The chapter provides the literature on ethical identity disclosure in Islamic banks where it is organized into six subsections. The first section discuss about the development of Islamic banks in Malaysia as well as in Kingdom of Bahrain. Next, in second section, there will be a discussion on corporate ethical identity and followed by regulation on disclosure. In the section of regulation, the researcher is going to discuss on disclosure standard that governed for both countries. Then, in fourth section is about theoretical perspectives where two theories being employed in this chapter. In fifth section reviews on the determinants of ethical identity disclosure which consist of board size, board independence, Shari'ah Supervisory Board and Investment Account Holder as well as reviews on two control variables which are banks' size and banks' profitability. Finally, in last section provides theoretical framework for this study.
DEVELOPMENT OF ISLAMIC BANKS IN MALAYSIA AND KINGDOM BAHRAIN
Islamic banking industry has been in practice worldwide for quite long time yet it only started to receive attention due to its fast evolvement and high popularity as it has received a warm welcome from Muslims as well as non-Muslims all over the world. Since then, many researches being done by the researchers in this banking area in order to help the bankers, investors as well as other users of Islamic banking to acquire more information and knowledge before engage in any kind of banking engagement. Ariffin et al. (2009), Makiyan (2008) and Sundararajan (2007) discussed about the risk, challenge and disclosure in Islamic banking industry have addressed the issues of disclosure of risk and risk management faces by Islamic banks, particularly when Islamic banks faced a unique risk associated to their profit and loss sharing financing. Since Islamic banks have a different and unique element as compared the other conventional institution and organization, therefore fully disclosure on information of Islamic banks' operation need to be conducted in the area of Islamic banking industry as Islamic banks modes of financing is mainly based on the profit loss sharing agreement between the bank and the Investment Account Holders.
According to Abdullah (2011), the development of Islamic banking in Malaysia took place on 1960s which has been on gradual basis and evolutionary approach. It started with the establishment of the Pilgrims Fund Board or Lembaga Tabung Haji in 1969 and it has been established to provide saving accounts for Muslims to go for pilgrimages whilst performing their Hajj. Even though Pilgrims Fund Board is not financial institution per se but it was the first institution that uses Shari'ah principles in distributing the return through investment made by their depositors.
On 1974, the Islamic Development Bank in Jeddah has been established and it was the culmination of efforts taken by the Organisation of Islamic Countries (OIC) which led by the Islamic Secretariat and chaired by the late Tunku Abdul Rahman, together with Malaysian legal experts and bankers. In the subsequent years, driven efforts from the establishment of Islamic Development Bank in Jeddah has led Malaysia to set up Islamic banking institution and it started by forming a steering committee in 1981 specifically to making recommendation for the establishment of Islamic banks in Malaysia (Azahari, 2009). Then, in 1983, Bank Islam Malaysia Berhad (BIMB) has been established as the first Islamic banks in Malaysia under the Islamic Banking Act 1983. With development of BIMB in Malaysia, it has given significant milestone to the development of Islamic banking industry in Malaysia which then followed with the commencement of Bank Muamalat Malaysian Berhad in 1999 (Abdullah 2001).
Further, 1993, the concept of Islamic window has been introduced by the Central Bank of Malaysia for the scheme of "interest free banking". This scheme has been introduced in order to give opportunities to the existing conventional banks in Malaysia to provide Islamic product and services to their customer and at the same time to attract foreign investor come to Malaysia (Bahari, 2009). Since Islamic banking system is free from interest, therefore those conventional banks with Islamic windows need to separate their conventional funds and Islamic funds in order to ensure there is no commingling of fund between these systems (Sole, 2007). By the establishment of the Islamic banking scheme, Malaysia has become the first country that implement dual baking system which include full-fledged banking system and interest free banking system whereby this system have run concurrently in Malaysian financial system (Bank Negara Malaysia, 1999). Later, in 1999, Central Bank of Malaysia has introduced the concept Islamic banks subsidiary. This system allowed the conventional banks with Islamic windows to establish Islamic subsidiary and convert their operation as full-fledged Islamic banks (Sole, 2007). The participation in Islamic banking subsidiaries is seen as a positive step in creating potential growth to enhance the global integration of domestic Islamic banking industry. By the early of 2007, there were eleven full-fledged Islamic banks being operated in Malaysia (Yusof, Wosabi and Majid, 2009). Then, by then end of 2007 and early 2008, the conversion of all Islamic banking windows to Islamic subsidiaries has taken place which makes there is increasing of domestic focus towards Islamic banking industry (PricewaterhouseCoopers, 2008). Currently, there are 16 Islamic banks in Malaysia where 10 of them are local banks and the other 6 are foreign banks (Bank Negara Malaysia, 2011).
