islamic perspective of maximizaing shareholders' wealth

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Prepared by: 1. Afiqah Nur Binti Yahya 2. Mardiah Binti Shaharum 3. Norsuria Binte Jani 4. Nur Ayuni Binti Mat Nawi 5. Nur I’ffah Binti Muhammad Nasir Islamic Perspective of Maximizing Shareholders’ Wealth Financial Management Analysis IBF 6135

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Islamic Perspective of Maximizing Shareholders WealthFinancial Management Analysis IBF 6135Prepared by: 1. Afiqah Nur Binti Yahya 2. Mardiah Binti Shaharum 3. Norsuria Binte Jani 4. Nur Ayuni Binti Mat Nawi 5. Nur Iffah Binti Muhammad Nasir

Contenti. ii. iii.

iv.v. vi.

The concept of wealth & seeking of wealth in Islam History of maximization of wealth The concept and practice of maximization of wealth Maximization of shareholders wealth: arising issues Islamic perspective of maximizing shareholders wealth Solution

The concept of wealth & seeking of wealth in IslamDefinition of wealth Wealth from Islamic point of view

Authorities related to the seeking of wealth

Definition of wealthWealth is whatever mankind possess Wealth is things that can be

acquired and possessed /reserved whether in the form of corporeal (ayn) or usufruct (manfaah) have some value the benefit of which is permitted by law

All things which are capable of being owned (al-Qamus al-Muhit)

Wealth from Islamic point of view

Muslims generally are divided into 3 views on wealth:Wealth is the aim of life They ignored all authorities & rulings on halal & haram in the seek of wealth For them Islam is only about Ibadat like solat, fasting, & wudhu Thus men have absolute right to own & seek wealth Allah solely owns the wealth, Men are only the trustees We are responsible to manage the worldly wealth according to divine rules & laws as already prescribed by Allah. Thus mens right to wealth is not absolute but restricted

Wealth should be avoided. They took all verses & hadith on the bad influences of wealth They ignore the authorities on the importance of wealth Thus, they viewed that Muslims in general should avoid the seek of wealth.

Verses & hadith on the negatives of wealth and they love the wealth, loving them ardently (al-Fajr:20) , who amasses wealth and counts it over and again, he thinks that his wealth will immortalise him forever (al-Humazah:2 &3) The above verses are describing those who are being cursed by Allah. One of the characters of those who will be punished by Allah in the day of judgment is that when they were alive they loved wealth so much and were busy in seeking the wealth. the day when nothing will avail, neither wealth nor offspring (as-shuaraa:88) , and his wealth shall be of no avail to him when he perishes(al-

The Prophet said "If the son of Adam (the human being) had two valley of money, he would wish for a third, for nothing can fill the belly of Adam's son except dust, and Allah forgives him who repents to Him. (Sahih Bukhari Vol.8, Book 76, No.444) This hadith shows that man will never be satisfied with wealth that he gained, he would want to acquire more. The Prophet S.A.W. said: "I don't fear poverty for you, but rather I fear that you will compete with one another (to see who has more possessions). (reported by al-Hakim) This hadith shows how great is the fitnah of wealth that this was the main fear of the Prophet S.A.W "The Day of Judgement has come close, and mankind will only increase their desire for this world, and they will only go farther and farther away from Allah. There is a direct relationship between a love of this world and loss and loss of devotion to Allah; the more a person loves this world, the less he loves Allah, and viceversa.Thus, one's love for money will harm him in this world, and in the Hereafter as well.

All of theses authorities show that wealth could give a bad influence and negative impact on human being. However this is not due to the wealth itself but to the attitude of men towards wealth. This is because men were created with the nature to love wealth. Wealth & children are an adornment of the life of the world(alKahf:46) People are naturally tempted by the lure of women, children, treasures of gold and silver, horses of mark, cattle and plantation (Aali Imraan:14) However this love to wealth should be put in line with his greater responsibility towards Allah, as a khalifah (vicegerent) on the earth. Wealth should be the tools and means for men to achieve the main aim in achieving Allahs blessings . It should not be the other way to be their main aims.

Verses & Hadith on the positive of wealth & encouragement to seek for it

Islam, through some Quranic verses, has encouraged the believers to seek wealth and spent it fi sabilillah

.

