Finance Assignment - Islamic Finance: The conflicts of interest inside the Shari'a supervisory board

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International Journal of Islamic and Middle Eastern Finance and Management Emerald Article: The conflicts of interest inside the Shari'a supervisory board Samy Nathan Garas

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To cite this document: Samy Nathan Garas, (2012),"The conflicts of interest inside the <IT>Shari'a</IT> supervisory board", International Journal of Islamic and Middle Eastern Finance and Management, Vol. 5 Iss: 2 pp. 88 - 105

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The conflicts of interest inside the Shari’a supervisory board

Samy Nathan Garas New York Institute of Technology, Manama, Bahrain

Abstract

Purpose – The purpose of this study is to identify the relation between the conflicts of interest in the Shari’a Supervisory Board (SSB) in the Islamic financial institutions (IFIs) and six independent variables: the SSB executive position, the SSB remuneration, the relation between the SSB members and the Board of Directors (BoD), and the multiple memberships in Islamic funds, issuers of Islamic bonds (Sukuk), and companies trading in capital markets.

Design/methodology/approach – The variables are articulated in six hypotheses and tested by ordinary least square regression. The data were collected via a questionnaire which was sent to the shareholders, the BoD, and the SSB members of all of the IFIs in the Gulf Cooperation Council (GCC) countries.

Findings – The results indicate that the SSB executive position, the relation between the SSB members and the BoDs, and the membership in Islamic funds and issuers of Islamic bonds are significantly related to the conflicts of interest, whereas remuneration and membership in companies trading in capital markets have insignificant relation.

Research limitations/implications – The paper does not address the impact of SSB ownership in the IFIs, or the relation between the SSB and the shareholders, or the impact of the corporate governance codes on the relationship between the IFI and the SSB.

Practical implications – The study recommends testing the hypotheses in other geographies to generalize the results, and measuring the impact of the SSB ownership on the conflicts of interest as well as its relation with shareholders, regulators, and clients.

Social implications – The paper provides practical implications to the SSB members and the BoD in the IFIs and calls for setting a maximum number of SSBs for each SSB member.

Originality/value – This study contributes to the literature gap of the SSB role in the governance of IFIs. It is believed to be one of first studies that provide empirical evidence about the SSB conflicts of interest in the IFIs of the GCC region.

Keywords Shari’a supervisory board, Conflicts of interest, Islamic financial institutions, Board governance, Corporate governance, Islam

Paper type Research paper

1. Introduction Although there is a gap between religion and financial system, under Islam there is no separation between religious life and business life (Nicholas, 1994). The principles of the Islamic financial system are derived from Islamic canon law (Shari’a), which regulates every aspect of Muslims’ life, including the way of generating profit. The Islamic Shari’a has established specific guidelines for Islamic financial system such as prohibition of interest in all transactions (Gerrard and Cunningham, 1997; Haque, 1999; Khan and Mirakhor, 1992; Quran, n.d.; Saeed, 1996), prohibition of gambling which takes different forms of combative relationship between two contracting parties (Rosenthal, 1975), and prohibition of some lines of business such as arms, alcohol, and tobacco (Wilson, 1997). On the other hand, the Islamic Shari’a emphasizes full disclosure and transparency among trading parties in every transaction (Ebrahim, 2001; Thomas et al., 2005).

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International Journal of Islamic and Middle Eastern Finance and Management Vol. 5 No. 2, 2012 pp. 88-105 q Emerald Group Publishing Limited 1753-8394 DOI 10.1108/17538391211233399

Since Muslims could not have authority on the conventional financial institutions to adapt the aforementioned principles in their transactions, they established the Islamic Financial Institutions (IFIs) based on Shari’a principles. The IFIs are controlled by classical Board of Directors (BoD) as well as Shari’a Supervisory Board (SSB) to ensure their compliance with Shari’a. The IFIs started in 1970s in Egypt and spread around in the Middle East, North Africa, Far East, Europe, and the USA. In 2009, the number of IFIs has reached 458 worldwide as reported in the Appendix.