Association of Islamic Banking Institution Malaysia (AIBIM) was established in 1996 as the association of Interest Free Banking Institution Malaysia. The establishment of this association is to practice and promote sound Islamic banking system in Malaysia also to provide advice and assistance to the AIBIM members. Besides, it also helps in promoting education and training Islamic banking personnel in Islamic banking. Currently, the members of AIBIM are consists of eleven domestic banks, two development banks and ten foreign bank operating in Malaysia. Islamic Banking & Finance Institute Malaysia (IBFIM) has been officially launched on 19 February 2001. This institute dedicated to produce well-trained, high caliber personnel and executives with the required expertise in Islamic banking and finance industry. Besides, it is aim to assist the Islamic finance personnel through Shari'ah-based training program, Shari'ah advisory services and consultancy, research and development in Islamic finance. Currently, there three categories of courses offered by IBFIM, namely Continuous Professional Development (CPD) Programs, Certification Programs and Customized Programs. In December 2005, Central Bank of Malaysia has set up International Centre for Education in Islamic Finance (INCEIF) to further strengthen Malaysia's position as international Islamic finance centre. Currently, INCEIF is the only university that wholly dedicated to postgraduate studies in Islamic Banking and Finance. This university is structured to provide training and knowledge through academic programs and industry training to students. Currently, there three academic programs provided by INCEIF, which are Chartered Islamic Finance Professional (CIFP), Mater in Islamic Finance and PhD in Islamic Finance. The objective of these programs is to produce high competent professional for Islamic financial service s industry, globally. On March 2008, the International Sharia'h Research Academy for Islamic Finance (ISRA) was established to promote applied research in the area of Islamic banking and finance. ISRA will plays as repository of Shari'ah views and fatwas also undertake studies pertaining to the contemporary issues in Islamic banking industry. Besides, ISRA will contribute in strengthening human capital development in Shari'ah and also aims to promote innovation and dynamism of Islamic finance through research and rigorous intellectual dialogues and provide platforms for engagement among practitioners, scholars, regulators and academician. As part of INCEIF, ISRA is able to utilise on the facilities and infrastructures as well as the expertise and resources in INCEIF.
While in Kingdom of Bahrain, according to Baba (2007), it has become leading financial centre in the Middle East since the establishment of its offshore banking sector in October 1975 which make the numbers of international banks set up their offshore operation in Bahrain. Then, its Islamic banking industry starts to be developed in year 1979 with the establishment of Bahrain Islamic Bank (BIsB) as the first Islamic bank in Bahrain. After more than two decades, Bahrain has become leading centres for Islamic finance as many Islamic banks and Islamic financial institutions have been established which makes Bahrain become pre-eminent financial Islamic financial centres in the Middle East. Currently, Bahrain have 26 Islamic banks which comprise of six retail Islamic banks and twenty wholesale Islamic banks registered under Central Bank of Bahrain (Central Bank of Bahrain, 2012).
According to Lewis and Algaoud (2001), this emergence is due to several strategic factors such as its strategic location which located in the Middle East and Gulf Region area. Besides its strategic location, with their wide range of infrastructure and facilities as well as concentration in Islamic banking with their specialized expertise and well educated trainees in Islamic banking, Bahrain has able to attract foreign investor from western countries to participate in Islamic banking industry including Citibank and HSBC Bank. Further, after almost two decades, Bahrain able to show their financial innovation ins Islamic banking industry, for instance, Bahrain Islamic Banks (BIsB) has become pioneer in the issuance of sukuks (Islamic bonds) which enlisted in the stock exchange (Bahrain Monetary Agency, 2004). Furthermore, by having supportive regulatory environment by the Bahrain Monetary Agency also has contributed to the excellence of Bahrain as Islamic financial centres in continuing participate in the Islamic market.
Besides, in effort of promoting the innovation in the Islamic financial markets, there are numbers of international Islamic institutions have been developed and hosted by Bahrain, for example, with establishment of the International Islamic Financial Market (IIFM), International Islamic Rating Agency (IIRA), General Counsel for Islamic Banks and Financial Institutions (GCIBFI) and Bahrain Institute of Banking and Finance (BIBF). Further, in March 1991, Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) have been established in Bahrain and this organisation is supported by institutional members that come from 45 countries including central banks, Islamic financial institution as well as other institution from international Islamic banking and finance industry (Vinnicombe, 2010). With the establishment of these institutions, it shows that the growth of Islamic banking and finance in Bahrain has led to the diversity of financial products and activities in the Islamic financial markets as well as enhance the development and governance structures in Islamic banking and finance industry.
CORPORATE ETHICAL IDENTITY
According to Gray and Balmer (1998), corporate identity could be defined as the reality and the uniqueness of organization, which could be seen throughout in each aspect of organisation's activity. Typically, organisation's identity can be perceived from its business strategy, philosophy and values as well as its cultures and structures. It is a kind of signature that communicates about the organisation itself.
