelt thanks to my director of the study, Professor Khaled Hussainey, whose precise and precious supervision has led me towards the accomplishment of this study. I cannot forget his continuous precious help, inducement and propositions. I have learned more important things from him than just studying: I have learned how to behave, to have patience and to give to other people, especially those who need help and support. Great thanks as well to Dr Antonios Kallias, my second supervisor, for his feedback and comments. I want to especially express my truthful appreciation to Professor Mehmet Asutay (Durham University) my external examiner and Dr. Ahmed Aboud, my internal examiner, for their valuable comments and propositions which assisted to progress the last version of this thesis significantly. My heartfelt thanks also to my parents, for their unlimited kindness, sacrifice and help. “And lower to them the wing of humility out of mercy and say, ‘My Lord, have mercy upon them as they brought me up [when I was] small.’” (Al-Israa: 24). My deep thanks also to my sisters, brothers and sisters-in-law for their continued love and moral support. A very special thanks to my brother-in-law, Khaled Habil, for his unlimited support since the first day we came to the UK. Most importantly, I am very grateful to my lovely husband, Khaled Almagbari, for his support, patience and love through my PhD journey. Furthermore, my deep thanks to my wonderful children, Rofeida and Ali, for their love and patience during my studies, they have kept me merry with their cheerfulness, smiles and laughter. I love them dearly, and I hope they will be successful in their life. In addition, I am also thankful for the academics and colleagues in the Department of Accounting and Financial Management at the University of Portsmouth, especially to Dr Awad Ibrahim and 3
  6. Amal Yamani , who supported me and gave me encouragement throughout this research. I owe special thanks to Professor Adel Ahmed, Dr Zakaria Aribi and Dr Tasawar Nawaz for their feedback on my index. I am thankful to Dr Rihab Grassa for her assistance, particularly regarding the data of financial ratios in IBs. I want to thank Souzan Mahmoud, who helped me to learn how to access Fitch Connect and collect the relevant financial statements. In line with this academic support, my special thanks go to Professor Ibrahim Balkir, Dr Adel Sarea, Dr Mohammed Alswaidan and Mr Farrukh Raza, who gave me the opportunity to discuss my research findings with them. I am thankful for Durham University for organising the Islamic Finance Summer School which I attended in 2017. This gave me the chance to meet plenty of professionals and academics who gave me beneficial recommendations for my studies. Last but not least, I also gratefully acknowledge the financial support given to me from my country, Libya; I hope that peace will be restored to you soon. Lastly, I believe I owe an apology to anyone who has assisted and supported me in achieving my PhD but whom I have forgotten to acknowledge here. 4
  7. Contents Abstract ..............................................................................................................................................1 Declaration .........................................................................................................................................2 Acknowledgements ............................................................................................................................3 Contents..............................................................................................................................................5 List of Tables .......................................................................................................................................8 List of Figures ......................................................................................................................................8 List of Abbreviations ..........................................................................................................................9 Chapter 1: Introduction....................................................................................................................10 1.1 Overview.................................................................................................................................10 1.2 Research Motivation ..............................................................................................................11 1.3 Research Objectives ...............................................................................................................13 1.4 Research Questions ................................................................................................................13 1.5 Potential Contributions of the Research ...............................................................................14 1.6 Summary of Empirical Results ...............................................................................................15 1.7 Research Implications ............................................................................................................16 1.8 Structure of the Thesis ...........................................................................................................17 Chapter 2: Conceptual and Theoretical Framework .......................................................................18 2.1 Overview.................................................................................................................................18 2.2 Part One: Background on Islamic Banks ................................................................................18 2.2.1 Historical and Development of the Islamic banking ......................................................18 2.2.2 The principles of Islamic banking....................................................................................20 2.3 Part Two: Corporate Governance and Accountability ..........................................................25 2.3.1 General introduction to corporate governance .............................................................25 2.3.2 Corporate Governance Based on an Islamic Standpoint ...............................................25 2.3.3 Accounting, auditing and governance standards for Islamic financial institutions ......27 2.4 Part Three: Theoretical Framework.......................................................................................34 2.4.1 Agency theory ...................................................................................................................35 2.4.2 Signalling theory................................................................................................................36 2.4.3 Stakeholder theory............................................................................................................37 2.4.4 Accountability theory ........................................................................................................38 2.5 Chapter Summary...................................................................................................................39 Chapter 3: Literature Review and Hypotheses Development .............................................................40 3.1 Overview.................................................................................................................................40 5
  8. 3 .2 Part 1: The Quality of Corporate Governance Disclosure in the Annual Reports of Islamic Banks.............................................................................................................................................40 3.2.1 Prior studies on corporate governance disclosure in IFIs ...................................................40 3.3 Part 2: The Determinants of AAOIFI Governance Disclosure ...............................................46 3.3.1 Corporate governance characteristics ...............................................................................46 3.4 Part 3: The Impact of AAOIFI Governance Disclosure on Financial Performance. ...............52 3.4.1 Corporate governance mechanisms and firm-specific characteristics (control variables) ..58 3.5 Chapter Summary...................................................................................................................62 Chapter 4: Research Methodology .....................................................................................................63 4.1 Overview.................................................................................................................................63 4.2 Research Philosophy ..............................................................................................................63 4.3 Research Approach ................................................................................................................64 4.4 Research Methodology ..........................................................................................................65 4.5 Sample and Data ....................................................................................................................66 4.6 Content Analysis .....................................................................................................................68 4.7 AAOIFI Governance Index ......................................................................................................68 4.8 Validity and Reliability of the AAOIFI Governance Index .....................................................73 4.9 AAOIFI Governance Disclosure Determinants.......................................................................76 4.9.1 Regression model ..............................................................................................................76 4.9.2 Firm characteristics as a control variable...........................................................................76 4.10 AAOIFI Governance Disclosure Consequence .....................................................................79 4.10.1 Regression model ............................................................................................................79 4.11 Chapter Summary ..................................................................................................................81 Chapter 5: Results of AAOIFI Governance Disclosure Level ................................................................82 5.1 Overview.................................................................................................................................82 5.2 Level of AAOIFI Governance Disclosure in Banks and Countries ..........................................82 5.3 Level of disclosure by year .....................................................................................................87 5.4 Level of disclosure by dimensional analysis ..............................................................................88 5.5 Chapter Summary ....................................................................................................................89 Chapter 6: Findings and Discussion of Determinants of AAOIFI Governance Disclosure (empirical results) ...............................................................................................................................................90 6.1 Overview ..................................................................................................................................90 6.2 Descriptive analysis ..................................................................................................................90 6.3 Bivariate Correlation ................................................................................................................92 6.4 Checking normality ..................................................................................................................95 6.4.1 Graphical method .............................................................................................................95 6
  9. 6 .4.2 Numerical method ............................................................................................................96 6.5 Regression analysis ..................................................................................................................98 6.5.1 Independent variables for corporate governance characteristics ....................................100 6.5.2 Control variables of firm characteristics ..........................................................................103 6.6 Endogeneity Problems ...........................................................................................................104 6.6.1 Estimation of a lagged structure......................................................................................105 6.7 Chapter Summary ..................................................................................................................108 Chapter 7: Findings and Discussion of the Impact of AAOIFI Governance Disclosure on Performance ........................................................................................................................................................109 7.1 Overview ................................................................................................................................109 7.2 Descriptive analysis ................................................................................................................109 7.2.1 Return on asset and return on equity ..............................................................................109 7.2.2 Independent variable and control variables ....................................................................110 7.3 Bivariate Correlation ..............................................................................................................110 7.4 Checking normality ................................................................................................................112 7.4.1 Graphical method ...........................................................................................................112 7.5 Regression analysis ................................................................................................................114 7.6 Endogeneity Problems ...........................................................................................................119 7.6.1 Lagged Structure and Consequences of AAOIFI Governance Disclosure ..........................119 7.7 Chapter Summary ..................................................................................................................121 Chapter 8: Conclusion ......................................................................................................................122 8.1 Overview...............................................................................................................................122 8.2 Main Findings and Contributions.........................................................................................122 8.3 Critical Reflections on the Results .......................................................................................124 8.4 Research Implications ..........................................................................................................125 8.4.1 Theoretical implications ..................................................................................................125 8.4.2 Practical implications.......................................................................................................126 8.5 Research Limitations and Suggestions for Future study .....................................................127 8.6 Epilogue ................................................................................................................................128 References .......................................................................................................................................129 Appendix A: sample of AAOIFI Governance disclosure index ..................................................152 Appendix B: A Summary of Literature Looking at How Corporate Governance Mechanisms Affect the Level of Disclosure .....................................................................................................162 7
  10. List of Tables Table 3 .1: Outline Of Previous Studies on Corporate Governance Disclosure in Islamic Financial Institutions ........................................................................................................................................42 Table 3.2: A Summary of Literature Connecting Corporate Governance Disclosure and Performance .....................................................................................................................................54 Table 4.1: Comparison of Positivism and Interpretivism ..................................................................64 Table 4.2: Sample of this Current Study (IBs that Adopt AAOIFI Standards as Mandatory) ............67 Table 4.3: AAOIFI Governance Index ................................................................................................70 Table 4.4: Pilot Study ........................................................................................................................75 Table 4.5: Summary of Dependent, Independent and Control Variables ........................................79 Table 4.6: A Summary of Dependent, Independent and Control Variables, Definitions and Measurements That Are Used To Examine Firm Performance ........................................................80 Table 5.1: Disclosure Level by Bank ..................................................................................................85 Table 5.2: Average Level of Disclosure across All Countries in the Sample ......................................86 Table 5.3: Descriptive Statistics of AAOIFI Governance Disclosure Level for the Sample Period 2013–2014 ........................................................................................................................................87 Table 5.4: T-test Result Comparing Differences Between 2013/2014 .............................................87 Table 5.5: T-test Result Comparing Differences between 2013/2015..............................................88 Table 6.1: Descriptive Statistics of the Variables ..............................................................................92 Table 6.2: Pearson Correlation Matrix ..............................................................................................94 Table 6.3: Normality Testing One-Sample Kolmogorov-Smirnov Test .............................................97 Table 6.4: Regression Result: Determinants of AAOIFI Governance Disclosure ...............................99 Table 6.5: Regression Results of Estimated Lagged Stricture for the AAOIFI Governance Disclosure Model ..............................................................................................................................................107 Table 7.1: Descriptive Statistics of the Consequence of AAOIFI Governance Disclosure ...............109 Table 7.2: Result of the Correlation Analysis of the Consequence of AAOIFI Governance Disclosure ........................................................................................................................................................111 Table 7.3: Regression Result: Consequences of AAOIFI Governance Disclosure (ROA) .................117 Table 7.4: Regression Result: Consequences of AAOIFI Governance Disclosure (ROE) .................118 Table 7.5: Regression Results of Estimated Stricture for Consequences of AAOIFI Governance Disclosure ........................................................................................................................................120 List of Figures Figure 4.1: Deductive Process ...........................................................................................................65 Figure 4.2: Inductive Process ............................................................................................................65 Figure 6.1: Normal P-P Plot of Regression Standardized Residual of Determinants of AAOIFI Governance Disclosure .....................................................................................................................95 Figure 6.2: Histogram of Determinants of AAOIFI Governance Disclosure ......................................95 Figure 7.1: Histogram of consequences of AAOIFI Governance disclosure measured by ROA ......112 Figure 7.2: Normal P-P Plot of Regression Standardized Residual (ROA) .......................................112 Figure 7.3: Histogram of AAOIFI Governance disclosure measured by ROE ..................................113 Figure 7.4: Normal P-P Plot of Regression Standardized Residual .................................................113 8
  11. List of Abbreviations AAOIFI CG ACs ACM BM CEO IBs IFIs ROA ROE LEVE F .SIZE LQ ASSET GTH SSB SR BOD OLS OECD GCC AGC IAHs ISR BNM IFSB BCBS IFRS PLS 9 Accounting and Auditing Organisation for Islamic Financial Institutions Corporate Governance Audit Committee Size Audit Committee Meeting Board Meeting Chief Executive officer Islamic Banks Islamic Financial Institutes Return On Asset Return On Equity Leverage Firm Size Liquidity Asset Growth Sharia Supervisory Board Sharia Review Board Of Directors Ordinary Least Square Organisation for Economic Co-operation and Development Gulf Cooperation Council Audit and Governance Committee investment account holders Internal Sharia Review Bank Negara Malaysia Islamic Financial Services Board Basel Committee on Banking Supervision International Accounting Standards Board Profit and Loss Sharing