The Gulf Cooperation Council (GCC) countries excluding Oman (Bahrain, Kuwait, Qatar, Saudi Arabia, and United Arab Emirates (UAE)) hold 219 IFIs out of 458 which constitute almost half of the total number of IFIs. This large number of IFIs in small geographical countries (except Saudi Arabia) has brought several challenges before the IFIs such as the shortage of qualified manpower that understands the IFIs transactions, and the shortage of the qualified Shari’a scholars who suits the SSB membership. In 2009, the SSB members were found to be 100 Shari’a scholars in the GCC region (CIBAFI, 2009; Zawya, 2009; IFIS, 2009), which is way below the number of IFIs. In the meantime, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) has set the Governance Standard No. 1 requiring the Islamic banks to establish their SSBs with three members as a minimum in each SSB and recommending the same requirement for other types of IFIs such as Islamic insurance companies, Islamic funds, Islamic real estate companies and Islamic corporations trading in capital markets (AAOIFI, Governance Standards, 2008; Hassan, 2001). The shortage of Shari’a scholars coupled with AAOIFI requirements has ended by having some Shari’a scholars sitting on several SSBs, which creates conflicts of interest and limits their contributions in each SSB (Al Qattan, A., 2008; Hameed, 2009). Moreover, some of the SSB members were offered executive positions inside the IFIs, while others received high remuneration. On the other hand, some of the SSB members have established their relations with the BoD. This study defines the conflicts of interest and discusses the impact of these variables on the conflicts of interest.

2. Literature review and research hypotheses Islamic Shari’a has defined conflicts of interest as offenses (haram). One hadeeth says “leave that which makes you doubt for what does not make you doubt” (Hadeeth from Mohammed al-Hassan bin Ali narrated by Al-Tirmidhi; Al Nesaa’i; and Ahmed). This hadeeth considers conflicts of interest as any situation that creates doubts in others. Another hadeeth says “who keeps himself away from doubts, will highly exalt his religion and his integrity; and whoever commits doubtful things, commits offenses (haram)” (Hadeeth narrated by Al Boukhari; Muslim; Al-Tirmidhi; and Al Nesaa’i). The second hadeeth emphasizes the positive side of the eliminating the conflicts of interest, which is exalting the individual’s religion and integrity. Accordingly, conflicts of interest are not desirable in Islam whether in personal life or in business arena.

Al Qari (2008) defines conflicts of interest as “the shortage in fulfillment of two desires in a contractual agreement because they go against each other”. This definition addresses the conflicts of interest in all kinds of relationship. Also, Rizk-Al Qazzaz (2008) defines conflicts of interest as:

[. . .] the impairment of the decision maker’s objectivity and independence due to physical or emotional desire for himself or his relative(s) or his friend(s); or the changes in the person’s performance due to direct or indirect personal concerns or awareness of some information.

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This definition highlights the impact of conflicts of interest on decisions and performance which is relevant to the SSB work. Based on the second definition, Faddad (2008) and Al Qattan (2009) conclude that conflicts of interest are not treason because conflicts resemble competition between different desires that raise suspicion in others’ minds, while treason is an illegal crime which leads to a legal penalty. Since Shari’a scholars are the most reverent people among Muslims, they do their best to keep themselves away from doubtful situations to maintain their integrity.

The shortage of Shari’a scholars’ number might create conflicts of interest when the SSB member sits on several SSBs and takes advantage from the information of the IFIs. Thomas et al. (2005) confirms that the number of qualified Shari’a scholars is too limited to meet the growing demand of the IFIs. However, Bakr (2002) argues that the involvement of Shari’a scholars in more than one SSB leads to conflicts of interest because it is hard to express an independent opinion for two different IFIs during the release of new products by two competitors. On the other hand, the IFIs’ regulators did not issue a standard or address the consequences of violating the privacy rules and sharing the information of one IFI with another (Bakr, 2001). However, the existence of a code of ethics inside the IFIs can work as a supplementary document that informs the SSB members about the rules of privacy, and information sharing (Faddad, 2008; Issa, 2009). The discussion is theoretically sound; nevertheless, it is hard to be applied practically because the IFIs are obliged to choose from the available Shari’a scholars (Al Qari, 2008; Al Qattan, A., 2008, 2009; Al Qattan, M., 2008; Issa, 2009). Some of the IFIs (Khaleeji Commercial Bank in Bahrain, Dubai Islamic Bank in Dubai, and Qatar Islamic Bank in Qatar) have recruited popular Shari’a scholars who are multi-lingual with advanced knowledge in economy and law in order to have a relative advantage in the market.