Berrone et al. (2005) argued that ethical identity is good investment in business as it can produce positive environment and give good impact to the organisation, for instance by exercising and implementing ethical code of conduct in the organisation, the head of organisation it can instil and influence the ethical behaviour of the employees. Besides, it can generate positive atmosphere in the organisation like the sense of trust and commitment, thus it can attract more investors as they believe that ethical identity of the organisation is one of the important pillars in order to have successful performance. Besides, the researchers believe that organisation with a strong ethical identity can maximize the satisfaction of the stakeholder and then it would lead to the greater achievement by the organisation. In this study, the authors examined and analyse the relationship between corporate ethical identity, which comprise of two dimensions, corporate revealed ethics and corporate applied ethics, with the satisfaction of stakeholders and companies' performance. Here, corporate revealed ethics can be defined as communication of ethical identity in the companies which revealed in their corporate statement, whereas corporate applied ethic is more towards on action and policies imposed in the organisation, which focus on day to day activities. As a result, they found that corporate ethical identity could produce greater satisfaction to the stakeholder and thus lead to the positive influence on companies' performance. Correspondingly, the other two dimensions, corporate revealed ethics and corporate applied ethics have positive effect both to the stakeholder satisfaction and corporate financial performance. While the corporate applied ethics has a big influence on stakeholder satisfaction, the corporate revealed ethics shows a positive effect of shareholders' value. Therefore, it shows that having corporate ethical identity is a crucial element to the organisation in order to have great performance.
According to Haniffa and Hudaib (2007), Islamic bank are said to have ethical identity this institution need to attain not only their financial goal, but also to achieve their social goal since Islamic banks foundation is based on religious foundation and Shari'ah principles where their ultimate goal to have a betterment of society. In addressing the practice of social reporting, ethical identity disclosure in Islamic banks should be different for the conventional one since the matters emphasize and the underlying principle in those two banks are different (Haniffa, 2002). Besides, in conventional banks, the disclosures of their identity only consider the material and moral aspects, in contrast Islamic ethical identity; the Islamic banks need to include the material and moral aspects together with Shari'ah framework that aligned with Islamic principles.
Importance of Ethical Disclosure
Recently, many studies were conducted on discussing on the disclosure issues in banking sector particularly the financial disclosure. As for the Islamic banks, ethical identity disclosure is important as it play significant role as it may influence Muslim decision makers, especially when society perceived banks' operation as being unclear. Islamic Banking industries have been encouraged to be transparent about their information especially about banks' currents condition and future prospect in order to avoid any doubt and argument in the operation.
Ariffin, Archer and Abdel Karem, (2009) states the establishment of Islamic banks is important in catering the needs of Muslim society by following the Shari'ah principles as guideline in their operation. Such ways are portrayed by many features, including the prohibition of interest and the use of profit sharing investment. As such, studies of assessing the strength of communicated ethical identity of Islamic banks are important since Islamic banks are accountable not only to society but also to God. Besides, transparency in Islamic banks' ethical identity is essential to the society as it is one of the approaches to obtain ethical and social activities of Islamic banks. For example matters pertaining to Islamic banks product, financing activities and community activities.
Further, as investment account holder is one of the important stakeholders of Islamic banks, therefore sufficient, consistent and appropriate information need to be disclosed especially pertaining to the their investment account holder funds. Having appropriate disclosure will enables the investors to assess the risk and return of their funds (Ibrahim, Ismail and Zabaria, 2011). In fact, one of the reason those investors provide their funds is because of Shari'ah-compliant banking services offered by Islamic banks. Therefore, in order to retain those investors, disclosure in Islamic banks' reporting, Shari'ah matters and risks factors is crucial especially with regard to the ethical parts in the operation.
The profit sharing element makes Islamic banks faces unique risk as compared to the other conventional banks and organization, which makes Islamic banks are more vulnerable than conventional banks. One of the reasons is that profit sharing loss modes is more complex as compared to the conventional financing because it involves some activities that not being engaged by the conventional one including the ways of funds being used in the investment project, as well as the determination of profit loss sharing agreement on investment project. (Ariffin et al., 2009; Makiyan, 2008; Sundararajan, 2007). In the study by Ariffin et al. (2009), they found the greater the risk being disclosed, the greater the confidence of investment account holder to have investment in Islamic banks, and the more market participants are able to monitor the banks. Besides, as the profit-loss sharing of financing is one of the crucial parts in the Islamic banks, by shifting the direct risk of banks to their investment account holder may increase the risk of the assets side of banks as well (Makiyan, 2008)
In Al - Quran, the transparency and disclosure matters have been highlighted several times. For example in Chapter 2, Verse 282, it states that to be transparent when involve in business transaction. In carrying out business transaction, the parties involved must always write the contract of transaction and bring witnesses during the contract being agreed between parties as well as during the contract being executed. This is to avoid any miscommunication as well as unjust element.