  12. Chapter 1 : Introduction 1.1 Overview The Islamic banking industry has expanded dramatically universally. According to Ernst and Young (2015), the global Islamic assets held by conventional banks reached over US $1.8 trillion in 2013. In fact, since there has been more attention in financial institutions on the progression and development of Islamic banking, the corporate governance (CG) of Islamic banks (IBs) has become more developed and seems to be more of a challenge (Grassa, 2016). In addition, CG has a greater level of importance in financial institutions and has become a fundamental role in reducing the owner-management conflicts, since banks have begun to mobilise public saving, depend on public trust and have more diverse stakeholders (Darmadi, 2011). It is important to consider the concept of CG in relation to Islamic banking in order to maintain this accomplishment and to further ensure the success of Islamic banking (Sulaiman et al., 2015). So, IFIs must be guided to achieve their objectives in line with Sharia principles (Zain et al., 2015). Bandsuch et al. (2008: 101) define CG in the following way: “Corporate governance (CG) refers to the variety of principles and practices that direct the core processes and relationships of business. More specifically, CG reflects the formalised values and procedures implemented by the business’s recognised authority (e.g., owners, directors, and managers) in its various operations and interactions with stakeholders”. From the Islamic perspective, CG is a system that ensures accountability and responsibility regarding Islamic principles and fairness to all stakeholders (Matoussi and Grassa, 2012). According to Hasan (2011:30), the concept of Sharia governance is “peculiarly exclusive and unique to Islamic system financial management”. Sharia governance has a unique character in the Islamic system of financial management. The concept of good CG includes three crucial issues, namely transparency, disclosure and accountability, to ensure the protection of all stakeholders, including minority shareholders (Paino et al., 2011). Disclosure is the primary focus of the accountability function of IBs to its stakeholders (Ismail, 2015). According to the AAOIFI (2010), the annual reports of IBs should disclose all fundamental information to notify society about their operation. Thus, IBs should disclose as much information as possible in a succinct, truthful and comprehensive way to their stakeholders (Haniffa and Hudaib, 2007). Societies also might drive IBs to improve their transparency and show a higher level of support to their stakeholders with regard to improving their ethical behaviour (Al-Qadi, 2012). To the best of the researcher’s knowledge, there is a limited amount of research that has explored the level of AAOIFI governance disclosure among IBs that mandatorily adopt AAOIFI 10
  13. standards . However, previous studies have not examined the factors that affect levels of AAOIFI governance disclosure for IBs that have mandatorily adopted AAOIFI standards. A number of CG studies examined the determinants of CG disclosure level, such as (Samaha et al., 2015; Farook et al., 2011; Bhatti and Bhatti, 2009; Albassam, 2014; Abdullah, 2013). In addition, limited studies have explored AAOIFI governance disclosure in IBs, based on AAOIFI 2010 governance standards. For example, Abdullah (2013) is limited to AAOIFI governance standards No. 6 only, while other studies focus on standards No. 7 or No. 1 only (Ismail, 2015; Harun, 2016). Other studies focus on specific countries only such as, Al-Baluchi (2006) who study just Bahrain, Sudan, Qatar and Jordan, whereas Harun (2016) focuses on the Gulf Cooperation Council (GCC). Thus, this study examined AAOIFI governance disclosure for IBs that mandatorily adopt AAOIFI standards based on a comprehensive disclosure index developed using AAOIFI governance version 2010. The researcher focuses on IBs that have mandatorily adopted AAOIFI standards, because it is expected that these banks will meet most of the AAOIFI standards requirements, especially the banks that operate in Bahrain. Bahrain has a strong regulatory authority and a fairly strong accounting profession to ensure compliance. Also, IBs that mandatorily adopt AAOIFI standards will disclose at least the bare minimum amount of information required by the AAOIFI, as it is expected by the stakeholders (AI-Abdullatif, 2007). Consequently, all IBs should prepare their annual reports based on AAOIFI standards. Therefore, this study seeks to examine if IBs disclose AAOIFI governance in their annual reports, with the expectation that IBs should cover all of the AAOIFI governance standards, because investors in these banks want to ensure that their funds are used efficiently (invested based on Islamic Sharia principles). The rest of this chapter is organised as follows: 1.2 Research Motivation, 1.3 Research Aim and Objectives, 1.4 Research Questions, 1.5 Potential Contributions of the Study, 1.6 Summaries of Empirical Findings and 1.7 Structure of the Thesis. 1.2 Research Motivation Compliance with Sharia in Islamic institutions is the primary objective of CG reporting from an Islamic point of view (Baydoun and Willett, 2000). As a result, one of the objectives of CG is that IBs have a responsibility to disclose all crucial information to their stakeholders about their operations (Maali et al., 2006). Although IBs must comply with the fundamental principle of Islam in their operations and financial transactions, Arifin et al. (2005) argued that there is lack of generally accepted 11
  14. governing , supervisory guidelines and best practice, that can be adapted to the specific challenges of IBs. The AAOIFI pronouncement is designed to serve IBs in different countries, and some countries (such as Bahrain, Qatar and Sudan) have mandatorily adopted AAOIFI standards. But, at present, the AAOIFI has no power to enforce its standards. Therefore, the first motivation for this study is to look at the level of AAOIFI governance disclosure in IBs that mandatorily adopt AAOIFI standards. The researcher expects a high level of AAOIFI governance disclosure from IBs that mandatorily adopt AAOIFI standards. This is because these standards have comprehensive guidance for IFIs and that Islamic accountability is the main motivation for dealing with IBs, constituting a main competitive advantage for IFIs. In addition, one of the key objectives of accounting and reporting, from an Islamic perspective, is to ensure that the business is accountable and adheres to Islamic rules (Sharia) (Maali et al., 2006). Therefore, IBs should disclose more information in their annual reports to ensure that they have attained the level of Sharia compliance, required by all stakeholders. The second motivation for this study arises from the lack of previous research that studies the impact of CG on AAOIFI governance disclosure in IBs. There are a few studies that focus on the concept of AAOIFI governance disclosure in IBs (Vinnicombe, 2010; Ullah, 2013; El-Halaby and Hussainey, 2015; Abdullah, 2013; Haniffa and Hudaib, 2007). However, these studies have not considered all of the AAOIFI governance and have not examined all countries that mandatorily adopt AAOIFI standards. Therefore, this study attempts to fill this gap in the literature by examining the impact of CG mechanisms on AAOIFI governance disclosure in IBs. In line with the first and second motivations, the third motivation for this study arises from a lack of studies that have examined the association between AAOIFI governance and bank performance. Consequently, this study seeks to investigate and address this. The importance of CG disclosure in IBs that mandatorily adopt AAOIFI standards is established during this study, because these banks should follow these standards as much as possible to demonstrate to all stakeholders that they are compliant with Sharia. As far as the researcher knows there have only been a few studies that have examined the CG disclosure in IBs, namely Abdullah et al. (2015). Who investigated the determinants of voluntary CG disclosure in IBs in the Southeast Asian and the Gulf Cooperation Council (GCC) regions; only AAOIFI governance No. 6 was studied. 12
  15. 1 .3 Research Objectives The aim of this study is to analytically examine the AAOIFI governance disclosure levels in the annual reports of IBs that mandatorily adopt AAOIFI standards. Moreover, this research examines its determinants and effect on performance. To achieve the aim of the research, the study has these objectives: 1. To measure the level of AAOIFI governance disclosure in IBs that mandatorily adopt AAOIFI standards. 2. To investigate the influence of CG mechanisms on AAOIFI governance disclosure in IBs. 3. To investigate the influence of AAOIFI governance disclosure on IB’s performance. 1.4 Research Questions Based on the above research aim and objectives and also the research motivations, there is a clear need to undertake further research into the AAOIFI governance disclosure of IBs that mandatorily adopt AAOIFI standards, because this is lacking in previous studies in AAOIFI governance. Therefore, the following research questions have been addressed: 1. What is the level of AAOIFI governance disclosure in IBs? To answer this question, a comprehensive unweighted AAOIFI governance disclosure index is adopted in this study (Table 4.3). The unweighted approach is used to code and measure the level of disclosure of AAOIFI governance in the annual reports. Consequently, a ‘1’ is given for each item in the AAOIFI governance disclosure index in the annual report, and a ‘0’ if otherwise. Each IB will be given a score based on the total number of AAOIFI governance disclosure items in the annual report. An unweighted disclosure index means that all items are given equal scores and importance (Shehata, 2014). This was developed by the researcher to indicate the extent of AAOIFI governance disclosure in the annual reports of IBs that mandatorily adopt AAOIFI standards. 2. To what extent do CG mechanisms affect AAOIFI governance disclosure in IBs? In answering this second research question, this study focuses on the influence of the CG mechanisms on AAOIFI governance disclosure. The CG mechanisms are: board size, independent directors, number of board meetings, non-executive directors, audit committee size and number of audit committee meetings. The data of CG mechanisms are mostly gathered from the annual reports of IBs that mandatorily adopt AAOIFI standards, but the 13
  16. financial statements are collected from Fitch Connect (www.fitchconnect.com). The OLS regression model is used to test the effect of CG mechanisms on AAOIFI governance disclosure level. 3. What is the impact of AAOIFI governance disclosure on the IBs’ performance? To answer the third research question, the study used bank performance as the dependent variable and the level of AAOIFI governance disclosure as an independent variable. The OLS regression model was used to test the impact of AAOIFI governance disclosure levels on the performance of each bank. 1.5 Potential Contributions of the Research The current study is expected to offer some contributions to the governance disclosure literature in three primary ways: AAOIFI governance level of disclosure, the impact of CG mechanisms on AAOIFI governance disclosure and the impact of AAOIFI governance disclosure on the banks’ performance. First, this will be achieved through the analysis of prior studies. Many of these studies have carried out a limited analysis of AAOIFI governance disclosure only, such as Abdullah (2013), who studied one AAOIFI governance standard in her study (No. 6 only); or other study who used a general AAOIFI standards index in specific countries, Al-Baluchi (2006). The current study makes a contribution to the existing literature on CG disclosure by measuring the level of AAOIFI governance disclosure, and uses a comprehensive index based on all of the AAOIFI governance standards from No. 1 to No. 6 (that were issued in 2010). The items included in the index are selected very carefully by reading the AAOIFI governance standards. The primary approach used in the previous studies is to initially select a group of items that represent the disclosure checklist and then employ them to screen the annual report. Next, each item is divided into sub-items, based on essential points in each standard (see Table 4.3). Furthermore, the sample of IBs in this current study is different from those seen in previous studies, such as Platonova et al. (2016) who focused on 24 IBs from the GCC region, and Abdullah (2013) who examined a sample of 67 IBs from the Southeast Asian and GCC region. 14
  17. In contrast , this study includes all IBs that mandatorily adopt AAOIFI standards. These include ten countries: Bahrain, Syria, Qatar, Sudan, Tunisia, Jordan, Lebanon, Palestine, Oman and Mauritius. This study, however, excludes IBs in Lebanon and Tunisia and some banks from Sudan, because the researcher did not have access to the annual reports of these banks and, despite sending emails to these banks, they did not reply. Moreover, there has been a lot of attention on a wide range of research in recent years, which has focused on AAOIFI standards, such as El-Halaby and Hussainey (2016), Sarea (2012) and Vinnicombe (2010). However, these studies do not focus on AAOIFI governance but study AAOIFI accounting standards and CSR. The current study is the first study to focus on all of the AAOIFI governance. Secondly, the literature on CG provides mixed empirical evidence for variables related to the association between CG characteristics and the level of disclosure (Herwiyanti et al., 2015; Abdullah et al., 2015; Srairi, 2015). However, there are limited studies that have sought to conduct an analysis concerning the effect of CG mechanisms on AAOIFI governance disclosure. Therefore, the second contribution of the current study shows the main drivers for the disclosure of AAOIFI governance, by considering the impact of bank governance on the disclosure level among IBs that adopt AAOIFI standards. Finally, to the best of the researcher’s knowledge, the current study offers the first empirical evidence of the impact of AAOIFI governance disclosure in IB performance. 1.6 Summary of Empirical Results The main findings in this study are:  The level of AAOIFI governance disclosure in IBs is on average 33% per annual report. It seems that the level of AAOIFI governance disclosure in IBs that mandatorily adopt AAOIFI is very low. It is lower compared with some previous studies, such as (Paino et al., 2011; Vinnicombe, 2010; Al-Baluchi, 2006 and ElHalaby and Hussainey, 2016), which found a higher level of disclosure in IFIs.  The only CG factor that affects the level of AAOIFI governance disclosure is ACs, which is found to be statistically significant and positive at 1%, which indicates that the number of audit committee members affects the level of AAOIFI governance disclosure in IBs. 15
  18.  Regarding consequences, the study finds that AAOIFI governance disclosure has an insignificant relationship with bank performance, measured by both return on asset (ROA) and return on equity (ROE). 1.7 Research Implications The main implications in this study are: With respect to the result of the insignificant effect of AAOIFI governance disclosure on bank performance (measured using ROA and ROE ratios) ,this result confirms that IBs focus on being an effective corporate citizen and accepting their social responsibility to help develop the community, more than on how to make a profit. The result of the AAOIFI governance disclosure level demonstrates that the information related to AAOIFI governance was limited in the annual reports for the selected IBs. Thus, the regulatory council and policymakers might identify the minimum level of AAOIFI governance that every bank should disclose in the annual report. Moreover, in the future, policymakers should be more effective in supporting IBs to introduce the importance of AAOIFI governance to the staff by additional training for internal sharia review members, audit and governance members; this could potentially increase the level of AAOIFI governance disclosure. It could also be useful for the AAOIFI member to be cooperative and work extra closely with the central banks for the countries that adopt AAOIFI standards as mandatory, to ensure IBs in these countries are following the AAOIFI standards. The result of AAOIFI governance disclosure level shown in this study can be useful to the Sharia Supervisor Board (SSB) in the IBs, because the SSB can review and confirm that all of the activities are completely compliant with Sharia rules. This means that the SSB could have the authority to prohibit and evaluate the banks and guide when necessary, otherwise the SSB should disclose this information to the public. To do so, IBs will highlight their AAOIFI governance, and that, in turn, will increase their reputation and improve the faith of current clients and, as a consequence, engage with new investors and show a high level of trust from the public in IBs. This implication is supported by the result of El-Halaby et al. (2018) which suggested that IBs should improve the level of disclosure to engage more clients based on their faith and loyalty of following sharia compliance. 16
  19. 1 .8 Structure of the Thesis This thesis is structured into eight chapters. This chapter focuses on an overview of the study, looking at the motivation, research aim and objectives, research questions, potential contribution, a summary of empirical findings, and research implications. Chapter 2 focuses on the background of IBs, the characteristics of IBs and the AAOIFI (the benchmark for IBs). It also looks at the concept of CG and accountability, both in general and from an Islamic perspective, and provides a theoretical framework that has been applied in this study, such as agency, signalling and stakeholders’ theories. Chapter 3 reviews the literature related to the three research objectives: the level of CG disclosure in IFIs; the determinants of AAOIFI governance disclosure; and the impact of AAOIFI governance disclosure on IB’s performance. The chapter also develops the research hypotheses related to the determinants of AAOIFI governance disclosure and its impact on performance. Chapter 4 explains the methodology and discusses the research philosophy, strategies and research approach. The chapter explains and justifies the selection of the sample banks. In addition, it discusses the content analysis and discusses the AAOIFI governance disclosure index. Furthermore, it presents the assessment of the reliability and validity of the AAOIFI governance disclosure using the pilot study. Finally, the research design is outlined. Chapters 5, 6 and 7 present the results of the empirical findings on the level of AAOIFI governance disclosure, its determinants and its impact on IB’s performance, respectively. Finally, chapter 8 provides the concluding remarks of the thesis and presents a summary of the key findings of the research, critical reflection on the results, and discusses their implications. The remainder of the chapter shows the limitations of this research and highlights several avenues for future research. 17
  20. Chapter 2 : Conceptual and Theoretical Framework 2.1 Overview The current chapter presents a conceptual and theoretical framework used in this research. This chapter comprises of three parts: the first part shows an overview of the basic foundations that form the substance of IBs and sources of Sharia law; the second part outlines the concept of CG, both in general and from an Islamic viewpoint; moreover, the notion of accountability in Islam and the governance and guidelines of IBs (AAOIFI). The third part shows a discussion on the theoretical framework of CG through agency, signalling, accountability and stakeholder theories and from an Islamic approach identifying the contributions of these theories. 2.2 Part One: Background on Islamic Banks 2.2.1 Historical and Development of the Islamic banking Islamic banking is a banking or financing activities that comply with Islamic law (Sharia law) (Lateh et al., 2009). According to Kettell (2011), Islamic banking is based on Islamic principles that are completely different from conventional banking principles. In 1963, the first IB was instituted in Egypt, ‘The Mit Ghamr Savings Bank’. It was set up in a provincial village in the centre of the Nile Delta in Egypt and provided credit to small artisans and providers (Haron and Shanmugam, 1997, Mayer, 1985). Despite the political circumstances of the time, the bank was successful; however, in 1968 the Egyptian government closed the bank because of the changing political situation. However, the success of this IB paved the way, in 1971, for the Nasser Social Bank (Ariff and Iqbal, 2011). Another attempt was made in Malaysia, in 1968, and ‘Lembaga Urusan Tabung Haji’, was set up to help Muslim pilgrims save money for their pilgrimages (Abdullah, 2013). The progress of the Nasser Social Bank in Egypt affected many Muslim countries to establish Islamic banking (Malkawi, 2010). In 1974 the main institutionalisation derived from the foundation of the Islamic Development Bank. Therefore, this political endorsement was supplied via the organisation of the Islamic association, that was set up to represent the developmentorientated ‘World Bank’ of the Muslim world (Iqbal and Molyneux, 2005). For the past three decades, Islamic economics has been one of the quickest growing industries, and today there are more than 250 financial institutions across 45 countries (Magalhaes and AlSaad, 2013). Nowadays, IBs are the higher proportion of IFIs, extending locally and internationally over both Muslim and Western countries (Sarea and Hanefah, 2013). According to Abdullah et al. 18