However, sitting on several SSBs will enable the SSB member to have access to a lot of crucial information such as new products and services, managerial violations inside or outside the operation which might lead to potential losses, and the performance of the current projects and products (Issa, 2009). This information can bring tangible or intangible benefits to the SSB member such as moving the investments from one institution to another in case of potential losses and sharing the information of one institution with its competitors, clients or other stakeholders (Al Qari, 2008; Faddad, 2008). Hence, the AAOIFI Governance Standard (No. 1, 2008, Para 7) recommends recruiting an expert in the field of Islamic finance with normal knowledge in Shari’a to become an independent member and do the SSB functions as Shari’a scholars except for the right of voting on fatwas (Al Nashmi, 2002). The recruitment of this type of members will fill the shortage of Shari’a scholars by increasing the available number of SSB members. On the other hand, Al Salaheen (2005) recommends training the SSB members in different areas of knowledge.

The conflicts of interest do not only arise from the multiple memberships in several SSBs, but also from holding executive position in the organization. Previous studies (Al Bayrkdar, 2008; Al Qari, 2008; Al Qattan, 2009; Bakr, 2002; Faddad, 2008; Issa, 2009) confirm that holding executive position by SSB members besides their initial position as SSB members leads to conflicts of interest. The AAOIFI Governance Standard (No. 5, 2008, Paras 7-8) recommends that SSB members should not take any executive position in the institution because it impairs the SSB independence. Accordingly, we can infer the first hypothesis:

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H1. Conflicts of interest in the SSB are positively related to SSB executive positions inside the IFI.

Although the establishment of SSB is obligatory for Islamic banks to be licensed, it is recommended for other types of IFIs such as Islamic funds. According to the Appendix, the total number of Islamic funds in the GCC countries is seven funds (one in Qatar, one in Saudi Arabia, and five in UAE), which indicates their small market share in the financial markets. The small number of Islamic funds indicates the lack of investment in Islamic funds and the shortage in experts who can manage these funds including Shari’a scholars. Hence, the shortage in Shari’a scholars in this area of business might be challenged by conflicts of interest, as they sit on the SSBs of all these funds. Consequently, we can infer a positive relation between conflicts of interest and the membership in Islamic funds as in the second hypothesis:

H2. Conflicts of interest in the SSB are positively related to membership of SSBs in Islamic Funds.

The other types of IFIs that mainly deal with Islamic bonds (Sukuk) and the capital market might have the same type of conflicts as Islamic funds due to their similar nature of business. However, there are 34 IFIs (three in Bahrain, 13 in Kuwait, two in Qatar, five in Saudi Arabia, and 11 in UAE), which deal with Islamic Sukuk and capital markets in the GCC region compared to seven Islamic funds (the Appendix). The difference in the two numbers indicates issuers of Islamic Sukuk and capital markets have more investors and management than those who deal with Islamic funds. Consequently, the multiple memberships of SSB members in these types of IFIs might not create conflicts of interest because of the diversified activities which are conducted by these institutions. Thus, we assume a negative relation between conflicts of interest and membership of issuers of Islamic Sukuk and capital market companies as in third and fourth hypotheses:

H3. Conflicts of interest in the SSB are negatively related to membership of SSBs in issuers of Islamic Sukuk.

H4. Conflicts of interest in the SSB are negatively related to membership of SSBs in capital market companies.

In addition to the two factors of multiple memberships and holding executive position, the remuneration might play a major role in creating conflicts of interest. Since the SSB work is one of the commercial inputs in the IFIs, the SSB members are eligible to receive appropriate remuneration for their work (Al Qari, 2002). Al Shafei states that, “the Mufti [Shari’a Scholar] should have enough resource of income; otherwise, the people will put him under pressure” (Al Harani, 1977). This statement emphasizes the importance of remunerating the SSB members for their work. Some studies (AAOIFI Governance Standard, 2008; Al Nashmi, 2002; Bakr, 2001) recommend that shareholders approve the remuneration based on the BoD recommendation. Other studies (Abu Me’mer, 1994; Al Shemry, 1996; Wilson, 1990) recommend external parties for approval, such as the Islamic Development Bank, or Ministry of Awqaf, or Ministry of Justice, or the International Islamic Union Bank, or central banks. However, the collaboration between the IFIs and other external parties such as the central banks and SSC might lead to standardizing the remuneration in the market and mitigating the competition among the IFIs.