"O you who have believed, when you contract a debt for a specified term, write it down. And let a scribe write [it] between you in justice. Let no scribe refuse to write as Allah has taught him. So let him write and let the one who has the obligation dictate. And let him fear Allah, his Lord, and not leave anything out of it. But if the one who has the obligation is of limited understanding or weak or unable to dictate himself, then let his guardian dictate in justice. And bring to witness two witnesses from among your men. And if there are not two men [available], then a man and two women from those whom you accept as witnesses - so that if one of the women errs, then the other can remind her. And let not the witnesses refuse when they are called upon. And do not be [too] weary to write it, whether it is small or large, for its [specified] term. That is more just in the sight of Allah and stronger as evidence and more likely to prevent doubt between you, except when it is an immediate transaction which you conduct among yourselves. For [then] there is no blame upon you if you do not write it. And take witnesses when you conclude a contract. Let no scribe be harmed or any witness. For if you do so, indeed, it is [grave] disobedience in you. And fear Allah. And Allah teaches you. And Allah is Knowing of all things." (2: 282)
Corporate Ethical Identity Disclosure Level
Despite the growth of Islamic banking industry, few researchers have addressed the number of issues with regard to the ethical reporting disclosure in the context of Islamic banks (Haniffa, 2002; Othman et al., 2009). These studies been done to explore the corporate reporting of Islamic financial institution as well as to assess the level of disclosure of Islamic ethics in the financial report of Islamic banks, where most of them are descriptive and lack of empirical analysis of disclosure level in Islamic institution. Even though the current reporting seems enough and appropriate for organization to exercise their accountability, but the information on Islamic perspective is often lacking which makes the reports are not adequate enough to cater the Muslims needs, therefore the conceptual framework of ethical reporting based on Shari'ah principles have been proposed in order to fulfil the objective of accountability and transparency in Islamic economics in order to help Muslims decision maker as well as help the organization to fulfil their social obligation to the community (Zubairu, Sakariyau and Dauda 2012). Further, Baydoun and Willet (2000), suggested Islamic social standard should having the value added statement by following the principles of full disclosure and accountability, which based on Islamic ethical values. All the studies above proposed the theoretical framework on Islamic social report based on Shari'ah law.
Besides, Harahap (2003) have reviewed Islamic values disclosure on Bank Muamalat Indonesia by comparing the annual report disclosure of the banks with the conventional disclosure standard as well as AAOIFI standard for eight consecutive years. In this study, the authors found out that the degree of disclosure information of Bank Mualamat Indonesia is greater from year to year. They also highlighted that Bank Muamalat Indonesia complied more on conventional requirements as compared to AAOIFI requirement. This suggest Bank Muamalat Indonesia have emphasised more on general and regulatory standard rather Islamic accounting standards even though the banks is the first commercial bank that implement Shari'ah principle in their daily operation. Due to the practice, it show that their current disclosure system have no indication ethical and fairness, perhaps because of their regulators give more emphasis on their local regulations and of course based on decree from Indonesian Central Bank. According to Hameed (2010), this problem occurs because of our accounting standard is based on conventional accounting philosophy, however due to change in society needs, Islamic institution need to have new belief and philosophy since there are a lot of inconsistency in ethical and values between conventional and Islamic accounting standard.
REGULATION ON DISCLOSURE
In order to cater the needs of Islamic banking operation, there are several standard have been issued by the regulators, either domestically or globally, in regulating the disclosure standard for Islamic banks. In August 2003, Central Bank of Malaysia has issued GP8-i, which is a Guideline on Specimen Reports Financial Reporting for Licensed Islamic Banks (Bank Negara Malaysia, 2003). The issuance of this guideline is to provide the basis for presentation and disclosure requirement as well as to ensure consistency and comparability in the financial report of Malaysian Islamic banks in of carrying out their activities by complying with the provision Islamic banking Act 1983, Companies Act 1965, Shari'ah requirement and other guidelines issues by Central Bank of Malaysia. The GP8-i set out the minimum disclosure requirement that need to be complied by Islamic financial institution including corporate governance report, auditor's report, Shari'ah committee report and financial statement. Further, Islamic financial institutions also encouraged to disclose additional information like accounting policies, new financial instruments and other material activities that may influence the users of financial reports.