Believers, when the call for prayer is made on Friday, hasten to the remembrance of Allah and give up all trading. That is better for you if you only knew. When the prayer is ended, disperse in the land and seek Allahs bounty, and remember Allah much so that you may prosper (alJumuah:9&10)

In these verses, the believers were instructed to leave their transactions when it was prayer time. This shows that their transactions in dealing with wealth & property are allowed. Moreover, Allah instructed them, after they finished their prayer, to continue in pursuing the wealth. This is an encouragement to the believers to seek wealth for the sake

Narated By Abu Huraira : The Prophet pbuh said, "By Him in Whose Hand my life is, it is better for anyone of you to take a rope and cut the wood (from the forest) and carry it over his back and sell it (as a means of earning his living) rather than to ask a person for something and that person may give him or not. (Sahih Bukhari: The book of obligatory charity:No.1493)"The Prophet pbuh said that a woman may be married for her wealth, her beauty, her lineage or her religious commitment, and he (p.b.u.h) encouraged marrying the one who is religiously-committed. Abu Said Al-Khudri reported: We were travelling with the Prophet, pbuh when a rider came and began to look right and left. He said, He who has an extra wealth should give that to one who has no wealth, and he who has surplus provisions should give them to he who has no provisions, and he mentioned so many kinds of wealth until we thought that none of us has a right to a surplus.(Sahih Muslim, Book 18, No. 4290) The Prophet peace be upon him said, Allah has said, Spend (on charity) O son of Adam, and I shall spend on you.(Sahih Al-Bukhari and Muslim)

All the above hadiths show the importance of wealth as means & tools to discharge our duties & responsibilities as khalifahs in this

Therefore, Islam is not against the seeking of wealth, since it is considered a part of worship (ibadah) to Allah. Islam encourages Muslims to excel in the world and also the hereafter. However, with regards to the maximization of shareholders wealth, Islam puts some limitation to it. The concept as perceived by conventional view should not be absolute.

However, the seeking of wealth has been utilized by the conventional system to be primary objective. In the conventional economics, the primary objective of the firm is shareholders wealth maximization and also profit maximization. Thus we need to look at and understand the conventional maximization first, before we will discuss it from Islamic perspective.

ConclusionThe conventional maximization postulate hinges on the worldly material needs, a position totally different from the Islamic philosophy Islam sees human beings as having both material and spiritual needs. Their true happiness depends on a balanced satisfaction of both needs in this world and in the hereafter

History Of Maximization Of Wealth

In 1999, The Organization for Economic Cooperation and Development (OECD) issued a document;

The OECD Principles of Corporate Governance

Emphasizes that corporations should run, first and foremost, in the interest of shareholders.

The Origins of Shareholder Value

RETAIN

REINVEST

In 1960s and 1970s, The principle of retain and reinvest running into problem because of; i) the growth of corporation ii) the rise of new competitors

Thus, corporations grew too big with too many divisions in too many different type of businesses. Lead to agency theory.

Under new regime, top managers downsize the corporation they control,

DOWNSIZEby cutting the size of labor forces they employ,

to increase the return on equity.

DISTRIBUTEHence : Incidence of job loss; bluecollar & white-collar workers

THE CONCEPT AND PRACTICE OF MAXIMIZATION OF WEALTH

CONCEPT OF WEALTH MAXIMIZATIONWHAT IS WEALTH? Wealth or Value of a business is defined as the market price of the capital invested by shareholders.

WEALTH MAXIMIZATION?

A process that increases the current net value of business or shareholder capital gains, with the objective of bringing in the highest possible return.