  21. (2015), the percentage of assets of IBs around the world compounded with an annual increase rate of about 17% from 2009 to 2013. In addition, these assets in six core markets will reach the US $1.8 trillion by 2019. "This growth not only relates to assets but also to the products covered, this growth has outstripped corresponding developments in a complementary regulatory framework, necessitated by the unique characteristics of some Islamic contract”(Vinnicombe,2012: 78 ). In the modern world, IBs aim to enhance and improve the enforcement of the principles of Islamic law to all banking transactions, to make all stakeholders guarantee that all banking transactions are consistent with Sharia law (Paino et al., 2011). Countries that mandatorily adopt AAOIFI standards are the main leader in the Islamic banking sector. The AAOIFI standards were established in Bahrain where has a number of IBs and financial institutions. Moreover, it also hosts the General Council for Islamic Banks and Institutions. Bahrain and Sudan were the first countries to adopt AAOIFI (1998), followed by Qatar and Jordan (2002). So, the current study refers to these countries as the oldest ones that have adopted AAOIFI mandatorily. The first IB in Bahrain was set up in 1978, and today there are more than 20 IFIs in Bahrain. The total assets of IBs in Bahrain reached the US $25.4 billion by the end of 2012 (Central Bank of Bahrain, 2012). Islamic banking in Bahrain has a specific law that is different from the laws of conventional banks and, according to ministerial decision No. 6, of 1998, IFIs must mandatorily adopt AAOIFI standards (Safieddine, 2009). From 1 January 2011, Bahrain issued a CG code by the Ministry of Industry and Commerce and the Central Bank of Bahrain. This code was set up not to change company law, but to enhance the company law and ensure equal disclosure under that law (Central Bank of Bahrain, 2011). Like Bahrain, Sudan became the second country to adopt AAOIFI standards in 1998. The first IB in Sudan was the Faisal Islamic Bank of Sudan (1977); this was the first step to introduce Sudanese Islamic banks. IBs in Sudan was favoured by both the government and the people because most Sudanese people were afraid to conduct transactions with conventional banks that ran their operations based on interest (Hamdi, 1982). The main aim of the Sudanese IBs is to help and encourage society by offering support in various ways, such as supporting the agricultural sector, industrial sector and social sector (Mohsin, 2005). However, Sudan has faced some economic problems. The Sudanese foreign debt is $24 billion, and the civil war costs $1 million every day; all of these factors affect the IBs and Sudanese companies (Hussein, 2001). 19
  22. In Jordan , it is more than two decades since the implementation of IBs. The Jordan Islamic Bank was founded in 1978 and was the first IB in Jordan since then the number of IBs in Jordan have increased, (Saleh and Zeitun, 2006). The IBs in Jordan plays an important role in society by supporting different sectors in the country that require financial assistance. In addition, IBs in Jordan help the Jordanian economy by doing things in different ways to achieve their goals, such as providing training for their employees and adopting IT to provide good services for their customers. Moreover, this is helping to expand products and services of IBs to society. Qatar is also an example of a country that has adopted AAOIFI standards mandatorily. It is also one of the six greatest Islamic finance economies in the world, the total amount of Islamic assets in Qatar is over $81 billion (Tlemsani, 2015). Since 2002, IBs in Qatar have asked the Qatar Central Bank to carry out CG reports based on AAOIFI standards (Al-Baluchi, 2006; Safeddine, 2009). Karim (1996) claimed that the policies of accounting and disclosure level are different from one nation to another, and also from bank to another bank in the same nation, and occasionally from one year to another year. Farook et al., (2011) state that IBs should follow principles based on Islamic law (Sharia). The purpose of these principles should not be the maximisation of profit but should be to support society in avoiding riba (interest) and poverty (Besar et al., 2009). The main characteristic of IBs is the prohibition of interest in any activity because Islam prohibits Muslims from dealing with interest (riba). The Quran and Sunnah are the essential sources of Sharia, and it can be seen that the Quran determines the principles that are used as a control for IBs. Therefore, IBs not only have to carry out their aim of making a profit, but they also have to comply with Sharia principles (Ismail, 2015). 2.2.2 The principles of Islamic banking The major difference between Islamic and conventional finance is Sharia law, upon which the principles of Islamic finance are founded (Munir, 2013). Elasrag (2014) states that Sharia includes all sides of the life of a Muslim, besides religion, spirituality and principles, a Muslim reflects upon the social, political, cultural, legal, commercial and financial aspects of human existence. Similarly, Asyraf and Nurdianawati (2007) state that the holistic vision of Islam is a plenary and organised system of life reflected by the concept of Sharia. Sharia defined by Sardar (2003:17) as “a system of ethics and values covering all aspects of life (e.g. personal, social, political, economic and intellectual) with its unchanging bearings as well as its major means of adjusting to change”. The guidance of Sharia is given from the Holy Quran and the Sunnah of the prophet Muhammed (Peace Be Upon Him). Previous studies have discussed the principles of Islamic finance (Zaher and 20
  23. Kabir Hassan , 2001; Al-Jarhi and Iqbal, 2001; Wilson, 2006; Visser, 2013; Abdullah, 2013; Ghayad, 2008). In the following subsection, the six rules that govern Islamic investment and IFIs will be discussed. 2.2.2.1 Prohibition of interest rate (riba) El-Ashker (1987) defines the meaning of riba as the different among the amount borrowed and the amount due to be paid back. The ban of riba is mentioned in different places in the Holy Quran. For example, “Allah destroys interest and gives increase for charities” (AL-BAQARAH, 2:276) and “O you who have believed, do not consume usury, doubled and multiplied, but fear Allah that you may be successful” (ALI IMRAN, 3:130). Based on the literature, riba in Islam is considered as a notable origin of unjustified preference, where work transactions operate by employing a riba (interest) founded arrangement (Sarker, 1999). So, the ban of interest is a solution for building a right economic regulation in removing characteristics of exploitation or unjustified enrichment (Björklund and Lundström, 2005). This socalled Islamic economic system depends upon Sharia. The majority of Islamic academic state that the ban of riba in Islam is not just for religious reasons but also in order to a deeper interest for the ethical, economic and social welfare of the community ( Abdullah and Chee,2010). Different from some communities, where there is a separation between faith and country, and religion is considered to be a special issue, in an Islamic community Islam impacts the decision-making of its followers in each situation involving work. The effect of Islam on daily life, involving work practice, has been well documented in the Holy Quran and Sunnah, which are the major sources of work ethics in Islam (Aribi and Gao, 2011). Both of these sources consider riba as unfair treatment and exploitation and view it as inconsistent with the Islamic concept of fairness (Brian, 2011). According to Asutay (2010b:25), the origin of financial dis-optimality and socioeconomic unfairness is interested (riba), which is crucial for ensuring a “stable and socially affiant economic environment”. The aim of the prohibition of riba from the Islamic banking system is to protect all stakeholders’ interest (Iqbal and Molyneux, 2005). This aim is achieved not only by following the Sharia role but also from noting the importance of CG in Islamic banking. For example, AAOIFI governance standards state that IFIs should treat equity holders fairly and make sure all transactions do not contravene Sharia. Shares in profit and losses between creditors and entrepreneurs are accumulated and distributed in an equitable method, and this reflects real productivity and social justice (Askari et 21
  24. al ., 2010). So, the sharing of profit and risks of loss (PLS) is used in IFIs to replace the interest rate as a method of resource distribution and financial intermediation. 2.2.2.2 The sharing of profit and the risks of loss (PLS) The Islamic financial system supports the notion of PLS. This notion mentions fairness between the parties in regard to the financial transaction. According to Biancone and Maha (2014), lender and borrower are allowed to share a profit or ROA. In general, Islamic finance is interested in economic balance, fairness and the distribution of equality in society. The regulation of Islamic banking that is according to PLS has a further accountable process to lending, in addition to creating reasonable and quality operations (Khan and Mould, 2008). This accountability is important in IFIs as it helps to save the benefits of its stakeholders. Therefore, it is a challenge for IFIs to ensure there is development in all relevant areas of CG (Chapra, 2007). The aim of CG, in relation to IFIs, is being accountable by extending the level of disclosure beyond a financial focus to ensure and protect all stakeholders. The important issues regarding CG need to be coordinated with matters regarding the PLS system. The complicated accountability framework in IFIs brings about enquiries from stakeholders, which mean IFIs should follow a good Sharia compliance system (Majid et al., 2011). Based on Maqasid Al-sharia, the purpose of Sharia in any activity, including financial activity, is to encourage human welfare while providing the maximum number of objectives. Al-Ghazali defines Maqasid Al-Sharia, for instance, “Promoting the well-being of all mankind, which lies in safeguarding their faith (din), their human self (nafs), their intellect (aql), their posterity (nasl) and their wealth (mal)” (Chapra, 2000:118). Therefore, the concept of PLS in relation to the Maqasid Al-sharia method is to avoid inequality between all parties and to ensure fairness in society, as mentioned by Asutay (2007b), who regards the Islamic morals and principles of the individual, and their well-being, to be equal to the interests of society, which expands the narrow definition of the ‘Islamic code’. As a result, following the Islamic economic, moral system based on Maqasid Al-sharia, and preparing the fundamental principles in Islamic banking, leads to equitable distribution and fairness between all stakeholders. 2.2.2.3 Prohibition of uncertainty (gharar) Gharar refers to uncertain transactions resulting in uncertain results (Warde, 2000). According to Abdullah and Chee (2010), gharar can be separated into less important and limitless gharar, where the limitless type mostly ends up as a guesstimate. There are some hadith prohibitions on 22
  25. gharar , such as “Ahmad and Ibn-e-Majah narrated on the authority of Abu-said Al-khudriy: Muhammed (Peace Be Upon Him) has forbidden the purchase of the unborn animal in its mother’s womb, the sale of the milk in the udder without measurement, the purchase of spoils of war prior to their distribution, the purchase of charities prior to their receipt, and the purchase of the catch of a diver” (Ibn Maja, 35). This can be the reason for not understanding and appreciating the basis of the contract such the content not and the worth of the material and commitment (Ayub, 2007). Furthermore, the ban of gharar from the Quran is as follows: “And do not consume one another’s wealth unjustly or send it [in bribery] to the rulers in order that [they might aid] you [to] consume a portion of the wealth of the people in sin, while you know [it is unlawful]” (ALBAQARAH, 2:188). “O you who have believed, do not consume one another’s wealth unjustly but only [in lawful] business by mutual consent. Moreover, do not kill yourselves [or one another]. Indeed, Allah is to you ever Merciful” (AN-NISA, 4:29). The prohibition of gharar in IFIs means transparency and fairness (Visser, 2013), and this ban is consistent with the aim of CG in IFIs, as transparency and fairness are the most important aims in CG. Asutay (2010:28) states that “the ban of gharar (uncertainty) comes from the same motivation to the main feature of asset-based productive economic activity through embedded financing”. 2.2.2.4 Prohibition of gambling (maysir) Ayub (2007:62) defined gambling as: “The game of chance one gains at the cost of others: a person puts his money or a part of his wealth at stake wherein the amount of money at risk might bring huge sums of money or might be lost or damaged”. There is a ban on gambling in Islam because it is seen as a kind of unjust enrichment. Moreover, poor people in society have a right to the money wasted on gambling, as gambling will increase social damage (Asutay, 2010). This is inconsistent with CG in IFIs that aim to achieve fairness between all stakeholders, including society and avoid any conflict of interest (AAOIFI, 2010). In the Holy Quran, maysir has been mentioned in different parts, such as: “Satan only wants to cause between you animosity and hatred through intoxicants and gambling and to avert you from the remembrance of Allah and prayer. So will you not desist” [AL-MADAH, 5:91]. “They ask you about wine and gambling. Say, in them is a great sin and [yet, some] benefit for people. However, their sin is greater than their benefit.” Moreover, they ask you what they should 23
  26. spend . Say, “The excess [beyond needs]. Thus Allah makes clear to you the verses [of revelation] that you might give thought.” [AL-BAQARAH, 2:219]. 2.2.2.5 The payment of zakah Zakah, which is one of the five pillars of Islam, literally denotes purity. It is derived from the Quran and Sunnah (Salah, 2001; Sahee, 2000). Zakah has been mentioned in different parts in the Holy Quran, such as: “And establish prayer and give zakah and bow with those who bow [in worship and obedience]” [AL-BAQARAH, 2:43]. Moreover, “Your ally is none but Allah and [therefore] His Messenger and those who have believed – those who establish prayer and give zakah, and they bow [in worship]” [ALMA’IDAH, 5:55]. According to Shahul and Yaya (2005:85), they clarify zakah as “a religious obligation and a levy accepted by Islam on a Muslim’s income and wealth to be distributed to the defined beneficiaries, such as the poor and indigent”. Based on AAOIFI financial accounting standard No. 9 (zakah), IBs are committed to paying zakah. Also, AAOIFI governance standard No. 1 states that all IBs have to disclose information about zakah in their annual reports and the SSB is also required to disclose information about the banks’ responsibility in relation to zakah in their annual report (AAOIFI, 2010). According to Shanmugam and Zahari (2009), Zakah from the Maqasad Al-sharia perspective is applied in Islamic economic principles to remove the variance among the rich and the needy and to support the disadvantaged members of society. Moreover, the zakah is important in society because it contributes to ease poverty in communities and progress towards an increase in economic balance (Platonova, 2014). 2.2.2.6 Legitimate transactions The Islamic financial system for businesses or individuals does not admit to using anything that would be considered to be a transgression of Sharia in their activities. For example, an IB cannot finance, support or provide other services to alcohol, gambling or casino activities. According to AAOIFI governance standard No. 1, the SSB has to ensure in its report that all activities carried out by IBs comply with Sharia (AAOIFI, 2010). Based on Maqasid Al-sharia, Islamic banking has to avoid any activities that are deemed noxious and ethically inadmissible to humane welfare and the benefits of community. Moreover, IBs should seek to invest their finances using Islamic principles, to ensure their activities contribute to support both the well-being of and the interests of society (Platonova, 2014). 24
  27. 2 .3 Part Two: Corporate Governance and Accountability 2.3.1 General introduction to corporate governance Since the global financial crisis of 2007, a large number of researchers have focused on CG, particularly regarding financial institutions (Dalwai et al., 2015; Srairi, 2015). The terminology of governance in English comes from the Greek word ‘kybernan’, which means to guide, steer or govern (Cadbury, 2002). This refers to the association between the governors and the governed, such as the association between the government and the public (Salin et al., 2017). The Organisation for Economic Co-operation and Development (OECD) has given a precise definition of CG (2004:11) “Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring.” This description by the OECD specifically focuses on the transparency of accounting disclosure (Grais and Pellegrini, 2006). CG has become an important factor, with the aim of providing better and effective safeguards to all stakeholders, and also to make sure that the market has no doubts, and research displays a positive relationship among CG and shares price (Hasan et al., 2017b). 2.3.2 Corporate Governance Based on an Islamic Standpoint Based on the fast development of Islamic finance and the growing existence of IFIs, CG has received great interest in IFIs and become the most important issue. These institutions are significant, especially for Muslims, as they supply services that comply with Sharia principles, e.g. interest-free (riba-based) finance, and avoiding transactions which are prohibited by Sharia, such as alcohol, drugs and other activities that bring damage to society (Salin et al., 2017). IFIs should recognise society’s interest (Bhatti and Bhatti, 2009) while directing businesses to earn a higher profit. For example, IFIs should disclose more information which is reliable and relevant, because this information assists all stakeholders in making the right decision, depending on the level of transparency and disclosure in financial reports (Salin et al., 2017). The rule of governance in Islam includes all Muslims’ transactions because the resource is considered to be a trust from Allah (God) and an examination of their faith (Saeed, 1996). So, IFIs have to be honest and equitable between all stakeholders and shareholders. The definition of Sharia governance is a governance 25
  28. structure that confirms overall actions and business deals via IFIs are free from illegal elements , e.g. interest, uncertainty and other characteristics (Bahari and Baharudin, 2016). The principles of Sharia make CG in IBs both unique and essential. Meanwhile, the CG of IFIs is a structure that permits the guarantee of duty to Islamic principles to ensure fairness to all stakeholders. Therefore, Sharia governance has a unique characteristic of the Islamic system of financial management. Accountability, transparency and adequate disclosure are three essential ingredients in CG. According to Baydoun and Willett (2000), the essential aim of corporate reporting from an Islamic viewpoint is that it exceeds other targets to permit Islamic institution to present their compliance with Islamic law. Chapra and Ahmed (2002) stated that it is not true to assume that Islamic banks do not need to institute prudent corporate governance just because the Islamic value system equitably protects the rights of stakeholders. Islamic banks, like conventional banks, also deal with situations of loss and failure that result from an infraction of CG, such as the Ihlas Finance House in Turkey in 2001, and different cases of cheating that led to losses at Dubai IB from 2004 to 2007. So, these situations are reminders of the significance of CG for IBs (Ginena, 2014). Stakeholders in IBs have singular issues which justify particular CG attention, including compliance with Sharia in all activities and ensuring justice to all stakeholders (Ginena, 2014). According to Ali (2007), Sharia non-compliance in IBs leads to the withdrawal of deposits and brings about bank failure. This is consistent with Chapra and Ahmed’s (2002) study, which found that of those customers who deposit in IBs in various counties, 66.8% in Bangladesh, 85.6% in Bahrain, and 94.6% in Sudan, would move to another bank and withdraw their deposits if their IB was noncompliant with Sharia. There are two sides to the nature of CG in relation to IBs: the first one is that of Sharia, as based on Tawhid epistemology methodology, where IFIs follow Sharia in every functional role (Hamid et al., 2011). The concept of Islamic CG has wide practical implications, in particular reducing the transaction cost in the environment of decision-making and obtaining those targets within the limit of Sharia principles (Choudhury and Hoque, 2006). The second side is the specific characteristic of Islamic financial and economic standards. From an Islamic viewpoint, Sharia governs economics, human life and political attitude. Allah gives Sharia as the manifestation of his unlimited grace, the only actual embodiment to implement fairness (Sulaiman et al., 2015). The aim of Sharia CG is not just to safeguard the interests of stakeholders, but to accept the obligation of humans to Allah and the remnant of society. To understand Sharia CG, it is important to appreciate how the Islamic view works. Otherwise, it will be difficult to realise the true rationale 26