Besides, in December 2007, Islamic Financial Services Board (IFSB) has issued IFSB-4, namely Disclosures to Promote Transparency and Market Discipline for Institutions offering Islamic Financial Services (excluding Islamic Insurance (Takâful) Institutions and Islamic Mutual Funds. IFSB is an international standard setter which hosted by Malaysia and started its operations on 10th August 2003. As March 2012, this international body are comprise of 53 of regulatory authorities, eight international governmental organisations and 126 market players, professional firms as well as industry association. The IFSB has been established to promote soundness, stability, prudent and transparency of Islamic financial products and services through the issuance of international standard and guiding principles which consistent with Shari'ah principles in guiding the Islamic banks with regard to the disclosure requirement. ISB-4 have been issued in order to guide the Islamic financial institution by specify key principles as well as to promote transparency that should be followed and practised by Islamic financial institutions. Besides, as the set of disclosure requirement in this guideline could be differentiated by the type of stakeholder, therefore each market participants could have an access to relevant, reliable and timely information with regard to the risk and return faced by them as well as their financial position.
Further, in Bahrain, the Accounting and Auditing Organisation for Islamic Financial Institution (AAOIFI) have published the Accounting and Auditing Organization for Islamic Financial Institution (AAOIFI) standard on disclosures, FAS1 or General Presentation and Disclosure in Financial Statements of Islamic Financial Institutions on 2010. AAOIFI is an international body which has been established on March 1991 and hosted by Kingdom of Bahrain where it prepares standard on accounting, auditing, governance, ethics and Shari'ah for Islamic financial institutions. Currently, there are several countries have already adopted AAOIFI standard, including Bahrain, Jordan, Qatar, Sudan and Syria (Al-Chaar 2006). FAS 1 have been issued in order to guide the Islamic financial institution pertaining to the presentation of information that should be disclosed in the annual reports. In this standard, it also include complete list of financial statement that should be disclosed by Islamic financial institution (Mohamed Ibrahim, 2009).
THEORIES
Conventionally, theoretical model has been used in empirical studies in explaining theoretical assumption and the idea behind the whole assumption. In the prior studies of disclosure, different theories have been employed in explaining the disclosure practices of the organizations like in the study by Hossain (2008) and Cheng and Courtenay (2004) which used agency theory in assessing the association between board composition and voluntary disclosure, whereas in Haniffa and Cooke (2000), several theories have been employed by them, agency theory, resource dependence theory and stewardship theory in examining how the corporate governance attributes and company characteristics affecting the voluntary disclosure. On the other hand, in studying the determinants for corporate social disclosure for Islamic banks, Farook, Hassan and Lanis (2011) have utilised both political economy and legitimacy theories.
In this section, we are going to review four major types of theoretical perspectives on factors affecting the ethical identity disclosures in Islamic banks, namely agency theory, stakeholder theory, institutional theory and legitimacy theory. These theories are used in order to explain the connection and relationship between the research variables.
Agency Theory
Agency theory can be defined as theory that deals with the relationship between the agents and the principals. Typically, in Islamic banks, the management are the one that act as agents which control and run the Islamic banks' operation in order to maximize shareholders' value as the principal of the Islamic banks. Even though the managers needs to run the operation as well as involve in Islamic banks' decision making in order to attain the best value for the shareholders, but they also may have their own objective since the managers are always act out of self-interest and self-centred thus, they will care less towards shareholder interest (Fama and Jensen, 1983). Besides, in Islamic banks, the, manager not only acts as the agent of shareholders but also as agent for the investment account holder. This kind relationship would rise conflict of interest problem in dealing with the as the managers need to manage the shareholder's fund as well as investment account holders' funds (Archer, Karim and Deehani, 1998).
Besides, agency theory also concerns on the issues of information asymmetry which occurs when the managers itself possess superior and better knowledge and expertise about the business position compared to the shareholders and investment account holder. In Islamic banks, the investment account holders usually possess little information pertaining to the Islamic banks' operation as well as on the investment account holders' management. Even though their investment is in equity form but they have not entitle the right of the shareholders. Due to that, they have no right to participate or interfere in the management of their investment fund which makes them having information asymmetry. Also, as they do not take any part in their funds' management, they might face greater risk in terms of market risk and Shari'ah risk (Ameer, Othman and Mahzan, 2012).
Due to agency problem, several mechanisms have been suggested by the researchers in mitigating this problem. According to Bathula (2008), the board of director mechanism could be used in mitigating the agency problem as it is a low-cost alternative which can be viewed from several perspectives. For instance in terms of the board size and board independence, the Islamic banks might able to mitigate the agency problem by strengthen the Islamic bank corporate governance. By taking into consideration on the board of director composition, the effectiveness of the board oversight could be improved in the Islamic bank. Another alternative is by increase the transparency level in Islamic banks especially for the investment account holder (Ameer et al., 2012) as they also regarded ad important stakeholder, therefore the management of the Islamic banks should improve their transparency level, thus the Islamic banks could retain the investment account holder to continue invest their funds. Thus, by examine these two mechanisms and other related governance aspects, the Islamic banks performance conclude be improved and subsequently improve their disclosure of level.