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The remuneration should not only be established by the right party, but also for the relevant amount. The remuneration amount might be computed as a percentage of the annual profit, similar to the BoD remuneration, or a monthly salary, or an annual fixed amount, or no remuneration at all. Several studies (Al Bayrkdar, 2008; Al Qari, 2002; Al Salaheen, 2005; Issa, 2009) confirm that computing the remuneration as a percentage of annual income leads to conflicts of interest. On the other hand, they reject the monthly salary because it brings down the level of SSB members to the employees’ standard, which negatively affects the SSB authority and independence. Furthermore, AAOIFI Governance Standard (No. 5, 2008, Paras 7-8) recommends that SSB members should not take any unusual fees, or bonus, or become significant shareholders because it impairs their independence. Also, Issa (2009) recommends that SSB remuneration should be computed as a fixed amount and recorded in the SSB contracts. Otherwise, the SSB members should not take any reward from the executive management. Al Qari (2002) emphasizes that SSB remuneration should be disclosed in the IFI financial statements to eliminate any conflicts of interest. He argued the ethical foundation for the SSB remuneration and called for excluding the remuneration from the priorities of the SSB members due to their integrity, knowledge, and piety. He emphasized that SSB members will never forsake their eternity for temporal benefits. Other studies (Abu Ghudda, 1997; Daoud, 1996) call for seeking God’s reward rather than a human reward of cash, which is a high ethical motive. Hence, we can propose the fifth hypothesis which assumes a positive relation between conflicts of interest and remuneration:

H5. Conflicts of interest in the SSB are positively related to SSB remuneration.

Besides the aforementioned factors that might create conflicts of interest, the influential relation between the SSB members and the BoD might lead to conflicts of interest. Since the number of qualified Shari’a scholars is limited and their names are popular in the community due to their religious position, there is a possibility of building an influential relation between the two boards outside the workplace, which might have impact on the recruitment of the SSB members. In practice, there are four different approaches used by the IFIs in recruiting the SSB members, where the BoD is included in three of them. First, the shareholders recruit the SSB members as they recruit the BoD (Abu Me’mer, 1994; Al Haiti, 2009; Al Tayyeb, 2009). This approach is followed by Qatar Islamic Bank, Faisal Islamic Bank of Egypt and Sudan, AlBaraka Bank of Sudan and Mauritania, and the Islamic International Bank for Investment and Development. The advantages of this approach include the enhancement of the SSB independence, the absence of the influential relation between the two boards (Al Qari, 2002; Bakr, 2001; Hassan, 2001), and the confirmation to its ultimate authority over other governance organs (Abu Me’mer, 1994; Al Dareer, 2001; Al Nashmi, 2002; International Islamic Union Bank Law, 1982). However, the limitation of this approach is derived from the lack of the shareholders’ experience in recruiting the unqualified members (Al Bayrkdar, 2008; Al Salaheen, 2005). Second, the recruitment of SSB members might be made by the shareholders upon a recommendation from the BoD due to its experience and awareness of business requirements. This approach is recommended by AAOIFI Governance Standard and other scholars (AAOIFI Governance Standard No. 1, 2008; Abu Ghudda, 2003; Al Qattan, 2004; International Institute of Islamic Thought, 1996) to overcome the limitation of the previous approach; however, the influential relation between the two boards might

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have an impact on the recruitment. Third, the BoD might recruit the SSB members directly as it occurs in Jordan Islamic Bank, Dar Al Mal Al Islami, and the Kurdistan International Bank for Investment and Development. Previous studies (Al Bayrkdar, 2008; Al Salaheen, 2005; El-Khelaifi, 2003; International Institute of Islamic Thought, 1996) criticize this approach because it grants the BoD the right of dismissing the SSB members and opens the door for the influential relation to control the BoD decision. Nevertheless, this approach is recommended in the case of losing one member for any reason before the end of his contract (Al Dareer, 2001). Fourth, the executive management might recruit the SSB members in collaboration with the BoD. This way is also criticized because of the influential relation between the two boards and the pressure the SSB receives from the executive management (Abu Ghudda, 2001; Al Nashmi, 2002). Thus, the relation between the members of the two boards might create conflicts of interest. Accordingly, we propose the sixth hypothesis that assumes a negative relation between conflicts of interest and the relation between the two boards:

H6. Conflicts of interest in the SSB are negatively related to the SSB relation with the BoD.