  29. behind Sharia CG (Muneeza and Hassan, 2014). Maali et al. (2006), state that the outcome of this target is that IBs own accountability to show all information fundamental to their stakeholders, about their process. 2.3.3 Accounting, auditing and governance standards for Islamic financial institutions The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) is an international Islamic organisation that is a not-for-profit corporate body that prepares accounting, auditing, governance, ethics and Sharia standards for IFIs and industry (AAOIFI, website). The AAOIFI was established in agreement with the Agreement of Association, which was signed by IFIs in Algiers on 1st Safar, 1410 H, which corresponds to 26 February 1990. The AAOIFI was then registered in the State of Bahrain as an international, autonomous non-profit-making corporate body (AAOIFI, website, AAOIFI, 2010) on 11 Ramadan 1411 H, which corresponds to 27 March 1991. Since the establishment of the AAOIFI in 1990, up until 2017, 94 standards have been issued, as follows: 54 on Sharia; 26 on accounting; 5 on auditing; 7 on governance; and two on codes of ethics. “AAOIFI Shari’ah standards have been made part of the mandatory regulatory requirements in jurisdictions such as Bahrain, Oman, Pakistan, Sudan, and Syria. While AAOIFI accounting standards have been made part of the mandatory regulatory requirements in jurisdictions such as Bahrain, Jordan, Oman, Qatar, Qatar Financial Centre, Sudan, and Syria, AAOIFI auditing, governance and ethical standards are not part of the mandatory regulatory requirements for Islamic finance. Instead, these standards are used voluntarily by leading IFIs across all major Islamic finance jurisdictions” (AAOIFI, website, 2017). Thus, the AAOIFI has introduced a greater harmonisation of Islamic financial exercise around the world (AAOIFI, 2015). AAOIFI standards aim to provide and improve auditing accounting, and ethical governance standards are linking to the actions of IFIs (Sarea and Hanefah, 2013). IBs must comply with the code of the country where they are established. Thus, the AAOIFI has to convince the central banks and supervisory powers to execute AAOIFI standards in their countries (Abuhmaira, 2006). Although Bahrain, Qatar, Lebanon, Jordan, Sudan, Mauritius, Syria, Tunisia and Oman have adopted AAOIFI standards as mandatory (Al Qamashoui and Hussainey, 2016), the AAOIFI does not have the strength to compel its standards (Karim, 1996). 2.3.3.1 AAOIFI corporate governance standards The AAOIFI has provided guidelines on Sharia governance by publishing seven standards for Sharia governance. The main aim for the establishment of these standards is to confirm the efficient 27
  30. function of the IFIs ’ system and to encourage transparency and to make sure that, for all stakeholders, the IFIs comply with Sharia by following good CG (Bahari and Baharudin, 2016). This study will focus on six standards (it avoids standard No. 7 because the researcher did not find any academic literature to confirm that CSR is a part of the CG rules or codes). Therefore, the following text details a short overview of the governance standards for IFIs:  Standard No. 1: Sharia Supervisory Board The Sharia Supervisory Board (SSB) is an independent body entrusted with the function of directing, revising and monitoring the actions of IFIs to ensure that they comply with Sharia principles (Hamza, 2013). According to the AAOIFI (1999, 2008, 2010, 2015), the SSB requires at least three members with knowledge of Islamic jurisprudence (Fiqh almua’malat) to be appointed by stakeholders in the SSB’s annual general meeting. The SSB confirmed its decision about all financial transactions having to comply with Sharia principles in the report, and stated that all SSB members should sign this report (Grais and Pellegrini, 2006).  Standard No. 2: Sharia Review The aim of the Sharia review (SR) is to confirm that all IFIs’ business and transactions achieve the requirement of Sharia (Bahari and Baharudin, 2016). The AAOIFI defines SR as “an examination of the extent of an IFI’s compliance, in all its activities, with Sharia. This examination includes contracts, agreements, policies, products, transactions, memorandum and articles of association, financial statements, reports and circulars” (AAOIFI, 2010:14). The SR does not relieve management of its responsibility regarding compliance with Sharia.  Standard No. 3: Internal Sharia Review The important subject discussion consistent with the advanced development of IFIs is the internal Sharia review (ISR). According to the AAOIFI (2015), the ISR is executed via an independent section or is an integral part of the internal audit and control section. The main objective of this standard is to supply an independent estimation, with an emphasis on an efficient internal monitoring system, and to evaluate the level of Sharia compliance (Bahari and Baharudin, 2016). The ISR should have perfect and constant support of the management and the BOD (AAOIFI, 2015). The ISR provides experts who are knowledgeable in Sharia law and responsible for improving their education to maintain their proficiency. 28
  31.  Standard No. 4: Audit and Governance Committee The role of the Audit and Governance Committee (AGC) in IFIs is essential because it manages the primary objective of an IFI by promoting significant transparency and disclosure in financial reports. Also, it enhances the general trust of the IFIs in its enforcement of Sharia law and principles (AAOIFI, 2015). The accountability of the AGC will include the following (AAOIFI, 2015): 1. Understanding the business and control environment of IFIs. 2. Understanding the prime risk items to which the business is exposed. 3. Controlling the efficiency of the reporting operation carried out by management. 4. Reviewing resources and skills, the extent of responsibility and overall work programme. 5. Reviewing the performance of internal control. 6. Ensuring IFIs comply with central bank inspectors’ requirements. 7. Ensuring IFIs comply with Sharia rules and principles.  Standard No. 5: Independence of the Sharia Supervisory Board Independence of the SSB is one of the key components of perfect governance in IFIs. According to AAOIFI governance (2015, p.44), the objective of this principle is “an attitude of mind which does not allow the viewpoints and conclusions of its possessor to become reliant on or subordinate to the influences and pressures of conflicting interest. It is achieved through organisational status and objectivity”. The SSB is under double the amount of pressure: not only in relation to the commercial reasons of IBs but also because it seeks to maintain its reputation that the validated products are produced without error (Hamza, 2013). The SSB should avert the possible and existing cases that reduces its capacity to make an objective professional decision (AAOIFI, 2015).  Standard No. 6: Statement on Governance Principles for IFIs At present, globally, the governance of firms is an essential issue in world economics for governments, because they must ensure that firms’ objectives are set and how to achieve these objectives by monitoring performance (Opata and Awino, 2017). The aim of this standard is requisite to support the expansion of investigative governance practices within IFIs. According to the AAOIFI (2015), this statement on governance principles explains the scope for governance in IFIs. 29
  32. Based on the AAOIFI , the 12 principles of governance include the following (AAOIFI, 2015): 1. Effective Sharia compliance structure, which means that an IFI should establish an efficient way of ensuring sharia compliance. This structure should cover the efficiency of the function played via BOD, SSB, administration and auditors, in so far as to relate to sharia compliance. 2. Fair treatment of equity holders. This means that an IFI should provide the equityholders with voting rights, adequate opportunity to have a dialogue with the institution and to select members of the governing BOD and SSB. 3. Equitable treatment of fund providers and other significant stakeholders. This means that an IFI should ensure equitable and unbiased treatment of fund providers and other significant stakeholders and associated investments, as well as in relation to the provision of adequate financial and non-financial information to allow them to take appropriate decisions regarding their dealing with the institution. 4. Fit and proper conditions for both the board and management. This means the IFI should decide upon a set of criteria to govern the appointment of persons to serve on the BOD and SSB, as well as for the appointment of management. 5. An effective oversight. This means that BOD should play an effective function in leadership, direction and monitoring the implementation of its policies, as well as in promoting a sound control sharia-compliant culture with the IFI. 6. Audit and governance committee (AGC). This means an IFI should have an audit and governance committee whose role and responsibilities should be to set appropriate terms of reference, which should among others matters include the process for financial reporting, internal controls, internal audit oversight, external audit oversight and sharia compliance. 7. Risk management. The BOD of an IFI should be actively involved in setting the risk appetite and should make sure that there are appropriate policies and systems for identification, measurement, analysis, reporting and mitigation of risks. 8. Avoidance of conflicts of interest. This means an IFI should set appropriate governance structure to ensure that members of BOD, members of SSB, management and staff, as well as external parties with substantial dealings with it, avoid conflicts of interest. 9. Appropriate compensation in the instance of any policy oversight. This means an IFI will set appropriate governance structures in relation to remuneration policies for BOD, SSB and management. 30
  33. 10 . Public disclosure. This means that an IFI should adopt high standards of reporting and satisfy the information need of owners, investment accountholders, regulatory, Zakah and other related agencies. 11. Code of conduct and ethics. This means an IFI should select policies and steps coordinated with sharia, to enhance a code of moral and accountable behaviour via members of BOD, members of SSB, management and employees. 12. Appropriate enforcement of governance principles and standards. This means an IFI should have a mechanism to ensure that the principles and standards on governance are adhered to and monitored. Most previous studies examined AAOIFI accounting and audit standards across the same countries (Vinnicombe, 2010; Sarea, 2012; Ullah, 2013; Sakib, 2015); however, there are limited studies for AAOIFI CG, such as Abdullah (2013), who studied CG standard No. 6 only. Therefore, as far as the researcher knows, the current research is the first to investigate the determinants and consequences of AAOIFI governance standards in all IBs that have adopted them as mandatory. This research is also the initial research to consider comprehensive AAOIFI standards regarding IBs and CG-specific characteristics in the analysis. 2.3.3.2 Accountability concept from an Islamic perspective In general, there are several definitions of accountability. Gray et al. (1995: 38) explained accountability as “The duty to provide an account (by no means necessarily a financial account) or reckoning of those actions for which one is held responsible”. Lozano (2005: 21) declares “accountability involves much more than simply providing information; it involves building a corporate licence to operate through interaction with other social actors…. Accountability is not a question of metrics, but vision and accountability is a tool available for firms to show their responsibility through corporate reports”. According to Jackson and McLeod (1982), accountability clarifies what has been done, what is presently being done and what will be done. So, accountability includes the disclosure of more information (Naser et al., 2006). All human existence is under a commitment to be thankful to Allah. He gave Islam to humankind as a whole religion, as mentioned in the Quran “This day I have perfected for you your religion and completed My favor upon you and have approved for you Islam as religion.” (Al-Ma’idah, 3). So, as everything belongs to Him, Muslims should know what He wants and follow His order (Hassan and Salman, 2017) “Say: 'Surely my Prayer, all my acts of worship, and my living and my 31
  34. dying are for Allah alone , the Lord of the whole universe, He has no associate. Thus have I been bidden, and I am the foremost of those who submit themselves (to Allah).” (Al-An’am: 162-163) On the day of judgement, Muslims become responsible in front of Allah for all dealings with others in relation to business activities (Hassan and Salman, 2017). Accountability in Islam indicates that we have obligations towards Allah and then the whole of society, which aims to safeguard people’s interests from any potential abuse. As mentioned in the Quran: “So by your Lord, We will surely question them all, About what they used to do” (Al-Hijr: 92–92). Moreover, “And stop them; indeed, they are to be questioned” (As-saffat: 24). Considering accountability, in practice, this should lead to more transparency, which would lead to improving stakeholders’ knowledge about IBs activities. It does not only mean accountability for financial reporting but, beyond the financial and technical side, also recognising fairness in society (Muwazir et al., 2006). Alshehri (2012), argued that accountability is considered to be the fundamental basis of the Islamic system. The concept of accountability is, therefore, applied to all Muslims’ lives and their relationship with Allah and then with others (Al-Jirari, 1996). The Prophet Muhammed (Peace Be Upon Him) stressed that accountability is an essential standard for the relationship conducted within the Islamic community, via saying: “All of you are guardians and are responsible for your subjects. The ruler is a guardian of his subjects, the man is a guardian of his family, the woman is a guardian and is responsible for her husband’s house and his offspring, and so all of you are guardians and are responsible for your subjects.” [Sahih al-Bukhari and Muslim]. Islamic accountability is the primary stimulus for dealing with IBs, constituting a central competitive advantage for IFIs. This indicates that everybody is accountable to Allah for their works and this is coming from the supreme meaning of Tawhid (oneness of God) and should be the foundation of CG in Islam. Sharia is general direction guiding every side of practising Muslims’ daily lives (Vinnicombe, 2010). Hence, Sharia acknowledges that what practising Muslims have to undertake in the worldly/material transaction must be controlled by religious/Islamic value, namely responsibility, morality, equity, accountability and social equity (Maali and Napier, 2010). Grais and Pellegrini (2006) assert that the SSB in IBs is responsible for ensuring that business transactions are Shariacompliant, by depicting responsibility, efficiency, privacy, independence and disclosure. From all the previous discussions in this chapter, particular those which mention the failure and financial disgrace of various IFIs and the implications of Sharia non-compliance risk, the requirement for a good Sharia CG system is a vital part of the CG of IFIs. The SSB in IBs is responsible for ensuring that business deals are Sharia-compliant, by depicting accountability, 32
  35. independence , confidentiality, efficiency and disclosure (Grais and Pellegrini, 2006). In addition, with the huge growth of the IFIs sector across the globe it is important to provide a good Sharia governance system that is compliant with Islamic principles across all of the activities. Therefore, the SSB, which is expert in Sharia, especially Fiqh Almuamalat, plays a significant function in IFIs in defining the legitimacy of the confirmed products of IBs. To protect the credibility of the SSB and to maintain the legitimacy of the products of IBs, it is important to provide a good Sharia governance system. According to Wilson (2009), the Sharia governance system plays a significant function in enhancing moderation and equity in financial deals and, therefore, promoting the general confidence in IBs on the side of compliance with Sharia principles. The AAOIFI governance standards are established to develop and enhance the Sharia governance system in IFIs; five out of seven standards in AAOIFI governance are related to Sharia governance in particular. The SSB is an important standard in AAOIFI governance as it functions a significant role in agreeing on a fatwa and improving, examining and checking the Sharia standards. According to the AAOIFI (2008), the SSB contributes to the importance of Sharia-confirmed tools, examining any request they receive, and consulting on all the AAOIFI standards issues of auditing, accounting and codes of ethics, to confirm these issues are compliant with Sharia principles. The main motivation for the emergence of the AAOIFI governance standards is to provide comprehensive guidelines for the SSB, to check and supervise the activities of IFIs, to confirm that they are compliant with Sharia principles (AAOIFI, 2010). Moreover, based on AAOIFI governance standards No. 1, the SSB must be experts in different subjects, including Sharia scholars, accountants, economic experts and lawyers with experience of IFIs. All of these requirements enhance the SSB reports that are important in IFIs, especially regarding the compliance with Sharia principles. In this respect, the AAOIFI governance has different procedures for the various SSB functions, including reviewing, planning and preparing working documents, as well as processing and documenting the outcomes and providing a Sharia review report (AAOIFI, 2010). AAOIFI governance requires that SSB report should adhere to a specific format, and this report is very important to all stakeholders as approval of compliance with Sharia principles in IFIs and to find out information about IFIs. Therefore, SSB supports fair disclosure and transparency as the crucial concept of CG. 33
  36. 2 .4 Part Three: Theoretical Framework This part seeks to review the theoretical framework of the research. According to Rwegasira (2000), and Solomon (2007), it is difficult to depend on one theory in CG because it is related to various fields, including economics, management, law, finance and politics. The theory is important for research because it is a determinant of which kind of data may be used and collected. Therefore, the theoretical framework of this study provides the reader with the link between research questions, hypotheses and findings. According to Gray et al. (2009: 13), “the lens of theory enables us to evaluate practice and policy against criteria that we deem appropriate”. The definition by the Cambridge dictionary Matsumoto (2009), is “a formal statement of the rules on which a subject of study is based or of ideas, which are suggested to explain a fact or event or more generally, an opinion or explanation.” Basically, CG supplies a robust framework that resolves the issues and disagreements between an organisation’s stakeholders (Khir et al., 2007). This framework is developed from current CG theories. IFIs are required to conform with traditional CG guidelines so that they are able to operative a dual banking framework. So, it is fundamental to ensure that these theories are in line with Sharia values (Htay and Salman, 2013). Different theories could illustrate the CG disclosure phenomena, for instance, agency theory, stakeholder theory, stewardship theory, signalling theory, accountability theory, communication theory and economic theory. Nevertheless, some prior studies have selected agency theory only to explain their empirical results (Chalevas, 2011; Zattoni et al., 2013). Therefore, like other research (Ntim et al., 2012a; Haniffa and Hudiab, 2006; Jakling and Johi, 2009), the current study adopts multiple theories to investigate the association among AAOIFI disclosure, CG characteristics and bank performance. Agency theory is adopted as a main theoretical framework in the current study because of its dominance in CG disclosure literature. Signalling theory, stakeholder theory and accountability theory are supplemented with agency theory because of the complicated nature of CG and disclosure phenomena. Moreover, there is a number of weaknesses when using individual theories (Chen and Roberts, 2010); however, more than one theory can complement another theory and enhance its potential strength. This study also refers to the main origins, namely the Quran and Maqasid Al-sharia, in regard to any Islamic concepts, which are guides to help people understand the purpose of Sharia governance. In the next subsections, agency, signalling, stakeholder and accountability theories are briefly reviewed. The reason for selecting these theories is because they help to illustrate the association between CG, disclosure, determinants and bank performance. 34