Stakeholder Theory
Stakeholder theory views organisation and society are interdependent, therefore besides the responsibility towards shareholders, the organisation need to broad their responsibilities in serving the societies (Kiel and Nicholson, 2003). Stakeholder theory refers to association between the organisation and various group people, internal and external, which have interests in it. The basis of the theory is the stronger the organisation's relation with the other parties, the easier for the organisation meeting the organisation's objective. This theory helps the organisation in working towards sustainability development.
According to Freeman et al. (2004), stakeholder theory is an extension of the agency theory as the board of directors need to take into account not only the shareholders interest, but also other interest of many stakeholder groups which linked to the social, environmental and ethical consideration. Thus, the shift of boards' role has led to the stakeholder theory development (Bathula, 2008). Freeman et al. (2004) suggest that as business is about value creation therefore, the board of directors' should putting together a deals that makes the supplier, customer, employees, managers, societies as well as the shareholder can win continuously over time. Besides, in order to avoid and resolve a conflicting interest among the stakeholders' the board of directors need to create as much value creation as possible and ensure the stakeholders not exit the deal
While in Islamic banks context, Dusuki (2007) mention there are seven group of stakeholder involved in Islamic banks, namely customer, depositors and investors, managers, employees, regulators, Shari'ah advisor and society as these seven groups of people are the one who represent the primary stakeholders of Islamic banks. In stakeholder theory, as far as the social disclosure is concern, it is viewed as one of the response towards the significant pressure that come from the external environment, either from group of individual or general public. Therefore, it shows that the Islamic banks need to disclose their information, especially pertaining to the ethical and social activities, as a part of communication between the Islamic bank and the stakeholders. Further, Maali (2003) claim that in reporting the ethical disclosure, the concept of accountability, social justice and ownership is a fundamental that need to be taken into account by the Islamic banks.
Stakeholder theory also suggests that when Islamic banks are capable in creating superior performance, then it can meet the expectation from various groups of stakeholders. This is because, ethical and social identity has been highlighted to be one of the important drivers in influencing the stakeholder's opinion. Failure to disclosed the ethical and social information, it may lead to potential withdrawal of support by the stakeholders and it may give adverse result to the Islamic banks' performance. Hence, it is important for the Islamic banks to disclose and communicate the information pertaining to their ethical and social identity as it is one of the approaches to portray that they are fulfilling the expectation of the stakeholder (Sundararajan, 2007). By increase the ethical disclosure in Islamic banks, it may improve the stakeholders' relation and thus it may improve the Islamic banks' performance. It is important to have a full and proper disclosure in ethical, performance and activities as it give a room for the stakeholder to assess the actual performance of the banks. Besides, as the Islamic banks are also associated to the several types of risk, therefore, proper transparency is needed to enable the stakeholder obtained necessary information, especially information on their investment.
Legitimacy Theory
Legitimacy theory can be defined as the idea or perception where the organisation must act properly and desirably, within the social system, norm, value and belief that is acceptable to the society. As the notion of legitimacy theory is the social contract between the organisation and society as a whole, therefore, disclosure practice is the explanatory factor in maintaining the diverse expectation from its stakeholder.
Deegan (2000) claimed that legitimacy theory suggests the organisation need to continually seeking to ensure that operates within the norm and bounds of their societies. This proved that the greater the effort of the Islamic banks in attempting to establish congruence between the ethical and social value of their activities, the greater the acceptability values and behaviour of the society towards Islamic banks' operation. Thus, if disparity exists between the Islamic banks and the society, it will give a threat to the banks in the form of legal and economic sanction. While, Adam (2002) observed that one of the reason why the organisation keep on producing social and environmental report is not because of pressure from public, but because they want to improve their corporate image to the customer, investor, regulators and the society. However, for the Islamic banks, as the ethical, social and environmental disclosure is considered as crucial instruments of corporate communication, therefore the banks should have activities that could give highly impact towards the society and environment, thus it would give them competitive relevance as a result of their transparency of their information.
Further, Nik Ahmad and Sulaiman (2004) claimed that in legitimacy theory, firm need to take measures to ensure their performance and activities are acceptable to the society. Therefore, as far as society is concerned, the Islamic banks are required to disclose their ethical, social and environmental information and failure to disclose could give adverse impact to the Islamic banks. As Islamic banks deals with investment account holders and other Muslim depositors, therefore, they are responsible in disclosing adequate information on Islamic banks performance, risk factors, Shari'ah compliance issues, social as well as environmental issues that may associate to their investment. Failure to disclose the appropriate information, it would give severe impact towards Islamic banks' reputation as one of the Islamic institution.