CONCEPT OF WEALTH MAXIMIZATIONGoal that encompasses everything that is expected out of a management Concern with top managements plans It is a long-term goal

CONCEPT OF WEALTH MAXIMIZATION (i) wealth for the long-term (ii) risk or uncertainty (iii) the timing of returns (iv) the stockholders return

It considers

CONCEPT OF WEALTH MAXIMIZATION FROM ISLAMIC PERSPECTIVEIslamic approach emphasizes value-maximization in view of the greater good of the society rather than selfish pursuit of profit maximization

Concept of justice Miskawayh (1968), justice dictates one not to be greedy in lawful earning

PROFIT MAXIMIZATION VS WEALTH MAXIMIZATIONPROFIT MAXIMIZATION Profit cannot be ascertained well in advance to express the probability of return. The term profit has no clear meaning. The executive have or the decision maker may not have enough confidence in the estimates of future returns so he does not attempt to maximize further. WEALTH MAXIMIZATION There is no vagueness in wealth maximization goal. It represents the value benefits minus the cost of investment. It is argued that a firms goal cannot be to maximize profits but to attain a certain level or share of the market or certain level of sales.

PROFIT MAXIMIZATION VS WEALTH MAXIMIZATIONPROFIT MAXIMIZATION The risk variations & related capitalization rate is not considered in the concept of profit maximization. WEALTH MAXIMIZATION There should be balance between expected return and risk.

The goal of profit maximization is considered to be a narrow outlook.

The goal is considered to be a broad outlook.

PROFIT MAXIMIZATION VS WEALTH MAXIMIZATIONPROFIT MAXIMIZATION It ignores the interests of the community. WEALTH MAXIMIZATION Its objective is to enhance the shareholders wealth.

The criterion of profit maximization ignores the time value factor for the profits of a project.

Wealth maximization concept fully considers the time value factor of cash inflows.

ADVANTAGES & DISADVANTAGES(PROFIT MAXIMIZATION VS WEALTH MAXIMIZATION)

GOAL

Profit maximizationOBJECTIVE

Large profitsADVANTAGES

Easy to calculate profits. Easy to determine the link between financial decisions and profits.DISADVANTAGES

Emphasizes the short-term. Ignores risk or uncertainty. Ignores the timing of returns. Requires immediate resources.

GOAL Stock holder wealth maximization OBJECTIVE Highest share price of common stock ADVANTAGES Emphasizes the long term. Recognizes risk or uncertainty. Recognizes the timing of returns. Considers stockholders return. DISADVANTAGES Offers no clear relationship between financial decisions and stock price. Can lead to management anxiety and frustration. Can promote aggressive and creative accounting practices.

PROFIT PROFIT PROFIT

PROFIT

PROFIT

Maximization of Shareholders Wealth

PROPONENTS = Advantages

OPPONENTS= Disadvantages

Proponents: Maximization of shareholders wealth can lead toA better quality of Financial PerformanceAn effective corporate governance The corporations long term stability Executives can focus to improve real performance and create value for business prosperity.

Directors and Management owe fiduciary duty towards shareholders and hence have to discharge their responsibilities diligently.

Portfolio of the corporation and its risk assessment can be improved and eventually generate long-term wealth.

Cont.Stakeholders (investors) are only interested in maximizing their return on investment.

Might use their influence to put their personal interest ahead of the economic interests.The NEED for the profitmaximization of Shareholders value or wealth

Cont.

There is one and only one social responsibility of business to increase its profits so long as it stays within the rules of the game, which is to say , engages in open and free competition without deception or fraud

Its the ends of corporate decision making that is able to determine the means. best interests of the corporation are advanced when managers act exclusively in the economic interests of shareholders

Opponents: Maximization of shareholders wealth can lead toTHEORY : The ideology does NOT entirely disregard the stakeholders interests.

REALITY: Stakeholders interests will distract the executives from their duty to maximize shareholders wealth

Cont..

Often associated with greediness

Contradicting moral tenets

Received many criticisms as it has negative impact on social, ethical and economic aspects

Cont..1. Disregarding corporate social responsibility It has different motivation & interest and thus, diverts from the maximization goal.

2. Denying other stakeholders rights The focus is on the shareholders only. They are the residual claimants and given the priority.

Cont.3. Unethical practices Driven to do manipulation on companys stock price in order to boost the executive pay. Morality of business would decline.

4. Render the corporation vulnerable Find recourse to make a fast-cash (shortterm oriented) and neglects the fundamental business processes.

Cont.5. Attention to the expectation markets and not on the real market performance Stock market is the avenue for the corporation to determine how it is likely to perform in the future. It can lead to create illadvised incentives and generate inauthenticity in executives.