  37. 2 .4.1 Agency theory According to Clarke (2004), agency theory is widely used in different academic fields, such as accounting, marketing, finance and political science. Jensen and Meckling (1976), stated that agency theory is a relationship among principals (owners) and agents (management), where principals give the authority to managers to manage the company and make decisions. The main important issue in this contractual association is the disagreement of interest among the two sides (owners and management). The fundamental supposition of this agency issue is that because a manager’s pay-related benefit is based on a firm’s performance, managers tend to manage in a way that would focus on their self-interests (Kim and Mahoney, 2005; Ryan and Schneider, 2003). According to Kam (1990), one goal of agency theory is to supply illustrations regarding the kind of request for financial information, and the value of exposing this information. The annual report should have more information about the company because this would distinguish it from other poorly managed companies (Demski, 1974). In other words, disclosing extra information is perhaps a way of relieving the impact of the agency problem (Marston, 1996). Several studies have debated that voluntary disclosure decreases agency control costs (Chow and Wong-Boren, 1987; Linsley and Shrives, 2006). Also, Barako (2007), stated that the voluntary disclosure of financial reports could be used as an example of the application of agency theory. Moreover, Healy and Palepu (2001), stated that asymmetric information among owners and management in relation to the agency problem could be reduced by the voluntary disclosure in financial reports. Also, Fathi (2013), mentioned that to decrease agency conflict, managers could deliver the company’s performance information, to assert their position for shareholders and creditors, by being more transparent when they publish financial reports. Archer et al. (1998), state that there are three kinds of agency issues considered by agency theory. The first is that the managers of the firm may earn more non-pecuniary interests than those that would be incurred if the owners incurred the cost themselves. The second problem happens when directors invest in high-venture investments that subsequently put the lenders at risk; managers may support the shareholders by conceding the investments that would have meant a profit for the lenders. The third problem occurs when the managers are more informed regarding what is happening inside the organisation than the owners – this problem is called information asymmetry. According to Jensen and Meckling, (1976), good CG characteristics are needed to align the interest of directors with that of shareholders, and therefore minimise agency costs. IFIs usually face more agency problems than conventional banks (Safieddine, 2009). Antonio (2001), states 35
  38. that agency problems also appear in the association between owners and IB agents . So, IFIs need good CG for many reasons. First, the problem of separation between owners and management, which based on agency theory, is a major factor in IBs compared with traditional banks. Also, IBs have more responsibility to shareholders and must make sure they are complying with Sharia (Safieddine, 2009; Sarker, 2000). Customers of IBs in Bahrain and Sudan are willing to withdraw their deposits if they discover a case of non-compliance with Sharia (Chapra and Ahmed, 2002). The consequence of non-compliance with Sharia in IBs could have a negative effect on their reputation, resulting in the loss of customers. To conform to the Sharia principles in IBs, there are important differences regarding agency structure in IBs compared to those seen in traditional banks (Zainuldain et al., 2018). For example, the unique contractual arrangements of mudarabah and musharakah investment accounts, present various kinds of agency problems among investment account holders (IAHs) who have cash-flow rights and shareholders who own the control rights (Safieddine, 2009). Generally, banks have a lower level of disclosure than other financial institutions, and this increases the agency problems. Agency theory is interested in the many ethical issues that emerge that are non-compliant with Sharia. This theory states that principals delegate powers to the agents to manage the company, and from the Islamic point of view this is considered as trust (Amanah). Therefore, the agents must strive to fulfil their contractual duties and responsibilities (Htay and Salman, 2013). In general, agency theory accepts that good CG leads to decreases in agency costs, improved governance practice, disclosure and financial performance (Fama and Jensen, 1983; Khan et al., 2013). Thus, this theory is employed to investigate both the determinants of AAOIFI governance disclosure and the consequences. 2.4.2 Signalling theory Signalling theory refers to how firms give signals to users through the financial report. It includes information about the consequences of management activity in recognition of an owner’s wishes, such as bank performance (Aryani, 2016). According to Jensen and Meckling (1976), signalling theory is considered to be an expansion of agency theory, and it appeared to demonstrate the information asymmetry between owners and managers. The information asymmetry problem happens when one side in the market has further information than the other party (Watts and Zimmerman, 1986). It has been used to illustrate the information introduced voluntarily by managers (Singh and Mitchell Van der Zahn, 2008; Elshandidy et al., 2013). The theory illustrates that staff with a high standard of education signal more information about their outcomes, to 36
  39. distinguish themselves from other staff with a lower standard of education . Therefore, signalling theory clarifies how information asymmetry, among several parties in the market, can be reduced, with the more informed side signalling to the less informed side (Morris and Hough, 1987). That means “an action taken by a high-type manager that would not be rational if that manager was a low type” (Scott, 2003: 422). From an Islamic perspective, IBs desire to differentiate themselves from other IBs that do not fully comply with Sharia, during voluntary disclosure CG and performance. So, IBs signal their compliance and financial achievement to society even if their achievement is not strong. Also, through signalling theory, this research is expected to provide evidence of the importance of transparency and disclosure in financial reports in IBs. According to Haniffa and Cooke (2002), signalling theory was employed to illustrate directors’ incentives to disclose additional information in their annual reports. Financial statements have to disclose sufficient information through the managers, to notify particular signals to probable users. From a signalling theory perspective, IBs desire to distinguish themselves from the other IBs that are not completely compliant with Sharia, during voluntary disclosure in their annual reports. Thus, IBs will signal their financial performance, comply with Sharia and provide all other important information to stakeholders, to let them know that they are better than other banks. 2.4.3 Stakeholder theory Stakeholders are people who have a direct or indirect interest in the business (Carroll and Buchholtz, 2014). Freeman (1994: 46), defined stakeholders as “any group of individuals who can affect or who are affected by the achievement of the organisation’s objectives”. Post et al. (2002: 8), stated: “stakeholders in a firm are individuals and constituencies that contribute, either voluntarily or involuntarily, to its wealth-creating capacity and activities, and who are therefore its potential beneficiaries and risk bearers”. According to Gray et al. (1995), agency theory deals with the association among management and shareholders, whereas stakeholder theory deals with the association between management and all other stakeholders, such as an employee, owners, customers, suppliers and the government. Solomon (2010:15) defined stakeholder theory as follows: “Companies are so large, and their impact on society so pervasive that they should discharge accountability to many more sectors of society than solely their shareholders… not only are stakeholders affected by companies but they, in turn, affect companies in some way.” The above demonstration implies that companies have to save the interests of various stakeholders, involving shareholders (Clarke, 1998; Rhianon Edgley et al., 2010), although the expectation of stakeholders is different: employees want a good income and job security while 37
  40. shareholders expect a remuneration return . Additionally, creditors wait for the company to have a powerful financial position in order to secure the safety of their investments, while the policy market expects compliance with CG regulations to protect their stakeholders’ interest. From an Islamic perspective, stakeholders expect IBs to comply with Sharia principles, therefore serving society and encouraging Islamic values. It can be seen that, regarding the Islamic way, administrative managers of IFIs are responsible to God (Allah) as an essential stakeholder. Stakeholders’ theory is usable with such research by measuring the function of IBs across different stakeholders via experimenting with the level of CG disclosure (compliance with Sharia to satisfy Allah first, then community, and obtaining a top financial performance to satisfy the owners). If the information is useful to stakeholders, it means that the information is also significant for stakeholders and meets with their interests. 2.4.4 Accountability theory Based on an accountability theory, the expression ‘accountability’ alludes to the task of agents to supply information to all stakeholders. According to Jagadeesan et al. (2009), the managers’ responsibility is to achieve a realised set of tasks, which support the rules and standards that are viable in their positions in the company. Gray et al. (1995), state that to be socially responsible, agents need to give all information, financial or non-financial, to their stakeholders. The accountability between principals and agents differs; certain principals managers may be responsible for employees for their earning, health and security, while workers may be accountable for their job execution (Ismail, 2015). Based on the Islamic viewpoint, accountability is first to God as the prime principal, then the owners, community and other stakeholders. Therefore, this theory is usable to the current research through growth, and this meaning includes further than just the IBs’ investors and owners. Baydoun and Willett (2000), argue that firms like IBs should disclose all information demanded via their stakeholders and community. Stewart (1984), argued that there are two requirements for public accountability: the provision of information, and an estimate of the work to carry out as a consequence of providing the information’. In support, Ibrahim (2006) stated that, from this point, accountability is not only a function to report performance, but it is a function that is used to execute or not execute certain actions. This research adjusts the notion of accountability from an Islamic perspective that may affect the categories of the disclosure. Regarding this notion, IBs are demanded to disclose CG information first to satisfy Allah and then all other stakeholders. 38
  41. 2 .5 Chapter Summary The conceptual framework of the current chapter covers the background on IBs (the history and principles of Islamic banking). Islamic finance has been one of the fastest-growing industries over the past three decades, and the Quran and Sunnah are the essential sources of Sharia. The major variance among Islamic and conventional finance is Islamic law. Furthermore, the main standards of Islamic banking are the ban of interest, the ban of uncertainty, the ban of gambling, payment of zakah, the PLS and legitimate transactions. The CG and accountability part covers a general introduction to CG and looks at this from an Islamic viewpoint. Accountability, transparency and adequate disclosure are the three essential ingredients in Sharia governance. AAOIFI is an international Islamic organisation that is a not-forprofit corporate body that prepares accounting, auditing, governance, ethics and Sharia standards for IFIs and the industry. The AAOIFI governance standards are SSB, SR, ISR, AGC, independence of the SSB and statement of governance principles for IFIs. Accountability, from an Islamic perspective, is applied to all Muslims’ lives and their relationship with Allah and then with others. The theoretical framework covers agency theory, signalling theory, stakeholder theory and accountability theory. Agency theory is an association between principals (owners) and agents (management), where principals give authority to managers to manage the company and make decisions. Signalling theory is considered to be an expansion of agency theory, and it appears to demonstrate the information asymmetry among owners and managers. The information asymmetry issue happens when one side in the market has more information than the other side. Stakeholder theory deals with the association between management and all other stakeholders such as employees, owners, customers, suppliers and the government. While accountability theory, according to the Islamic viewpoint, indicates accountability to Allah as the prime principal, then the owners, the community and other stakeholders. The next chapter provides a display of the previous literature and hypotheses development. 39
  42. Chapter 3 : Literature Review and Hypotheses Development 3.1 Overview The current chapter has three parts: part 1 consists of an overview followed by a discussion of CG disclosure in IFIs, and previous studies on CG disclosure in IFIs. Then, part 2 discusses the determinants of AAOIFI governance disclosure and hypotheses development. The whole hypotheses are developed according to the lack in the previous studies and supported by consistent theory. Finally, part 3 discusses the influence of AAOIFI governance disclosure on bank performance and hypothesis development. 3.2 Part 1: The Quality of Corporate Governance Disclosure in the Annual Reports of Islamic Banks As mentioned in chapter 2, the objective of a CG code is to progress voluntary disclosure, transparency and accountability (Monks, 2011; Bouwman, 2011; Allegrini and Greco, 2013). Although AAOIFI governance is not part of the mandatory regulatory requirements for IFIs, this governance is employed voluntarily by leading IFIs across all significant Islamic finance jurisdictions (AAOIFI, Website, 2017). However, IFIs should disclose all relevant and reliable information about their operations through annual reports, to let stakeholders and society assess their compliance with Sharia and how they fulfil their accountability to both Allah and society (Salin et al., 2017). Rising research interest has been paid to measuring the level of disclosure with regard to CG in IFIs. With the importance of this in mind, this part aims to discuss previous research that examines the level of disclosure with regard to CG in IFIs. 3.2.1 Prior studies on corporate governance disclosure in IFIs The range of voluntary disclosure in IFIs, where accountability and responsibility are assumed to be compulsory, is predicted to be higher than in non-IFIs, because IFIs have accountability to Allah first and then to society. Thus, the function of disclosure is owed fundamentally to Allah and then to the community (El-Halaby and Hussainey, 2015). The level of disclosure with CG characteristics has been examined by some of the research in IFIs, using content analysis and disclosure index (Al-Baluchi, 2006; Vinnicombe, 2010; Paino et al., 2011; Aziah Abu Kasim, 2012; Ullah, 2013; Ahmad and Daw, 2015; Abdullah et al., 2015; Sulaiman et al., 2015; Srairi, 2015; El-Halaby and Hussainey, 2016; Ajili and Bouri, 2017; Salin et al., 2017; Hasan et al., 2017b; Grassa et al., 2017). Table 3.1 presents an outline of prior studies on CG discourse in IFIs. The standard methodology 40
  43. used in most of the studies aforementioned above was to organise a relevant disclosure index . Some indexes were developed by using the indices of previous studies, such as Srairi, (2015) and Salin et al (2017), or by following guidelines published via the Central Bank of Malaysia (Bank Negara Malaysia (BNM)), such as Paino et al (2011) and Aziah Abu Kasim (2012), and others are based on AAOIFI governance standards, such as (El-Halaby and Hussainey, 2016; Al-Baluchi, 2006; Vinnicombe, 2010; Ullah, 2013; Ahmad and Daw, 2015). Other studies used mixed guidelines for their disclosure index, namely Sulaiman et al. (2015), who used the guidelines issued by BNM in 2007, the AAOIFI in 2008 and the Islamic Financial Services Board (IFSB) in 2006. Similarly, Abdullah et al. (2015), used a disclosure checklist based on various international CG benchmarks, containing the OECD principle of CG 2004, the Basel Committee on Banking Supervision (BCBS) 2006, AAOIFI governance standards and the IFSB. Also, Ajili and Bouri (2017) used an index based on the International Accounting Standards Board (IFRS) and AAOIFI standards. Although some of the previous studies used AAOIFI governance standards, such as Abdullah et al. (2015) and ElHalaby and Hussainey (2016), these studies only used a specific CG standard. Abdullah et al. (2015) used standard No. 6 only, while El-Halaby and Hussainey (2016) used standards Nos. 1 and No. 5. Also, Al-Baluchi (2006) created an index that includes 104 items based on AAOIFI standards, but just one item related to AAOIFI governance standard No. 1, which stated that in item 17 (Sharia supervisory board report) other items are related to accounting and auditing standards. Although Majid et al. (2011) developed a comprehensive CG disclosure index based on guidelines available to IFIs (BNM, IFSB and AAOIFI) and the index includes 123 items across the dimension, they did not clarify the sub-items in their index, and they did not use this index to measure the level of disclosure. Overall, there are many studies on aspects of Sharia governance (Aziah Abu Kasim, 2012; Salin et al., 2017; Paino et al., 2011) and the compliance of AAOIFI standards (Al-Baluchi, 2006; Vinnicombe, 2010; Abdullah et al., 2015; Sarea, 2012), a disclosure index used as a research method in some studies. For example, Abdullah et al. (2015), who investigated the determinants of voluntary CG disclosure practices of 67 IBs in the Southeast Asian and GCC region in 2009, and the research employed disclosure index based on AAOIFI standards, the IFSB “is an international standard CG guidance”, the OECD’s principles of CG (2004) and the BCBS (2006 paper). The index included 81 items, but most of these items did not relate to AAOIFI governance, as the study focused on standard No. 6 only. In addition, the study was based on AAOIFI standards issued in 2010. However, the study sample was from 2009 and for specific countries only (the Southeast Asian and the GCC regions). 41
  44. El-Halaby and Hussainey (2016), studied 43 IBs that adopted AAOIFI across eight countries based on 2015 AAOIFI standards; the index included 214 items required by AAOIFI standards. However, these items did not study all of the AAOIFI governance, but standards No. 1, No. 5 and No. 7 only; the study was limited to one year only: 2013. Similarly, Ajili and Bouri (2017), measured and compared the level of compliance with the disclosure requirement provided by the IFRS and AAOIFI in a sample of 39 IBs in GCC countries. The study adopted two disclosure compliance indexes: IFRS and AAOIFI. The AAOIFI index included 94 items related to accounting standards only, and they did not mention AAOIFI governance. Salin et al. (2017) studied Sharia CG disclosure compliance and created an index of 127 items. These items studied standards No. 1 and No. 6 only from AAOIFI. According to the check of prior research on AAOIFI governance disclosure index, most of the research is limited their study to scale AAOIFI governance in a single sample or a specific region, and the checklists in most of the previous studies did not study all of the AAOIFI governance (see Table 3.1). 1TABLE 3.1: OUTLINE OF PREVIOUS STUDIES ON CORPORATE GOVERNANCE DISCLOSURE IN ISLAMIC FINANCIAL INSTITUTIONS Author and Year Sample and Title Country Al-Baluchi (2006) Research Results Method 14 IBs from The impact of AAOIFI Content The level of voluntary Bahrain, 26 standards and other analysis disclosure raised next to from Sudan, 2 banks’ characteristics the enforcement of from Qatar and on the level of AAOIFI standards. 2 from Jordan voluntary disclosure However, in Sudan, the in the annual reports level of voluntary of IBs disclosure was significantly lower than that in the other three countries Vinnicombe IBs in Bahrain AAOIFI reporting Content High levels of compliance (2010) from 2004 to standards: measuring analysis in several places and 2007 compliance relatively low levels in other places Majid et al. Bank Negara Developing a CG Used an inclusive index (2011) Malaysia disclosure index for of disclosure items (BNM) IFIs gathered over all three 42
  45. newly issued governance guidelines available to IFIs (BNM, IFSB and AAOIFI) Paino et al. (2011) 17 IBs in Malaysia Sharia social responsibility and CG of the IBs in Malaysia Content analysis The high overall level of CG disclosure, approximately 91.91%, with 11 items Abu Kasim (2012) 7 takaful operators in Malaysia in the 2008/2009 annual report Seven IBs in Disclosure of Sharia compliance by Malaysian takaful companies Content analysis There is a scarcity of information to all stakeholders to make good decisions Compliance with Content These banks comply with Bangladesh AAOIFI guidelines analysis a mean of 44.68% of Ullah (2013) regarding the general AAOIFI guidelines presentation and regarding the public disclosure in the show and disclosure in financial statements financial statements of IBs in Bangladesh Ahmad and 17 banks in Compliance with the Content The Sharia compliance Khatun Bangladesh Sharia governance analysis level of the IBs is higher, (2013) systems of the approximately 75% AAOIFI: a study on Bangladeshi IBs Ahmad and Ben Fashlowm Compliance with Questionnaire The result found the level Daw (2015) Islamic branch AAOIFI guidelines in and content of compliance with in Libya from regard to the general analysis AAOIFI standards based 2010 to 2013 presentation and on the general disclosure by Libyan presentation disclosure IBs in the annual reports was very low. Abdullah et al. 67 IBs in the Determinants of Content The voluntary CG (2015) south-east voluntary corporate analysis disclosure level less than Asian and GCC governance 43 40%