The H6 are articulated in equation (1) using ordinary least square (OLS) regression to test the relation between conflicts of interest as the dependent variable and the six independent variables:

conflicts ¼ a þ b1position þ b2Memb1 2 b3Memb2 2 b4Memb3 þ b5Remun 2 b6Relation þ 1i ð1Þ

The probabilities of difference (b) are compared by using OLS regression for a given level of significance (a). Position indicates the executive position that might be held by the SSB members, Memb1 indicates the multiple memberships in Islamic funds, Memb2 indicates the multiple memberships in corporations issuing Islamic bonds, Memb3 indicates the multiple memberships in companies trading in Islamic capital markets, Remun refers to the remuneration of the SSB, and Relation refers to the relation between the SSB members and the BoD.

3. Methodology The hypotheses have been tested by a questionnaire, which was mailed to all the IFIs in the GCC countries to collect the data in June, 2009. The questionnaire was examined against general appearance, wording and principles of measurement. The a for the conflicts of interest model was 0.658, which confirms the reliability of the measure as it approaches the standard measure of 0.70 (Cronbach, 1951; Nunnaly, 1978). The questionnaire was also examined against the different types of validity tests such as face validity, content validity, concurrent validity, criterion validity, predictive validity, and construct validity (Sekaran, 2003).

The population of the research included all the IFIs (219) in the GCC countries due to their relative small number, and the desire to produce reliable results. The elements of the population are the BoD, the SSB and the CEOs if they are board members. The population frame for IFIs is drawn from different resources such as central banks, stock exchanges of GCC countries, Arab Banking and Finance directory (2009/2010), Securities database (IFIS, 2009) and Zawya database (Zawya, 2009). Since the research discusses the relationship among two groups: the SSB and the BoD; the population was

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divided into two mutually exclusive groups to be meaningful to the study. Accordingly, the unit of analysis is at the group level, and the data was collected in a manner that would assess the needs of each group in the population. Stratified random sampling was employed among the different types of complex probability sampling (Sekaran, 2003; Thompson, 2002). The average response rate from each group in the five countries collectively exceeded 20 percent (Ritchie and Lewis, 2003) as per Table I except in the BoD of Saudi Arabia. Table I indicates the details of the response rate for each group.

4. Descriptive statistics Conflicts of interest inside the SSB have been tested by six questions. Three questions have scaling answers while the other three have multiple choice answers. Table II includes the questions with scaling answers.

The above three variables are included in one question which asks “do you prefer to recruit a Shari’a scholar that works already in another SSB?” The question was addressed to the BoD. The answer includes membership in different types of IFIs: membership in Islamic funds (Memb1), membership in corporations issuing Islamic bonds (Memb2), and membership in companies trading in Islamic capital markets (Memb3). Each variable is measured on a scaling level from 1 to 5 where 1 means no preference, 2 slight preference, 3 normal preference, 4 significant preference, and 5 strong preference. Memb1 has a mean of 3.3030 and SD of 1.61693, while Memb2 has a mean of 3.3788 and an SD of 1.65264. Memb3 has a mean of 3.4394 and an SD of 1.57996. Since the mean and the SD of the three variables are almost the same in the three variables, it indicates that the board members significantly prefer the Shari’a scholars who are members in other SSBs of Islamic funds, issuers of Islamic bonds, and companies trading in Islamic capital markets. The second group of questions includes three questions with multiple choice answers represented in Table III.

SSB BoD Country No. Rate (%) No. Rate (%)

Bahrain 18 45.00 19 47.50 Kuwait 26 33.33 29 37.18 Qatar 10 50.00 9 45.00 Saudi Arabia 9 23.68 6 15.79 UAE 13 30.23 10 23.25 Average collection 76 34.70 73 33.33

Table I. Response rate as a percentage of population

Variable Valid Missing Mean Median Mode SD Min. Max.