6. Results in inequity and instability Incapable of generating middle-class jobs (which have largely contributed to the innovation process in a corporation) and hence, unable to restore sustainable prosperity.

In the name of maximization.Sold key assets e.g (Kodaks patents) Cut back on customer service e.g (Sears) Showered CEOs with stock options e.g (Citibank)

Drained cash reserves to repurchase shares (FIs)

Accounting fraud to raise share price e.g (Enron)

Islamic perspective of maximizing shareholders wealth

Several views on profit maximization

Solution

Several views on profit maximizationSiddiqi (1972) Constrained profit maximization, which the constraints are: 1- Full compliance with Islamic concept of (social) justice 2 - Responsiveness to the welfare of others.

Chapra (1996) Islamic banks should not be solely profit oriented rather it must aim at promoting Islamic norms and values as well as protecting the needs of Islamic society as a whole without undermining its commercial viability Wahbah Al-Zuhayli (Al-Fiqh Al-Islami wa- Adillatuh) The primary goal of Islamic financial institutions is not profitmaking, but the endorsement of social goals of socioeconomic development and the alleviation of poverty.

Saeed M., Ahmed Z. U., Mukhtar S.M. (2001) Islamic view of value-maximization is the greater benefit for the society rather than selfish pursuit of profit maximization. Hence, the concept of justice is the foundation of the principle of value-maximization. They refer to Miskawayhs (1968) definiton of justice in this context as fair play (to give and take in business according to the interest of all concerned) and just dealing (to act fairly towards oneslf and others).

Ismail (2002) The objective of Islamic banks should be towards maximizing profit. The bank is only responsible towards the shareholders and depositors; while the government is responsible towards social welfare. The profitability and the viability of the bank would be affected if banks use the shareholders fund or depositors money for social purposes Among the defects of this model are:(1) profit-centered model; (2) unequal distribution of wealth; and (3) disregarding social welfare responsibility

Ruzita, Selamah (2003) stated that profit maximization is applicable under the Islamic framework in order to obtain desired outcomes but it must take into account the Islamic values in the production of Islamic firms. They view that the Islamic firm that practices profit maximizing according to Islamic framework will guarantee efficient allocation of resources according to the hierarchy of needs of the society. (Zarqa, 1989)

Necessities comprise all activities and goods that are essential to the preservation of the five foundations of good individual and collective life, according to Islam, namely: religion (al-din), life (al-nafs), mind (al-aql), offspring (alnasl) wealth (al-mal).

Conveniences comprise all activities and goods that are not vital to the preservation of the five foundations, but are needed to relieve or remove impediments and difficulties in life.

Refinements include activities and goods that go beyond the limit of conveniences, they serve to brighten, complement or adorn life.

Khan (2007) claimed that Islamic financial institutions should aim at maximizing social welfare function apart from profit maximization as the objective of the institution as practiced in conventional.

Asutay (2007) added that community banking, responsible and ethical finance and corporate social responsibility (CSR) projects can be practiced to achieve the goal of social welfare by IFIs

SolutionBalancing Ethical Responsibility among Multiple Organizational Stakeholders Islam acknowledges that owners (shareholders) of firms have the right to make profit and gain wealth, but not to the extent of exploiting other stakeholders right. Contrary to the westerns view about stakeholders right, Islam does not view all the stakeholders equally the same. Owners or financiers and employees (management) are the first group of priority, followed by the suppliers and customers and finally the last group consists of all external parties (society at general). Of course, for this stakeholder model to function properly, principles of justice and balance, trust and benevolence must be strengthened.

Pyramid of maslahah Al-Qaradawi (1998; 2001) a renowned contemporary shariah scholar explains the concept of maslahah in the event of conflict of various categories of interest as follows: When there is a conflict between two interests (small & big), the smaller would be sacrificed to protect the bigger interest. When there is a conflict between two interests (private & public), the private interest would be sacrificed to shield the public interest. When there is a conflict between realization of benefit and prevention of harm, the main priority goes to the prevention of harm. (Both benefit and harm in terms of size, effect and duration need to be evaluate precisely). The maslahah concept in preventing harm indeed is an ample guidance for managers to make decisions for the firm when they encounter conflicting interests that involves trade-offs.

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