  46. regions in 2009 disclosure : evidence from IBs in the southeast Asian and GCC regions Sulaiman et al. (2015) BNM in 2008, 2007 and 2006 respectively CG of IFIs in Malaysia Content analysis Srairi (2015) 27 IBs operating in five GCC countries for three years (2011–2013) 43 IBs across eight countries (MENA) in 2013 CG disclosure practices and performance of IBs in GCC countries Content analysis Determinants of compliance with AAOIFI standards by IBs Content analysis Ajili and Bouri (2017) 39 IBs in GCC countries between 2010 and 2014 A comparative study between IFRS and AAOIFI disclosure compliance: evidence from IBs in GCC countries Content analysis Salin et al. 16 IFIs in Sharia compliance on Content The mean of compliance level according to AAOIFI standards for the SSB is 68%, CSR is 27%, and the show of financial positions is 73% The study finds that the level of compliance with the IFRS is higher than that of compliance with the AAOIFI. Also, the compliance with IFRS/AAOIFI disclosure requirements is higher for larger and more established IBs The research found the (2017) Malaysia CG disclosure: analysis majority of IFIs in El-Halaby and Hussainey (2016) Different levels of CG quality in the annual reports of IFIs the year after the guidelines were incorporated in the comprehensive CG index Just two nations, the UAE and Bahrain, have a higher level of CG: approximately 57% and 56.8% respectively empirical evidence of Malaysia moderately Malaysian IFIs disclosed the information regarding Sharia CG Hasan et al. 39 banks in Influence of internal Content There is a variance in (2017) Bangladesh and external analysis governance compliance from 2011 to governance 2014 mechanisms on CG disclosure among Islamic and conventional banks 44 among IBs and conventional banks, as IBs have a lower level of compliance
  47. Generally , the prior research did not take the opportunity to expand the study of AAOIFI governance disclosure in IBs and further participate to the knowledge of AAOIFI governance, by creating a new index to include all AAOIFI governance issued in 2010. Furthermore, the sample also looks at the wider viewpoint, which includes 126 observations of IBs that mandatorily adopt AAOIFI. Regarding the level of disclosure, prior studies offered mixed results (Paino et al., 2011; Vinnicombe, 2010; Al-Baluchi, 2006). All found higher levels of disclosure in IFIs. Specifically, Vinnicombe (2010) examined the extent to which IFIs in Bahrain complied with AAOIFI standards in their financial reporting. The study found high levels of compliance in several places and relatively weak levels in other places. Similarly, with Paino et al. (2011), their research aimed to investigate the state of Sharia, social responsibility and CG in IFIs in Malaysia. They concluded that there was a high overall level of CG disclosure, approximately 91.91% with 11 items. Also, Srairi (2015), who investigated the influence of the CG disclosure level on bank performance for 27 IBs in GCC countries. He found that two countries only, the UAE and Bahrain, possess a higher level of CG disclosure approximately 57% and 56.8% respectively. El-Halaby and Hussainey (2016) explore to what extent IBs that adopt AAOIFI standards were compliant with the AAOIFI; this was based on an examination of 43 IBs across eight countries. The study concludes that the mean compliance level of AAOIFI standards that were related to the presentation of a financial statement was 73%. Otherwise, some prior studies found the level of CG disclosure was low, such as Aziah Abu Kasim (2012), who measured the disclosure of Sharia compliance as reported via the Sharia committee in the annual reports of takaful companies in Malaysia. She found that there was a scarcity of information to help investors and other stakeholders to make well-informed decisions. Similarly, Ullah (2013) examined the level of compliance with AAOIFI guidelines regarding general presentation and disclosure in the financial statements of IBs listed in Bangladesh. The outcome of this study was that these banks complied with a mean of 44.68% of AAOIFI guidelines. Also, Abdullah et al. (2015) investigated the determinants of voluntary CG disclosure practices of 67 IBs in the south-east Asian and GCC region. They found that the average level of voluntary governance disclosure is less than 40%. Mahmood and Khatun (2013), who investigated the compliance level of 17 IBs in Bangladesh for the year 2011, created an index based on AAOIFI governance standards No. 1 to No. 5. The results show that the level of Sharia compliance in fully fledged IBs is higher than others, although the index in this study was dependent on AAOIFI governance. However, they did not study standard No. 6, and studied one specific year and one country only. 45
  48. Recently , Salin et al. (2017) used data from all 16 IFIs in Malaysia, for one year only (2013), to test the range of Sharia CG disclosure compliance. The outcome of the study was that the majority of IFIs in Malaysia moderately disclosed information regarding Sharia CG. Also, Ajili and Bouri (2017) measured and compared the level of compliance with disclosure requirements via the IFRS and AAOIFI in IBs in GCC countries. The study found that the level of compliance with the IFRS is higher than the level of compliance with the AAOIFI. Also, the compliance with IFRS/AAOIFI disclosure requirements is higher for bigger and more established IBs. Lastly, Grassa et al. (2017) studied the impact of CG on IBs products and services disclosure on a sample of 78 IBs across 11 countries from 2004 to 2012. The study found that there was a considerable advancement of products and services disclosure. Based on the previous discussion, the study expected that IBs have a higher level of disclosure resulting in the following research hypothesis: H1: There is a high level of AAOIFI governance disclosure in IBs. 3.3 Part 2: The Determinants of AAOIFI Governance Disclosure One of the primary purposes of this research is to test CG mechanisms as the main determinants of AAOIFI governance disclosure. Various prior studies address the influence of CG mechanisms on disclosure, such as (Hasan et al., 2017b; Ho and Wong, 2001; Al-Moataz and Hussainey, 2013; Gisbert et al., 2014; Scholtz and Smit, 2015; Nguyen et al., 2014; Elfeky, 2017; Almanasir and Shivaraj, 2017), with little attention being given to AAOIFI governance (El-Halaby and Hussainey, 2016; Abdullah et al., 2014 and Abdullah et al., 2015). Appendix B presents a summary of the literature that relates to how CG mechanisms impact the level of disclosure. The details of this table will be discussed in the next subsection (CG mechanisms). Due to the relatively small amount of research undertaken on AAOIFI governance in IBs, this research contributes to the CG literature on IBs by examining the determinants of AAOIFI governance disclosure in IBs. The next subsection shows the literature on CG mechanisms that can effect CG disclosure. These are an independent board, board size, board meeting, the duality of CEO position, ACs and ACM. The framework of the check is as follows for every chosen variable: the relevant theoretical literature is briefly disclosed, the previous empirical literature relating to the variable is then discussed and, finally, suitable hypotheses relating to the variable are stated. 3.3.1 Corporate governance characteristics Based on previous empirical studies, better regulation of CG mechanisms needs a reasonable level of disclosure and sufficient information to decrease information asymmetries among whole 46
  49. parties in the company (Joshi et al., 2016). Additionally, a robust CG structure raises the confidence of investors, as their investment will be guaranteed by the internal safeguard and a controlling system to ensure prudence regarding management activities. Therefore, this leads to a high level of disclosure and transparency requirements from public interest (Joshi et al., 2016). Depending on the agency theory framework, the CG characteristics are introduced to reduce opportunist behaviours among managers, to decrease input asymmetry and to ensure that managers work in the interest of the shareholder. It can improve a firm’s internal control and, consequently, develop the level of disclosure (Welker, 1995; Ho and Wong, 2001). Accordingly, it can be seen that CG characteristics could improve CG disclosure reporting. Therefore, the current research reviews prior studies that suggest there is an association among disclosure and CG mechanisms. 3.3.1.1 Independent directors Recently, independent directors have received increased interest from CG regulations and academic research (Almanasir and Shivaraj, 2017; Chen and Jaggi, 2000; Ho and Wong, 2001). Also, academics have pointed out that independent directors can safeguard shareholders and assist in decreasing agency costs (Lipton and Lorsch, 1992). Fama (1980), argued that a board of directors is the primary internal control character for monitoring managers. Also, the existence of independent directors on the board may increase the quality of the financial statement (Peasnell et al., 2005). According to agency theory, independent directors are further capable of limiting managerial opportunities (Fama and Jensen, 1983). The theory also suggests that the presence of independent managers on the board can reduce information asymmetry (Allegrini and Greco, 2013). Most of the prior research was found to have a positive relationship among CG disclosure and independent directors such as Abdullah et al. (2015), their research examines the determinant of voluntary CG disclosure of 67 IBs in the Southeast Asian and GCC region. They found that board independent has a significant and positive relationship with voluntary CG disclosure and their finding support that independent directors influence the level of voluntary CG disclosure. Similarly, Samaha et al. (2012) who found that the higher ratio of board independent increase the level of disclosure in 100 Egyptian listed companies. Arcay and Vazquez (2005) report that the ratio of independents on the board is positive associated to voluntary disclosure. Their research based on 117 firms listed on the Madrid Stock Market. Gisbert and Navallas (2013), they study the relationship between voluntary disclosure and CG in a sample of 62 Spanish firms in 2005. They found that the ratio of independent directors is strongly related with increased level of disclosure. 47
  50. In addition , Haniffa and Cooke (2002), state that independent directors can help the board with their knowledge and experience. Similarly, Garcia-Meca and Sanchez-Ballesta (2010) found that independent directors provide a high level of protection to shareholders. However, Ho and Wong (2001) examined the association between the proportion of board independent and voluntary disclosure in a questionnaire survey sent to all chief financial officers in listed companies in Hong Kong. They found an insignificant association among disclosure and independent managers and they explain the reason for their result maybe companies in Hong Kong are probable to comply with mandatory disclosure only. Thus, based on agency theory the following research hypothesis is developed: H2: There is a positive association between board independence and the level of AAOIFI governance disclosure. 3.3.1.2 Board size The board of directors (BOD) plays an essential function in CG and contains an overall number of administrative and non-executive managers on the assembly. Based on agency theory, board size is a potential variable of CG with regard to the monitoring of management performance (Allegrini and Greco, 2013). Also, the theory suggests that a large number of board directors affects the operation of managerial monitoring activities and control (Healy and Palepu, 2001). According to previous literature, board size affects the level of monitoring and disclosure (Rahma and Bukair, 2015). Also, previous studies found mixed results, as Ntim and Soobaroyen (2013), argue that the level of voluntary disclosure is positively influenced by increased managerial monitoring. Similarly, Al-Janadi et al. (2013), assert that board size enhances further efficient decision-making and extends information dealing capabilities. Also, Wang and Hussainey (2013), indicate that firms with larger boards are more likely to disclose information. Zaheer (2013), found that a larger board size positively influences the level of CG disclosure. Recently, and as consistent with previous studies, Grassa et al. (2017) found a positive relationship between board size and products and services disclosure in 78 IBs in 11 countries, throughout the period from 2004 to 2012. In contrast, others find no significant influence regarding board size on CG disclosure (Lakhal, 2005; Hasan et al., 2017b; Arcay and Vazquez, 2005). According to signalling and agency theory, the current research anticipates that a greater board size will raise board control. The consequence of this is an improvement in the level of disclosure in IBs. Based on agency theory, this study hypothesises that: 48
  51. H3 : There is a positive relationship between board size and the level of AAOIFI governance disclosure. 3.3.1.3 Board meeting The board’s performance is assessed by the number of meetings held during the year (Albawwat, 2015). Kanagaretnam et al. (2007), suggested that the more board meetings that are held throughout the year, the more the company is able to execute a supervisory function better and reduce the problem of asymmetric information. Agency theory states that the frequency of board meetings affects the strength of the CG component (Khanchel, 2007). More board meetings allow members to supervise better managers, which leads managers to display high-disclosure information to stakeholders (Lipton and Lorsch, 1992). Laksmana, (2008), stated that more board meetings lead companies to be more likely to show an increased level of transparency. Similarly, Hasan (2011), contended that a high meeting frequency would tend to signal achievement and provide extra information to all stakeholders; this is coordinated with signalling theory. Accordingly, several previous studies found an positive relationship among assembly meetings and financial reporting and disclosure Such as Albawwat and Ali (2015) who study the relationship between board meeting and voluntary disclosure in interim financial reports in Jordanian listed firms for the 2009-2013 the outcome of their study concluded that the disclosure level in Jordan listed companies affected by the number of board meeting. While Fiori et al.(2016) examined the effectiveness of CG on voluntary disclosure in a sample of 35 companies that linked the Pilot programme in 2011 and a similar 137 firms that did not, they conclude that there is no association between a board meeting and the level of voluntary disclosure. Based on agency theory, this research hypothesises that: H4: There is a positive relationship between board meetings and the level of AAOIFI governance disclosure. 3.3.1.4 Duality in position When the chairman of the board is also the CEO, the role of duality in the position occurs (ElHalaby and Hussainey, 2016). The CEO is a significant factor of CG because of its sensitive kind, due to the relationship among the agents and owners (Krause et al., 2014). According to agency theory, CEO duality is viewed as harmful, because the agent may follow their self-interest at the expense of the owners. Also, the theory states that effective monitoring of management execution will be provided via the division among the two functions (Jensen and Meckling, 1976; 49
  52. Haniffa and Cooke , 2002). According to Gul and Leung (2004: 356), “Firms with CEO duality are more likely to be associated with lower levels of voluntary disclosure since the board is less likely to be effective in monitoring management and ensuring a higher level of transparency”. According to Donker and Zahir (2008), agency theory predicts that duality in position creates a single power for the CEO that influences the efficient control exercised by the board. The outcomes of previous studies provide mixed findings on the relationship among duality in a position and CG disclosure. Several studies found a negative relationship among the two variables: Ezat and El-Masry (2008), found that CEO is negatively correlated with corporate disclosure levels. Also, Elfeky (2017), analysed the CG determinants, focusing on the range of voluntary disclosure in companies listed on the Egyptian stock market, this study also found that CEO is negative and statistically insignificant with the level of corporate disclosure, and the study concluded that, with low duality in position, there is a greater opportunity to disclose information voluntarily. In addition, Gisbert and Navallas (2013), studied the association among voluntary disclosure and CG in 62 non-financial Spanish companies listed on the Madrid stock market in 2005. They found that CEO is negatively and statistically significant, and this shows that duality in a position significantly decreases the disclosure of voluntary information. However, other studies did not find an important association among the two variables (Hasan et al., 2017b; Zaheer, 2013; Ho and Wong, 2001; Ghazali and Weetman, 2006). While some studies found a positive relationship between the two variables, namely Wang and Hussainey (2013), who examined the impact of CG on the level of voluntary disclosure and found a positive association between CEO and the level of voluntary disclosure. Also, Abdullah et al. (2015), investigated the determinants of voluntary CG disclosure practice about 67 IBs. The study found that the separation of the role between the board chair and CEO is strongly significant and has a positive relationship with voluntary CG disclosure. This result suggests that good CG mechanisms improve the level of CG disclosure in their annual reports. Also, in previous literature, Peng et al. (2007) and Hashim and Devi (2008), suggest the two functions should be discrete, for causes of independence. In disclosure practice, this research supposes that the division of functions among the chair and chief executive will improve the monitoring fineness and decrease the interests of hiding information, resulting in improved CG disclosure in IBs. Based on agency theory, IBs without CEO duality issues are predicted to have a higher CG disclosure level. Thus, the study develops the following hypothesis: H5: There is a negative relationship between duality in a position and the level of AAOIFI governance disclosure. 50
  53. 3 .3.1.5 Audit committee size Based on agency theory and signalling theory, companies with a larger ACS have a stronger incentive to maintain their independence and require more comprehensive disclosure standards (Fama, 1980; Spence, 1978). According to Mangena and Pike (2005), more effective control will be given to companies with a larger ACs. Barako et al. (2006), assert that ACS should lead to the integrity of the financial statement and monitoring of the firm’s internal financial regulation, moreover the development of corporate information disclosure. Also, Al-Janadi et al. (2013) assert that the function of the ACS is a central role to improve the level of disclosure in relation to the financial reports. Companies with a larger ACS are faithful to good quality financial performance (Abdullah, 2013). It can be argued that ACS can reduce agency conflicts by limiting the opportunistic behaviour of agents (Haniffa and Cooke, 2002). Some previous studies found a positive association between ACS and CG disclosure. For example, Almanasir and Shivaraj (2017) examined the determinants of CG voluntary disclosure in 61 firms listed in Jordan from 2010 to 2014. They report that appositive and significant relationship between ACS and voluntary CG disclosure. Similarly, Al-Moataz and Hussainey (2012) who reported that the higher number of AC lead to higher level of disclosure in 97 financial reports of Saudi Arabian listed firms from 2006 to 2007. Joshi et al. (2012) find a positive and significant relationship between ACS and CG disclosure practice using 850 firms listed on the Malaysia Stock Market in 2013. Meanwhile, Othman et al. (2014) found that there is an insignificant relationship between ACS and voluntary ethics disclosure in a sample of 94 firms listed on Malaysia stock market. According to agency theory, the current research expects that a more significant ACS will increase board-controlling capabilities and, thus, give a positive impact on the disclosure level practice in IBs. Therefore, the study hypothesises that: H6: There is a positive association between ACS and the level of AAOIFI governance disclosure. 3.3.1.6 Audit committee meeting Greco (2011), stated that the frequency of ACMs leads members to an accurate decision about a firm’s accounting principles, disclosures and evaluation. Also, Raghunandan et al. (2001), stated that audit committees that meet frequently are more likely to be well informed, more careful and more knowledgeable about the existing accounting and auditing issues, in relation to achieving their duties. Similarly, M. Allegrini (2011), highlighted that regular audit committee meetings 51