Memb1 66 10 3.3030 4 5 1.61693 1 5 Memb2 66 10 3.3788 4 5 1.65264 1 5 Memb3 66 10 3.4394 4 5 1.57996 1 5

Notes: n ¼ 76; Memb1 – membership in Islamic funds; Memb2 – membership in issuers of Islamic bonds (Sukuk); Memb3 – membership in companies trading in Islamic capital markets

Table II. Scaling questions measuring the SSB conflicts of interest

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The first question asks “which of the following positions is held by SSB members?” The question was posed to the BoD where 1.3 percent declared that some of the SSB members are department managers, while 1.3 percent indicated that some of the SSB members are shareholders with significant ownership. However, the majority of the answers (93.4 percent) confirmed that SSB members do not hold any managerial position. All the respondents indicated that the SSB has no representative on the BoD or other committees or even main clients. The missing answers were 3.9 percent only. Hence, the absence of the executive position among the SSB members indicates the absence of conflicts of interest.

The second question asks “is the average remuneration of SSB members higher/equal/lower than that of the BoD?” which was addressed to the BoD. The collected answers revealed that SSB remuneration is lower than the BoD remuneration in 59.2 percent of the IFIs, while the SSB remuneration is higher than the BoD remuneration in 14.5 percent of the IFIs. Only 15.8 percent confirmed that the two boards receive the same amount of remuneration. The missing answers were 10.5 percent. The results indicate that the SSB remuneration might not create conflicts of interest due to its small amount compared to the BoD remuneration.

The third question asks “is there any relation between the SSB member(s) and the board member(s)?” The question was addressed to the BoD where answers revealed the absence of influential relations between the two boards. About 23.7 percent of the respondents confirmed the existence of non-influential relation but the majority of the respondents (72.4 percent) indicated the absence of all relations among the members of the two boards. The missing answers were 3.9 percent only. The absence of relation between the two boards indicates the absence of conflicts of interest that might happen in the case of having influential relation. To conclude, the two groups of questions measure the six variables that affect conflicts of interest.

Valid Missing Variable Frequency % Total % Total %

1 Other positions for SSB members a. Department manager 1 1.3 73 96.1 3 3.9 b. Member in the BoD 0 0.0 73 96.1 3 3.9 c. One of the main Shareholders 1 1.3 73 96.1 3 3.9 d. One of the main clients 0 0.0 73 96.1 3 3.9 e. Member of the Board Comm. 0 0.0 73 96.1 3 3.9 f. Does not hold any position 71 93.4 73 96.1 3 3.9

2 SSB Remuneration vs BoD Remuneration a. SSB Rem. , BoD Rem. 45 59.2 68 89.5 8 10.5 b. SSB Rem. ¼ BoD Rem. 12 15.8 68 89.5 8 10.5 c. SSB Rem. . BoD Rem. 11 14.5 68 89.5 8 10.5

3 Relation between SSB and BoD a. Influential relation 0 0 73 96.1 3 3.9 b. Non-influential relation 18 23.7 73 96.1 3 3.9 c. No relation 55 72.4 73 96.1 3 3.9

Note: n ¼ 76

Table III. Multiple choice questions measuring the conflicts of

interest

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5. Empirical results Conflicts of interest will be measured by applying joint confidence interval test to regression line coefficients from a multivariate least square regression technique. As it was mentioned the relation between the dependent variable and the independent variables will be formulated in equation (1).

The true values of different variables used in the model are described by Greek characters, while estimates are denoted with italic letters. The true values of the regression coefficients are represented by (a) as the intercept, while (b1, b2, b3, b4, b5, and b6) are the slopes of different variables, and (ei) represents the error term. The multiple linear regression model is applied to examine the observed relations among the six variables and compare them with theoretical relations. Plots of control against each one of the variables indicate that the relation between conflicts of interest and each independent variable is linear (Martinez et al., 2002). Table IV represents the product-moment correlation matrix between the conflicts variable and other independent variables.

Table IV indicates that most of the variables have significant correlation which is statistically acceptable in social science where it is not expected to get significant correlation among all the variables (Cohen, 1988). Nevertheless, it should be noted that the correlation among the variables does not reflect a causal relation (Simon, 1954).

Since the regression analysis is generally robust against minor violations of assumptions except for gross violation of normality assumption, the focus will be on the test of normality assumption. The following histogram in Figure 1 and the residual plots in P-P plot of Regression Standardized Residual in Figure 2 are used to test the normality assumption as they were used in previous research (Berry and Feldman, 1985; Cohen and Cohen, 1983; Goldfeld and Quandt, 1976). The results confirm the normal distribution of error (eis) with N , (mean ¼ 23.57 £ 10

2 16 , SD ¼ 0.959).