Institutional Theory
Institutional theory is a theory that deals with the social structures where it has become norms and routine in structuring the social behaviour. Later then, the norms and routines will be adapted as authoritative guidelines for the society (Scott, 2004). According to DiMaggio and Powell (1983), in institutional theory, organizations are governed by rules and regulation, therefore in order to survive and being given access to the resources in the society, the organization need to follow all the rules and regulations that have outlined by the institution. In Islamic banks, as far as the society is concern, the Islamic banks needs to conform to the prevailing Shari'ah compliance, rules and principles, as society is the one that need to bear the consequences from whatever decision taken by the Islamic banks
However, Meyer (1983) and Rowan (1977) argued that even the rules and regulation being followed and abide by those organizations; it is not guarantee that the organization may have an efficient operation. From these arguments, we could see that the main point of institutional theory is that in meeting the goals and objective of the organizations, the management and the board need to ensure that every stakeholders' interest which involve with the organization are protected and secured, especially the interest of society. Every economic decision taken by organization, it must be linked to society's environment (Judge and Zeithaml, 2004). Due to that, the Islamic banks need to ensure that their corporate governance as well as their Shari'ah governance must be in effective, proper and involve in achieving the corporate goals. According to Knetter (1989), sometimes different types of organisation may have different reaction to similar changes as factors like social, political and economic plays important role to particular environment. Therefore, in order for the Islamic banks to have great and efficient performance, those banks need to have Shari'ah Supervisory institutional support when engage in every type of activities. This is because, every decision making that being performed in the Islamic banks should be approved by the Shari'ah Supervisory Board, such as in terms of the Islamic banks product and every kind of activities. This is to ensure that every activity, decision making and performance are based on Shari'ah law and principles. Thus, by implement good Shari'ah governance, the Islamic banks may survive as this institution will provide their support in countering all those cyclical change.
CORPORATE ETHICAL IDENTITY DISCLOSURE DETERMINANTS
One eminent issue that has been discussed within the disclosure literatures is the factors and determinants affecting the disclosure level, either in company or institution. The determinants that have been used in these studies mostly are depends on the nature of the sample of organization such as size, profitability and industry size has been used by Othman et al. (2009) in looking for the determinants that affect the Islamic social reporting in Shari'ah compliance companies. In the studying the determinants of corporate ethical identity disclosure in Islamic banks, there are several determinant that have identified by the researchers. Besides, in study of corporate social responsibility disclosure in Malaysian Islamic banks by Masruki, Zakaria and Ibrahim (2009), they have examined several factors that might influence the level of disclosure, namely banks leverage, size and profitability. While, in the study carried by Abd Rahman et al. (2011) which discuss about the determinants of corporate social responsibility disclosure, the authors assessed the level of discourse in Malaysian government link company annual report as well as assessed factors that might affect the corporate social responsibility disclosure of Malaysian government link company, which are size, age, profitability and leverage of the company. Therefore, in this study, several factors have been identified in assessing the determinants of ethical identity disclosure level in Malaysian Islamic banks and Bahrain Islamic banks, namely board characteristics in terms of its composition, board size Said, Zainudin and Haron (2009), board independence (Chau and Gray, 2010), Shari'ah Supervisory Board and Investment Account Holders (Farook, Hassan and Lanis, 2011), banks' size and banks' profitability. Each of the determinants will be further explained in the following sections.
Board Composition
John and Senbet (1998) suggest that the effectiveness of board monitoring is determined by its composition, independence as well as the board size. In using board composition as the determinants, several characteristics have been identified which are board size, board independence and Shari'ah Supervisory Board.
Board Size
The first element of board composition that will be asses in this study is board size. Prior scholars have continued debated on the issue of board size as it can influence the ability of board's functioning. Some scholars have been support smaller boards number as they believe larger number of boards is less effective and will lead to the social loafing and free riding problem. As the number of people sits in the board increase, the problem of free riding become greater, thus it will reduce the board efficiency (Lipton and Lorsch, 1992; Hermalin and Weisbach, 2003). Besides, John and Senbet (1998) suggested that when the number of board increases, the problem of poor communication, work coordination as well as poor decision making will lead to decision making inefficiency which often associated with the large group may be existed since the boards' monitoring capacities may increase as well. Thus it may diminish the inability of board in controlling the management's action. Some scholars suggested having only seven or eight board members is enough for the boards as more than that would give a problem to the CEO in controlling the board (Jensen, 1993). Besides, it also would lead to the lack of cohesiveness in the board since it is difficult to coordinate and handle each one of the members and also is time consuming when it comes to the part in expressing opinions by each member (Lipton and Lorch, 1992). Consistent with this notion, large number of boards also can be disadvantage to the organization since it is difficult to maintain in terms of its planning, work coordination and decision making.