  54. would ensure there are clarity and knowledge in relation to accounting and auditing issues . Prior research has suggested that the number of meetings impacts on there being enough time to control and gain compliance with responsibilities of financial performance (Li et al., 2012; Elzahar, 2013; Al-Maghzom et al., 2016). Gray et al. (1995), assert that to be responsible, managers need to supply whole financial and non-financial information to their stakeholders. While some prior studies found an insignificant relationship between ACM and level of disclosure such as Madi et al. (2014), found no statistical association between the level of disclosure and ACMs, Othman et al. (2014) also report that ACM insignificant relationship with voluntary ethics disclosure in 94 companies listed in Malaysia Stock Exchange in one the year 2011. Based on agency theory, the frequency of ACMs may provide a level of control in relation to the activities carried out by IBs and, therefore, provide better CG disclosure within their annual reports. Thus, it is hypothesised that: H7: There is a positive relationship between the ACM and the level of AAOIFI governance disclosure. 3.4 Part 3: The Impact of AAOIFI Governance Disclosure on Financial Performance. As discussed in chapter 2, governance theories, especially agency theory, indicate that the enhancement of CG characteristics progresses a firm’s financial performance. According to Klapper and Love (2004), a good CG mechanism will lead to higher process performance and higher firm performance. Furthermore, an optimal CG mechanism raises the internal safeguard and will ensure the trust of investors regarding their investment (Zhang, 2012). The empirical literature examines the association between CG characteristics and a firm’s financial performance (Weir and Laing, 2000; Haniffa and Hudaib, 2006; Black and Kim, 2012; Al-Ataibi , 2017; Muriuki et al., 2017; Tariq and Abbas, 2013; Velte, 2017; Bhatt and Bhatt, 2017). Table 3.2 gives a summary of the literature relating to CG disclosure and bank performance. The influence of a good corporate mechanism on firm performance output shows mixed results. For example, Nelson (2005), demonstrated that a higher quality of CG positively impacts firm performance. Similarly, Bhatt and Bhatt (2017), analysed the CG framework impact of firm performance on 113 listed firms in Malaysia, and they found that firm performance is positively and significantly linked with CG. Also, Al–Ataibi (2017) investigated the extent of the impact of the principles of governance in improving firm performance. The study found that there is an influence of governance on developing firm Performance. Al-Najjar (2014) explored the relationship between 52
  55. CG and firm performance in five countries in the Middle East . The study found that board independence positively impacts firm performance. Anis et al. (2017), investigated the impact of board characteristics on a firm’s financial performance. They studied 70 firms over six years, from 2005 to 2010, and the sample included the most active companies listed on the Egyptian stock market. The study found that firm size is statistically significant with ROA and the age of the firm is statistically significant with market performance, measured using Tobin’s Q, while the CEO and firm accounting performance have a negative relationship. Additionally, Garefalakis et al. (2017) investigated the effect of CG information on bank performance. The study found that board independence strongly supports bank efficiency and operations. In contrast, Hassan et al. (2016) examined the association between CG mechanisms and financial performance in all non-financial companies listed on the Palestinian stock exchange during 2010 and 2012. The study found that corporate performance is negatively associated with CG. Similarly, Pearce and Patel (2017), found that board independence is not associated with firm performance and CEO is negatively associated with firm performance. Detthamrong et al. (2017), examined the association between CG and firm performance in 493 non-financial firms in Thailand between 2001 and 2014. The study found that CG is not associated with firm performance. As far as this researcher knows, there is no prior study on the effect of AAOIFI governance disclosure on bank performance in IBs. Thus, the current research tries to examine this issue. According to the agency theory, the current research hypothesises that: H8: There is a positive association between the level of AAOIFI governance disclosure and performance in IBs. 53
  56. 2TABLE 3 .2: A SUMMARY OF LITERATURE CONNECTING CORPORATE GOVERNANCE DISCLOSURE AND PERFORMANCE Direction of Relationship Authors Country and Sample Pillai et al. (2017) 349 companies Empirical Finding in GCC CG significantly affects firm Tobin’s Q and ROA during 2005–2012 Harun (2017) United Malacca Performance Measurement performance Berhad CG (UMB) has a relationship positive ROA and ROE with firm performance Foyeke et al. (2015) 137 companies in Nigeria ROA during 2003–2010 Positive Amoateng et al. (2017) 100 small and medium-size CEO is positively affected by ROA and net profit margin enterprises (SMEs) in Ghana ROA (NPM) during 2012–2016 Alvarado and Bravo (2017) US-listed firms during 2008– Board independence and Tobin’s Q 2012 board size are positively influenced performance 54 by the firm
  57. Ali et al . (2017) 100 non-financial firms in CG improves firm Pakistan during 2006–2008 Al-Ataibi (2017) ROA and ROE performance Companies listed on the Market value add (MVA), Kuwaiti stock market return on investment (ROI), NPM, ROA and return on ordinary share EPS Siswanti et al. (2017) Nine IBs during 2010–2015 CG has a significant impact on firm performance Albawwat et al. (2015) Companies listed on the The quality of disclosure Jordanian stock exchange leads to high performance during 2009–2013 Ogege and Boloupremo Nigerian banks (2014) A positive between CG relationship ROE and ROA and firm performance Hussain (2017) and Abdulhadi 124 companies in Malaysia Board size composition and have board ROA a significant impact on firm 55
  58. performance Garefalakis et al . (2017) 86 banks during 2008–2011 Board independence ROA strongly supports bank efficiency and operations Al-Najjar (2014) Publicly listed companies in Board independence is ROA, ROE and stock price five countries in the Middle positively associated with return East Silva et al. (2017) firm performance Companies listed in BM& Board FBovespa during 2010–2014 size associated is positively ROA with firm performance Taherian and Karampour Firms listed on the Tehran A significant effect between ROA (2017) stock exchange board size, CEO and firm performance Hassan et al. (2016) Firms listed Palestinian Negative stock the CG is negatively associated ROA, ROE and MBVR market with firm performance over 2010–2012 Pearce and Patel (2017) 56 on Publicly traded companies in CEO is negatively associated ROA
  59. the USA Amoateng et al . (2017) with performance 100 SMEs in Ghana during Board size is negatively ROA and ROE 2012–2016 associated with firm performance Vithessonthi et al. (2017) 493 firms in Thailand during ACs is negatively associated ROE 2001–2014 Pearce and Patel (2017) with firm performance Publicly traded companies in Board independence is not ROA the USA associated with performance Hatt et al. (2008) Malaysian-listed companies No Relation CG is not associated significantly Tobin’s Q with firm performance Haassouna et al. (2017) 85 Egyptian companies 2010 57 during listed No significant relationship ROA, ROE, Tobin’s Q and 2006– between disclosure and firm the performance market/book (M/BV) value
  60. 3 .4.1 Corporate governance mechanisms and firm-specific characteristics (control variables) The study objective is to examine the impact of AAOIFI governance disclosure level on bank performance. Thus, the independent variable, at this stage of the study, is the AAOIFI governance disclosure score, and bank performance is the dependent variable, as indicated by ROA and ROE. The rest of the variables relate to CG characteristics and firm-specific characteristics and are considered as control variables. 3.4.1.1 Independent directors and firm performance According to agency theory, independent directors help to reduce agency problems between agents and principals (Fama, 1980). Additionally, from signalling theory, “the presence of independent members on the board can serve as a signal to the existence of fewer agency problems” (Black et al., 2006). Fama and Jensen, (1983) argue that independent directors, with their expertise and connections to a firm, can then improve firm value. Moreover, Goodstein et al. (1994), suggest that the monitoring increases and affects firm value through a high number of independent directors. Empirical studies have found mixed results between independent directors and firm performance. A positive relationship is noted by Al-Najjar (2014), who explored the under-researched relationship between CG and firm performance in tourism companies. The study reported that board independence is found to be positively related to firm performance as measured by ROA. Similarly, using 27 IBs in five Arab Gulf countries for three years (2011–2013), Srairi (2015), found that the IBs with a high level of CG disclosure report a high level of performance measured by ROA and ROE. Also, Anis et al. (2017) studied the impact of board characteristics on bank performance using a sample of 70 firms over six years. They found a positive association between the independent board and bank performance. Furthermore, (Bravo and Reguera‐Alvarado, 2017; Pearce and Patel, 2017 and Garefalakis et al., 2017) found a significant and positive relationship between the two variables. On the other hand, Bozec (2005), investigated 25 Canadian companies from 1976 to 2000, measured by ROA, return on sales and Tobin’s Q, the study found that firm value was lower in companies that had a board dominated by independent board members. Al-Maghzom et al. (2016) found no significant association between the two variables. Recently, Molnar et al. (2017) also found no significant relationship between the independent board and firm performance. 58
  61. 3 .4.1.2 Board size and firm performance Allegrini and Greco (2013), state that board size is a vital factor that can affect management behaviour. Agency theory suggests that a larger board may have increased managerial costs, which then negatively affect firm value (Yawson, 2006). For instance, a large board may increase board expenses, remuneration and other allowances. A larger board can lead to an increase in agency costs and reduce firm value (Jensen and Meckling, 1976). Previous studies found mixed results between board size and firm performance. Gordon et al. (2012), suggested that more efficient CG practices are related to board size, which positively affect financial performance. Similarly, a larger board may attract more qualified members who may improve board decisions (Yawson, 2006). Al-Najjar (2014), found that large boards increase firm profitability. However, small boards show a greater level of efficiency in the stock market. Recently, (Hussain and Hadi, 2017; Taherian and Karampour, 2017; Anis et al., 2017; Pillai and AlMalkawi, 2017 and Silva et al., 2017) found a positive and significant relationship between the two variables. In contrast, some studies found the relationship between board size and firm performance is negative and insignificant, such as Amoateng et al. (2017), who studied the impact of CG practices on the performance of SMEs in Ghana. They found that board size has a negative and insignificant impact on firm performance. Similarly, (Hassan et al., 2016; Pearce and Patel, 2017 and Garefalakis et al., 2017) found an insignificant and negative association among the two variables. 3.4.1.3 Frequency of directors meetings’ and performance The main responsibility of a board director is monitoring the firm’s operation (Mahadeo et al., 2012; Khan et al., 2013). Hence, regular board meetings lead to good monitoring by managers (Vafeas, 1999). Regular board meetings can increase firm performance by relieving agency problems (Schwartz-Ziv and Weisbach, 2013). The existing literature on the association between the frequency of board meetings and firm performance is mixed. According to Schwartz-Ziv and Weisbach (2013), the relationship between the frequency of board meetings and financial performance is positive. According to agency theory, this may reduce conflicts and help to influence shareholders positively. Upadhyay et al. (2014) found a positive relationship between the two variables by using a sample of US firms. Similarly, Albassam (2014), pointed to a positive relationship between the frequency of board meetings and performance. 59
  62. On the other hand , Vafeas (1999) states that a high frequency of board meetings can increase agency costs. For example, travel expenses and meeting expenses can have a negative effect on firm value (Fama and Jensen, 1983). Vafeas (1999), as mentioned above, and Fich and Shivdasani (2006), also found that the frequency of board meetings had a negative effect on firm value. Similarly, Christensen et al. (2015) found the same result. Also, Hassan et al. (2016), found a negative relationship between the two variables. Recently, Chou and Buchdadi (2017), examined the impact of board meetings on banking practice in Indonesia. They found that board meetings enhance the operational performance of the bank. 3.4.1.4 CEO duality and firm performance Agency theory proposes that CEOs should run the firm in the best interest of shareholders (Jensen and Meckling, 1976). Jensen (1993) and Blackburn (1994), argue that merging the roles of chairperson and CEO may undermine the board’s controlling power. White and Ingrassia (1992), assert that CEO duality can lead to a decline in performance because of the agency cost if the CEO practices their interest at the expense of the shareholder. CEO duality is an essential dimension of governance which affects firm performance (Mollaha and Zamanb, 2015). According to agency theory, CEOs should run a firm in the best interests of shareholders (Chen et al., 2011). Mollaha and Zamanb (2015), investigated the impact of CEO power on financial performance during the period 2005–2011. They found a negative impact on firm value. Similarly, Mashayekhi and Bazaz (2008), argued that CEO duality could present self-serving chances to control board meetings that may have a negative effect on corporate financial performance. Similarly, Anis et al. (2017) found a negative relationship between CEO duality and firm performance. Also, Albassam (2014), found a negative impact on the two variables. On the other hand, Boyd (1995), found that CEO duality leads to a higher return on investment. Recently, (Opata and Awino, 2017; Pearce and Patel, 2017 and Scafarto et al., 2017) found a positive relationship between CEO duality and firm performance. In addition, (Garefalakis et al., 2017; Taherian and Karampour, 2017; Hussain and Hadi, 2017 and Muriuki et al., 2017) found a significant association among the two variables. Some research studies found that CEO duality does not affect firm value, such as Bozec (2005), who found the insignificant impact of CEO duality on firm value in a sample of 25 Canadian firms between 1976 and 2000. 60
  63. 3 .4.1.5 Audit committee size and firm performance ACs enforcement plays a vital role to ensure adequate CG to all stakeholders (Velte, 2017). Agency theory proposes that ACs decrease the conflict of interest and asymmetric information between management and investors (Jensen and Meckling, 1976). Zhang et al. (2007), stated that ACs is still valued as one of the essential governance characteristics that are recommended for developed governance accountability, transparency and reporting quality in firms. Most of the prior studies suggest that firms that employ large audit firms tend to have a high level of agency conflicts, and they aim to decrease the existing level of conflict through the staffing of external firms (Inchausti, 1997). Chan and Li (2008) investigate the impact of ACs on the firm value of 200 firms and found a negative association between the two variables. Similarly, Detthamrong et al. (2017) examined the association between CG and firm performance for a panel of 493 firms in Thailand during the period 2001–2014. They found that ACs had a negative effect on firm performance. Also, Hassan et al., (2016), found a negative association among the two variables. 3.4.1.6 Firm characteristics and firm performance Following previous studies (Aggarwal et al., 2008; Hassan et al., 2009; Harun, 2017; Al-Najjar and Al-Najjar, 2017; Bravo and Reguera‐Alvarado, 2017) the current study considers some firm characteristics, these controls are firm size, liquidity, leverage and firm asset growth. Al-Akra and Ali (2012) assert that firm size impacts on firm value because larger firms find it easier to obtain sources of funding. Also, significant total assets can be used internally as sources for the firm, and managers have more flexibility in using assets in the firm and, as a result, there is an improvement in firm performance and an increase in firm value Ezat and El-Masry, (2008). So, in previous studies, such as Hassan et al. (2009), a positive relationship is seen between company size and company performance. Similarly, Bravo and Reguera‐Alvarado (2017), found a positive association between company size and company performance. Also, Anis et al. (2017) found the same association between the two variables. Thus, the larger firm is usually expected to have a better value, especially regarding firm performance (Samaha et al., 2012). Liquidity is another variable that can affect firm performance. From a signalling theory perspective, companies with high liquidity tend to highlight their positive liquidity outcomes to indicate their abilities to investors. Also, agency theory confirms the relationship between liquidity and firm performance. Prior studies found a significant positive relationship between liquidity and operation standards (Schipper, 1991; White and Ingrassia, 1992). In contrast, AlMaghzom et al. (2016) found a negative association between liquidity and firm value. 61
  64. In regard to leverage , this might have a positive influence on bank performance. According to Hodgson and Stevenson-Clarke (2000), this effect might take place because tax deductibility on borrowing may result in a reduction in the cost of capital, which greatly raises company performance. In previous studies, there are mixed results for the association between firm value and leverage. Companies with rising leverage seek to have great operations to obtain higher profit growth (Ouma, 2012). Also, Pillai and Al-Malkawi (2017) found a significant relationship between leverage and firm performance. Meanwhile, some previous studies found a negative association between leverage and firm value (Ammann et al., 2011; Mangena et al., 2012; Bravo and Reguera‐ Alvarado, 2017; Hassan et al., 2016; Harun, 2017). Firm asset growth is related to the existence of firms because company growth is related to a rise in work actions (Henry, 2008). According to Henry (2008), firms may receive a good valuation with better growth opportunities. Empirically, prior studies have found a significant relationship between company growth and bank performance (Henry, 2008; Haniffa and Hudaib, 2006). 3.5 Chapter Summary The current chapter supplied literature discussions of CG disclosure in IBs, according to the prior studies in the level of AAOIFI governance disclosure, its determinants and bank performance. The research identifies different study gaps that need to be accomplished. Shortly, the study hypotheses of the current research can be distributed into three prime groups, according to research questions and objectives. Firstly, a group that is related to the level of AAOIFI governance disclosure. Secondly, the group of hypotheses that is linked to a relationship between the CG characteristics and AAOIFI governance disclosure, and the third group is linked to bank performance and AAOIFI governance disclosure level. The following chapter will present a consideration of the research methodology and methods applied to achieve the research questions. 62
  65. Chapter 4 : Research Methodology 4.1 Overview This chapter presents the research methodology used in this current research to obtain the study aim, response to the study questions and examines the hypotheses. In addition, it presents how the data is collected, the study sample, the reliability, and how the variables are measured. This chapter includes discussions on the research philosophy, approach and methodology used to measure the level of AAOIFI governance disclosure, the determinants and bank performance. 4.2 Research Philosophy The research philosophy is the approach used to collect data and then analyse, and consequently utilise, this data (Collis et al., 2003). Interpretivism and positivism are the two main approaches that can be used in the management research (Bryman, 2015). Positivism is supported by scientists’ views that the nature of knowledge is based on realism. Collis and Hussey (2009: 56) demonstrate positivism in management research as thus: “Today, researchers conducting business research under a paradigm that stems from positivism still focus on theories to explain and predict social phenomena”. Positivism illustrates the causal association between variables that can help to develop theories from the findings. Also, positivism is the view that social phenomena can be measured, and thus they can be interpreted using quantitative methods of analysis (Bryman, 2015; Saunders et al., 2007). On the other hand, interpretivism depends on the principles of idealism and explores the understanding of social phenomena. Also, interpretive philosophy emphasises the being of difference, which is necessary to enhance the research process between people and objects of the natural sciences. The process, therefore, requires a social science path to identify the subjective meaning of social action (Saunders and Lewis, 2009). Table 4.1, shows the difference between the positivism and the interpretivism philosophy. A paradigm is therefore characterised by sides, by an assured methodology that is adopted by researchers for acquiring or developing knowledge. A research paradigm is also concerned with two central concepts: the nature of the phenomenon under study and the function of the role of the researcher. Clarity on the research paradigm being followed assists researchers in conducting their studies more efficiently. Research methods and philosophies are two critical concepts that are consistent in a research paradigm. 63