A slight skewness is noticed in both histogram and P-P plot of regression; however, the regression analysis is robust in spite of this slight departure from its assumptions (Cook and Weisberg, 1982; Efron, 1988).

By testing the model against the four assumptions of regression, there is no major violation detected. Table V reports the results of regression analysis correlated.

In addition, Table V indicates the significance of the model ( p ¼ 0.0001). Since p-value is determined from F ratio, the large F ratio (5.009) indicates a significant result which cannot be referred to coincidence. On the other hand, Table VI highlights the significance of each one of the independent variables.

Table VI indicates that four out of six variables have a significant relation with conflicts variable while two remain with insignificant relation. These results

Conflicts Position Memb1 Memb2 Memb3 Remun Relation

Conflicts 1.000 Position 0.444 * * * 1.000 Memb1 0.073 0.211 * * 1.000 Memb2 20.068 0.215 * * 0.766 * * * 1.000 Memb3 20.013 0.259 * * 0.634 * * * 0.594 * * * 1.000 Remun 0.201 * * 0.267 * * 20.011 0.056 0.079 1.000 Relation 20.134 20.018 0.225 * * 0.126 20.090 20.118 1.000

Notes: Significant at: *p , 0.10, * *p , 0.05 and * * *p , 0.01

Table IV. Product-moment correlation matrix

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significantly support the proposed hypotheses. The Position variable has significant relation with Conflicts variable because its p-value , 0.01. Also, it has a b of 0.456 which indicates the positive relation between the two variables. This result supports H1:

H1. Conflicts of interest in the SSB are positively related to SSB executive positions inside the IFI.

Figure 1. Histogram of conflicts

of interest model

Dependent variable : COIBD25

Regression Standardized Residual

F re

q u

e n

c y

0 –3 –2 –1 0 1 2 3

Mean = –3.57E–16 Std.Dev. = 0.959

N = 76

Figure 2. Normal P-P plot of

regression standardized residual for conflicts of

interest model

Dependent Variable: Conflicts

Observed Cum Prob

E x p

e c te

d C

u m

P ro

1.0

0.8

0.6

0.4

0.2

0.0 0.0 0.2 0.4 0.6 0.8 1.0

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The result of Memb1 variable indicates a significant relation with Conflicts variable because its p-value , 0.05. In addition, it has a b of 0.417 which indicates the positive relation between the two variables. This result supports H2:

H2. Conflicts of interest in the SSB are positively related to membership of SSBs in Islamic Funds.

The result of Memb2 variable indicates a significant relation with Conflicts variable because its p-value , 0.05. However, it has a b of 20.338 which indicates a negative relation between the two variables. This result supports H3:

H3. Conflicts of interest in the SSB are negatively related to membership of SSBs in issuers of Islamic Sukuk.

The result of the Memb3 variable indicates an insignificant relation with Conflicts variable because its p-value . 0.10. However, it has a b of 20.219 which indicates a negative relation between the two variables. This result partially supports H4 because the proposed relation was significant while the actual result revealed an insignificant relation:

H4. Conflicts of interest in the SSB are negatively related to membership of SSBs in capital market companies.

The result of Remun variable indicates an insignificant relation with Conflicts variable because its p-value . 0.10. However, it has a b of 0.098 which confirms the positive relation between the two variables. This result partially supports H5 because the proposed relation was significant while the actual result revealed an insignificant relation:

H5. Conflicts of interest in the SSB are positively related to SSB remuneration.

The result of the Relation variable indicates a significant relation with Conflicts variable because its p-value , 0.10. Moreover, it has a b of 20.185 which indicates a negative relation between the two variables. This result supports H6:

H6. Conflicts of interest in the SSB are negatively related to the SSB relation with the BoD.

The derived conclusions confirm the validity of the model in measuring the conflicts of interest. Furthermore, Table VI includes the multicollinearity statistics with their tolerance and the variance inflation factor (VIF) which is well below the recommended threshold of 10.0. The lower the VIF, the more it indicates the absence of collinearity between conflicts of interest and other variables. The multicollinearity among the

Model Sum of squares df Mean square F Sig.

1 Regression 56.180 6 9.363 5.009 0.000 a

Residual 128.978 69 1.869 Total 185.158 75

Notes: aPredictors: (constant), Position, Memb1, Memb2, Memb3, Remun, Relation; dependent

variable: Conflicts

Table V. Analysis of variance (ANOVA)

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independent variables does not limit the use of multiple linear regression for prediction, yet it limits the use of multiple linear regression for identifying how variables are related. Also, it helps in identifying the form of relation among the independent variables (Netter, 1996).

Finally, Table VII indicates that explanatory power of the whole model (coefficient of determination ¼ R 2) is 0.303; which means the independent variables explain 30.30 percent of the change in the dependent variable (Conflicts). In addition, the result indicates that Durbin-Watson (d ) is 1.793. The D-W test detects the presence of autocorrelation (serial correlation). The value of the D-W test is usually between 0 and 4. If (d ) is around zero, the variables will be positively correlated. If (d ) is around 4, the variables will be negatively correlated. In either case, the model validity will be questionable. However, if (d ) is around 2, such as in our model (d ¼ 1.793), the variables will not be serially correlated.

To conclude, we find that the model of conflicts of interest is significant as a whole and four out of the six variables are significantly related to Conflicts variable. The results significantly support the H6 of conflicts of interest.

6. Research limitations Although the derived conclusions can be used as a platform for measuring the conflicts of interest in the SSB, there are still several limitations to this study. First, the research does not address the impact of SSB ownership in the IFIs which might create conflicts of interest if it is significant. Second, the research does not address the impact of the relation between the SSB and the shareholders, the clients, and other stakeholders which might create conflicts of interest if the relation is influential. Third, the research does not measure the impact of the codes of corporate governance in framing the relationship between the SSB and the IFI. Moreover, the research was conducted on a cross-sectional basis rather than longitudinal basis. Finally, the research was focused

Collinearity statistics

Variable Standardized coefficients b SE t-value p-value Tolerance VIF

Position 0.456 0.127 4.222 0.000 * * * 0.864 1.157 Memb1 0.417 0.147 2.379 0.020 * * 0.329 3.043 Memb2 20.338 0.132 22.102 0.039 * * 0.390 2.562 Memb3 20.219 0.118 21.554 0.125 0.508 1.970 Remun 0.098 0.196 0.931 0.355 0.908 1.101 Relation 20.185 0.192 21.701 0.093 * 0.851 1.174

Note: Significant at: *p , 0.10, * *p , 0.05 and * * *p , 0.01

Table VI. Multivariate least square regression

Model R R 2 Adjusted R 2 SE Durbin-Watson (d )

1 0.551 a

0.303 0.243 1.36721 1.793

Notes: aPredictors: (constant), Position, Memb1, Memb2, Memb3, Remun, Relation; dependent

variable: Conflicts Table VII.

Model summary

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on the GCC region which might affect the generalization of the results due to its unique culture. Although the GCC region has a large number of IFIs, yet the sample size is relatively small.

7. Research implications The results of this research corroborate the results of previous studies (Al Qari, 2002; Issa, 2009; Faddad, 2009). The research findings indicate that conflicts of interest are minimized if the SSB members do not hold any managerial position in the IFIs so that the SSB becomes independent from the management restrictions. Also, the absence of relation between the BoD and the SSB will eliminate the conflicts of interest and release the SSB from the BoD pressure. On the other hand, fixing the SSB remuneration will enhance its independence and bring more transparency if it is included in the financial statements. Finally, the multiple memberships of Shari’a scholars in several SSBs have different impact on the conflicts of interest according to the type of IFIs.

8. Conclusion The conflicts of interest in the SSB is significantly affected by the executive position of the SSB members, the membership in Islamic funds and issuers of Islamic Sukuk, and the relation between the SSB members and the BoD. The executive position and the membership in Islamic funds are positively related to the conflicts of interest, while membership in issuers of Islamic Sukuk, and the relation between the two boards are negatively related to the conflicts of interest. On the other hand, the SSB remuneration and membership in companies trading in the capital markets have no impact on the conflicts of interest.

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(The Appendix follows overleaf.)

Corresponding author Samy Nathan Garas can be contacted at: [email protected]

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