  66. 3TABLE 4 .1: COMPARISON OF POSITIVISM AND INTERPRETIVISM Panel A: Common Terms Used to Describe the Paradigms Positivism Interpretivism Quantitative Qualitative Objective Subjective Scientific Humanist Traditionalist Phenomenological Panel B: Features of the Paradigms Positivism Interpretivism A large sample is involved Used with small samples Concerned with hypothesis testing Helpful in generating theories Produces precise, objective and quantitative data Produces ‘rich’, subjective and qualitative data Produces results with high reliability but low Produces findings with low reliability but high validity validity Allows results to be generalised from the sample All findings can be generalised from one setting to to the population another setting Source: Collis and Hussey (2009:58-62) The current study uses the positivism philosophy. It examines the reality of an already existing phenomenon, the level of AAOIFI governance disclosure in IBs. The researcher uses existing theories in the emergence of the hypothesis that is tested and can, therefore, either be accepted or rejected (Saunders and Lewis, 2009). 4.3 Research Approach Deductive and inductive are the two main research approaches. The deductive approach is based on theory (or theories), with a developed hypothesis that is based on the theories. The study strategy is prepared to explore the hypothesis based on the gathered data (Saunders and Lewis, 2009). Meanwhile, with the inductive path, the data is based on the phenomenon that is gathered and tested and, consequently, a theory is established (Bryman and Bell, 2003; Babbie, 2015). In this research, the deductive path is used. Down this path, the study developed a hypothesis according to existing literature and theories and used a statistical method to examine the developed hypotheses. This approach corresponds with the aim of the research that is to identify the determinants and the bank performance on the level of compliance of AAOIFI CG. The differences between the research approaches (deductive and inductive) can be explained as follows: 64
  67. 1FIGURE 4 .1: DEDUCTIVE PROCESS 2FIGURE 4.2: INDUCTIVE PROCESS Source: Alotaibi (2016:115-116) 4.4 Research Methodology The current research investigates the level of disclosure of AAOIFI governance and tests the hypotheses of its determinants and its impact on bank performance. Milne and Adler (1999: 237) state that most researchers in the social accounting field have “focused on the disclosure organisations make in their annual reports. The research method that is most commonly used to assess organisations’ social and environmental disclosures and accountability is content analysis”. According to Campbell, (2000:48), annual reports “can be accepted as an appropriate source of a company’s attitudes towards social and ethical reporting”. Also, Buhr (1998:169), regarding an annual report, asserted that “they are the only form that is institutionalised and provided on a regular basis year after year”. Access to annual reports is easy, as they can be downloaded from a bank’s website. Crotty, (1998 :3) defined research methods as “the technique or procedures used to gather and analyse data related to some research question or hypothesis”. The current study adopted quantitative content analysis research methods in measuring the AAOIFI governance disclosure of IBs that adopt AAOIFI standards as mandatory. The financial reports of sample IBs from 2013 to 2015 analysed using disclosure index and content analysis. 65
  68. AAOIFI governance disclosure mentions to the standard of AAOIFI governance information disclosed in the annual report . The researcher measured the level of AAOIFI governance disclosure by the amount of AAOIFI governance information that is issued by the bank in the annual report. To measure the level of AAOIFI governance disclosure volume in the research, the un-weighted path is used to code and size AAOIFI governance disclosure through the annual report. Thus, ‘1’ is assigned for every AAOIFI governance disclosed in the annual report, and ‘0’ is assigned if the annual report does not provide any AAOIFI governance disclosure items. Each bank has been given a score of quantity, which represents the total AAOIFI governance disclosure items in the annual reports. It includes all AAOIFI governance standards from No. 1 to No. 6. To examine the impact of AAOIFI governance disclosure between the sample IBs, annual reports have been used as the primary resources in gathering data. While in measuring the bank performance, the researcher calculated the ratios manually based on the income statement and balance sheet that were collected from the www.fitchconnect.com. To test the hypotheses and test the relationship among the main variables, the research employed OLS regression. 4.5 Sample and Data The sample includes all IBs that have mandatorily adopted AAOIFI standards. There are ten countries that have mandatorily adopted AAOIFI standards “Bahrain, Syria, Qatar, Sudan, Tunisia, Jordan, Lebanon, Palestine, Oman and Mauritius” (Al Qamashoui and Hussainey, 2016). However, the study excludes IBs in Lebanon, Tunisia and some banks from Sudan, because the researcher did not have access to these banks’ annual reports and, despite sending emails to these banks, they did not reply. The years the study focused on were from 2013 to 2015, and this period includes 126 banks in total. The reason for selecting this period was because the latest IBs that adopted AAOIFI standards was in 2013 (Bank Nizwa), and 2015 was the most recently available annual reports produced by the sample of IBs. Table 4.2 shows the sample of this current study (IBs that mandatorily adopt AAOIFI standards). 66
  69. 4 TABLE 4 .2: SAMPLE OF THIS CURRENT STUDY (IBS THAT ADOPT AAOIFI STANDARDS AS MANDATORY) Bank Bahrain 1. Khaleeji Commercial Bank 2. First Energy Bank 3. Arab Banking Corporation (ABC) 4. Bahrain Islamic Bank 5. Venture Capital Bank 6. Ithmaar Bank 7. Gulf Finance House 8. Al Salam Bank of Bahrain 9. Bank Alkhair 10. Albaraka Islamic Bank Bahrain 11. Seera Investment Bank 12. International Investment Bank 13. Citi Islamic Investment Bank 14. Investors Bank 15. Liquidity Management Centre 16. Ibdar Bank 17. Kuwait Finance House-Bahrain Qatar 18. Qatar International Islamic Bank 19. Qatar First Bank 20. Barwa Bank 21. Masraf Al Rayan 22. Qatar Islamic Bank Doha 23. Q invest Bank Sudan 24. Faisal Islamic Bank Sudan 25. Al Shamal Islamic Bank 26. Saving & Social Development Bank 27. Farmers Commercial Bank 28. Al Jazeera Sudanese Jordanian Bank 29. Tadamon Islamic Bank 30. Blue Nile Mashreg Bank 31. United Capital Bank Jordan 32. Jordan Islamic Bank 33. Islamic International Arab Bank 34. Jordan Dubai Islamic Bank (Safwa Islamic Bank Syria 35. Syria International Islamic Bank 36. Albaraka Bank Syria 37. Cham Bank Palestine 38. Arab Islamic Bank 39. Palestine Islamic Bank Oman 40. Bank Nizwa 41. Alizz Islamic Bank Mauritius 42. Century Banking Corporation 67
  70. 4 .6 Content Analysis There is a wide range of definitions of content analysis; the majority agreeable one is that defined by Berelson (1952: 18) as: “Content analysis as a research technique for the objective, systematic and quantitative description of the manifest content of communication”. According to Guthrie and Abeysekera (2006:14), “Content analysis of annual reports is a technique for gathering data”. Content analysis is an important tool that has been used in the analysis of documents and texts that searches quantified content regarding predetermined categories. In prior CG disclosure studies, content analysis has been widely used (Samaha et al., 2012). The current study uses the disclosure index, which cross-checks with the annual report to identify the level of AAOIFI governance disclosure by IBs. The annual reports read line by line, the result ‘1’ given if there is bank disclosure in AAOIFI governance information and 0 otherwise. Some of the previous researchers have used this method in estimating either the preciseness of detail or level of disclosure in annual reports (Haniffa and Cooke, 2002; Ghazali and Weetman, 2006; Aribi, 2009; Alotaibi, 2016; Harun 2016 and Abdullah, 2013). The current research has chosen the content analysis technique to examine data around the level of AAOIFI governance disclosure, gathered from the annual reports of IBs. Content analysis is a suitable method for quantifying data during the reading of annual reports, as pre-determined groups can be used in a way that can be readily repeated (Bryman and Bell, 2003). 4.7 AAOIFI Governance Index The current study uses a comprehensive unweighted disclosure index to answer the first question in the study. It includes all AAOIFI governance standards issued in 2010. Consequently, a ‘1’ is given for each item in the AAOIFI governance index disclosure in the annual report and ‘0’ if otherwise. Every bank has been given a score based on the whole figure of AAOIFI governance disclosure items, in the annual report. The unweighted disclosure index means that all items are given similar results and importance (Shehata, 2014). Beattie et al. (2004: 126) stated that: “disclosure index studies are based on the general principles of content analysis as a wellestablished method in the social sciences”. Following the Beattie et al. (2004), the researcher developed a comprehensive AAOIFI governance index as “a partial type of content analysis”. Many types of research have employed a disclosure index as a study method (Maali et al., 2006; Aribi, 2009; Abdullah, 2013; Ismail, 2015; El-Halaby and Hussainey, 2015 and Harun, 2016). 68
  71. According to Guthrie and Abeysekera (2006: 11), “a disclosure index is a research instrument comprising of a series of pre-selected items which, when scored, provide a measure that indicates a level of disclosure in the specific context for which the index was devised”. Previous studies (Maali et al., 2008; Haniffa and Hudaib, 2007; Hassan and Harahap, 2010) employ several stages to develop the disclosure index. Therefore, in conducting this research, the researcher performs these stages. First, to measure the level of AAOIFI governance disclosure, the items in the index were developed based on all AAOIFI governance standards from No. 1 to No. 6, issued in 2010. Second, the items included in the index are selected very carefully by reading the AAOIFI governance, and then, the researcher selected the main dimensions of the index, which consisted of six main AAOIFI governance standards. After that, each item was divided into sub-items, based on essential points in each standard. For example, the first main dimension is SSB (AAOIFI governance No. 1), which is divided into 14 sub-items – six are related to SSB and eight are related to the SSB report. The index consists of 56 items that were created to measure the level of AAOIFI governance disclosure. The dimensions aimed to determine the level of AAOIFI governance disclosure using a CG index and the level of the AAOIFI governance sections in the annual reports. Table 4.3 shows the outline of the major dimensions in measuring AAOIFI governance disclosure in the sample IBs that adopt AAOIFI. Third, the process and confirmation of the AAOIFI governance disclosure index take place. The researcher confirmed items built in the index through discussion with the academic judge, namely Professor. Adel Ahmed (Al Ain University, UAE), Dr Zakaria Ali-Arabi (University of Central Lancashire), Dr Taswar Nawaz (Plymouth University) and my director of the study, Professor Khaled Hussainey. Finally, after confirming the index, the researcher decided whether to define a weighting to the AAOIFI governance disclosure checklist or not. In the current research, an unweighted AAOIFI governance index is employed to measure the level of CG disclosure. The reason for using an unweighted disclosure index is due to several researchers confirmed that both unweighted and weighted scores, generally lead to the same results when a large number of items are included (Marston and Shrives, 1991). In addition, this method has been used widely in previous research in measuring disclosure practices (Haniffa and Cooke, 2002; Abdullah, 2013; Elzahar and Hussainey, 2012 and Harun, 2016). Therefore, the study has selected this method, in measuring the level of AAOIFI governance disclosure quantity of IBs that adopt AAOIFI governance around the world. 69
  72. 5TABLE 4 .3: AAOIFI GOVERNANCE INDEX No. Governance Standards 1 Item No. Items/Scoring (1 if compliant, 0 otherwise) Reference 1 2 At least three members appointed by shareholders at the annual meeting Experts in Islamic commercial jurisprudence 3 The role, responsibilities and authorities of the board 4 SSB seek the service of consultants who have expertise in business, economics, law and accounting Approval/acceptance of the appointment of the SSB AAOIFI (2010, p.4) AAOIFI (2010, p.4) AAOIFI (2010, p.4) AAOIFI (2010, p.4) AAOIFI (2010, p.4) AAOIFI (2010, p.5) Sharia Supervisory Board (SSB) 5 6 *Items related to the SSB report 7* 8 9 10 11 12 13 14 15 The dismissal of a member of the SSB will require a recommendation by the board of directors and be subject to the approval of the shareholders at a general meeting The SSB report signed by the board members AAOIFI (2010, p.7) AAOIFI (2010, p.6) AAOIFI (2010, p.6) AAOIFI (2010, p.6) AAOIFI (2010, p.6) AAOIFI (2010, p.6) AAOIFI (2010, p.6) Information about the opinion of the board regarding the bank’s complete compliance with the rules of Islamic Sharia Information about the bank’s accountability of zakah Information about the bank’s accountability of actions that do not follow Sharia and how the bank deals with it information around profit distribution processes information around the independence of the Sharia board and the of topicality the board SSB has performed appropriate tests of documents, procedures and reviews of work, as appropriate, for the compliance with Sharia information around the date of the report and name of the bank AAOIFI (2010, p.7) Examination of the extent of an institution's compliance with Sharia in all activities – covers contracts, transactions, policies etc. The SR of an IFIs Sharia review does not relieve management’s responsibility for compliance AAOIFI (2010, p.14) AAOIFI (2010, p.14) 17 Ensure that the activities carried out by an IFI do not contravene Sharia AAOIFI (2010, p.14) 18 Reviewing other information and reports, such as circulars, minutes, operating and financial reports, policies and procedures AAOIFI (2010, p.15) 19 Discussing findings with a member of IFI management AAOIFI (2010, p.15) 16 2 Sharia Review (SR) 20 21 22 3 Internal Sharia Review 23 Carried out by an independent department or part of the internal audit department Continuous examination and evaluation of the extent of an institution’s compliance with Sharia The charter will be approved by the SSB of the IFI and issued by the board of directors The charter will be regularly reviewed (ISR) 24 25 26 27 70 The charter will make clear no executive authority has responsibility for the activities they review The staff have an appropriate educational background and training relevant to the ISR Comply with the code of Ethics for Accountants and Auditors of IFIs issued by the AAOIFI At least a quarterly written report will be prepared, which must be signed by the head of the ISR AAOIFI (2010, p.22) AAOIFI (2010, p.22) AAOIFI (2010, p.22) AAOIFI (2010, p.22) AAOIFI (2010, p.22) AAOIFI (2010, p.23) AAOIFI (2010, p.23) AAOIFI (2010, p.25)
  73. 4 Audit and Governance Committee (AGC) for IFIs 28 Review of internal controls (including an internal audit) 29 Reviewing resources and skills, the scope of responsibility, overall work programme and reporting lines of the internal audit 30 Reviewing the major outcome of an internal audit 31 Reviewing the IFIs code of ethics and the effectiveness with which it is implemented 32 Reviewing the effectiveness of the IFIs system for monitoring compliance with Sharia rules and principles 33 Reviewing the IFIs accounting policies and practices and reporting requirements 34 Ensuring that independence and professional integrity of auditors is not compromised 35 Review of interim and annual accounts and financial reports 36 Reviewing the compliance with Sharia rules and principles 37 Formally established by the board of directors from its nonexecutive members and appointed by the board of directors 38 The AGC must not have less than three members 39 The report of the AGC is submitted to the board of directors, through the chairman of the board, and copies sent to the CEO 40 SSB members will be fair, intellectually honest and free from conflict of interests SSB members are not to subordinate their judgment on Sharia supervision matters to others SSBs avoid potential and actual situations that impair their ability to make objective professional judgments SSB members are not employees of the same IFI 44 SSB members are not involved in any matter regarding managerial decisions and operational responsibilities of the IFI AAOIFI (2010, p.44) AAOIFI (2010, p.44) AAOIFI (2010, p.44) AAOIFI (2010, p.44) AAOIFI (2010, p.44) 45 Identify any situations that may impair independence and resolve them AAOIFI (2010, p.45) 41 5 No. Independence of the Sharia Supervisory Board Governance Standards 42 43 Item No. Items No. Sub-items Reference 46 Effective Sharia compliance structure 46.1 The interaction between the SSB or its members and management should be transparent The responsibility for the conduct of the overall affairs of the IFI by Sharia rests with the board of directors AAOIFI (2010, p.56) Equity holders should have access to vital corporate information about the conduct of the overall affairs of the IFI to allow them to make an informed judgment AAOIFI (2010, p.57) 46.2 6 Statement of Governance Principles for IFIs 71 AAOIFI (2010, p.32) AAOIFI (2010, p.33) AAOIFI (2010, p.33) AAOIFI (2010, p.33) AAOIFI (2010, p.33) AAOIFI (2010, p.33) AAOIFI (2010, p.33) AAOIFI (2010, p.34) AAOIFI (2010, p.34) AAOIFI (2010, p.35) AAOIFI (2010, p.36) AAOIFI (2010, p.36) 47 Fair treatment of equity holders 47.1 AAOIFI (2010, p.56)
  74. 48 Equitable treatment of fund providers and other significant stakeholders 47 .2 The BOD and management should be involved with the equity holders and responsible for managing successful and productive relationships with the equity holders AAOIFI (2010, p.57) 47.3 Controlling equity holders should safeguard their interests Safeguard against the risks of inequitable treatment of fund providers and other significant stakeholders AAOIFI (2010, p.57) AAOIFI (2010, p.57) 48.2 Provide adequate and timely information about major changes to its business that can have material consequences regarding their interests in the IFI AAOIFI (2010, p.57) 48.1 49 Fit and proper conditions for board and management 49.1 Selection of members of BOD, SSB and management should be transparent and based on a predefined set of criteria AAOIFI (2010, p.58) 50 Effective oversight 50.1 The BOD should set a clear strategic plan that sets forth the IFI business strategy and management plans to implement it The BOD should establish a wellaligned management structure that fosters the proper segregation of duties and enhances accountability and effectiveness of any management oversights Set effective financial and nonfinancial performance measures for the periodic assessment of the effectiveness of governance The BOD should understand its role and that of management in the area of risk management AAOIFI (2010, p.58) 50.2 50.3 51 Risk management 51.1 AAOIFI (2010, p.58) AAOIFI (2010, p.58) AAOIFI (2010, p.59) Management is responsible for assessing and managing the IFI disclosure to various risks 52 Avoidance of conflicts of interest 51.2 Approve the IFI risk strategy, and set tolerance levels for risks the IFI assumes, and establish the framework for management of the risks it takes on in its business AAOIFI (2010, p.59) 51.3 Establish a programme for succession planning and leadership development Identify all situations of potential conflicts of interest and institute codes and policies to ensure situations leading to such conflicts are avoided at all times Those charged with governance should act in a manner that is free and objective in perspective AAOIFI (2015, p.59) 52.1 52.2 72 AAOIFI (2010, p.60) AAOIFI (2010, p.60) 53 Appropriate compensation policy oversight 53.1 Developed on an independent and transparent basis AAOIFI (2010, p.60) 54 Public disclosure 54.1 Adopt high standards of reporting and satisfy the information needs of AAOIFI (2010, p.60)
  75. owners, investment account holders, other counterparties, regulatory, zakah and other related agencies 55 Code of conduct and ethics 55.1 56 Appropriate enforcement of governance principles and standards 56.1 Adopt policies, a procedure consistent with Sharia, to promote a code of ethical and responsible behaviour by a member of BOD, members of SSB, management and employees Have a mechanism to ensure the principles and standards of governance are adhered to and monitored AAOIFI (2010, p.60) AAOIFI (2010, p.61) The method used in measuring the AAOIFI governance disclosure level of the sample of IBs is as follows: AAOIFI governance disclosure (i, t) = ∑