While, there are some prior scholars are supporting large boards as they believe the large number of board would have greater monitoring and advice where it can help the managers in conducting the organization especially with increase of complexity of the organisation (Klein, 1998). On the other hand, Singh and Harianto (1989) found by having large number of boards, it can improve the performance of the board since large number of boards could reduce CEO denomination within the board, thus it may protect other shareholders' interest. Too small number of board also would give disadvantage to the organization as they would have a lack of experts in giving opinion pertaining to the organization economic decision, compared with having large number of boards. Further, large number of boards also would have diversity of experience and skills which then contribute to the organization achievement (Dalton and Dalton, 2005).
On March 2011, Central Bank of Malaysia have amended the Guidelines on Corporate Governance for Licensed Islamic Banks (GP1-i) where the guidelines prescribe that one of the most important factor in determining the effectiveness of the board is the number of the board itself (Central Bank of Malaysia, 2011). One the other hand, in Corporate Governance Code issued by the Central Bank of Bahrain have recommend to have at most 15 members in the board of directors and the board should review its size as well as its composition regularly to ensure that the size is small enough to have efficient decision making yet large enough to have more ideas from different specialties and perspectives (Central Bank of Bahrain, 2011).
Having the right number of members is one of the effective ways for the board to guide, direct and oversee the daily operation as well as the performance of management in Islamic banks effectively. Therefore, in order to be effective, the number of their members in the board must be appropriate and commensurate with the complexity and the scope of Islamic banks' operation (Central Bank of Malaysia, 2011). On the other hand, Blue Ribbon Commission (NACD, 1995) believe that the board size should have small number which enough to have thorough discussion, yet large enough to have variety of matters to be discussed. Further, Shakir (1997) claimed that the effectiveness of boards is not depends on the size, instead the experience, the skills as well as the knowledge of the members is the most important so that the task could be done efficiently.
In study by Akhtaruddin, Hossain, Hossain and Yao (2009), the authors found that board size is one of the significant factors that affect the voluntary disclosure in Malaysian listed firms as they found the greater the board size, the higher level of voluntary disclosure. While, in Rouf (2011) which examine the linkage between corporate characteristic and governance attributes towards the voluntary disclosure in Bangladeshi firms, the study found there is positive significant association between voluntarily disclosure and board size. Also, in study by Htay, Ab. Rashid, Adnan and Mydin Meera (2012) on Corporate governance impact on social and environmental information disclosure in Malaysian listed bank found that board size have significant influence on the social and environmental information disclosure in Malaysian banking sector as large board size seems to produce better effect towards the disclosure in banking sector. On the other hand in Uwuigbe, Egbide and Ayokunle (2011) found there is negative relationship between board size and environmental disclosure in study the effect of board size and board composition towards corporate environmental disclosure in Nigerian firm.
Board Independence
According to Bhagat and Black (1999), the board of directors are consists of individuals who are knowledgeable about the operation of the organization and familiar with economic of the industry as they are the one who are the best in organization strategic planning. However, in protecting the interest of society, independent directors are required to be part of the board members, even though they have no particular interest with the organization. According to the Guidelines on Corporate Governance for Licensed Islamic Banks (Central bank of Malaysia, 2011), it has describe that independent directors are the one who are independent, free and having no relationship with the management of the Islamic banks, either business relationship or other types of relationship. Besides, independent directors also must be the one who can interfere in Islamic banks operation by exercising their independent judgement (Central Bank of Malaysia, 2011). In Central Bank of Malaysia requirement, the Islamic banks need to ensure that at least one third of the board of directors' members are independent directors. The independent directors are required to be part of the board of directors as they may enhance the effectiveness of the board by providing new outlook, new information and new strategies to the board. Besides, independent directors also can help the board in providing necessary checks and balance towards operation of Islamic banks (Central Bank of Malaysia, 2011). This is to ensure that the Islamic banks operate in a good, safe and sound manner. While, in Corporate Governance Code of Central Bank of Bahrain suggest that at least half of the board members are non-executive directors and at least there of those people are independent. The code also suggests the board should have chairman who is independent director (Central Bank of Bahrain, 2011).
O' Higgins (2002) pointed out that as independent directors, the directors need to carry out their task fairly, without having any biased perception. The independent directors also need to give a counterbalance in controlling the management and provide them with external view, support and knowledge. Besides, as they are externally employed, therefore they could use their control and influence in enhancing the external networks and relation of the organization. Fama (1980) argued besides ensuring the effectiveness of the board, independent director usually being selected in order to help the board in monitoring each of the economic decision taken and at the same time protect the interest of stakeholders. While, Cheng and Courtney (2006) claimed that naturally independent directors have a strong enthusiasm and motivation in performing their duties in order to maintain their reputation, as society perceived them to be professionally and truly independent in any decision making task.
On the other hand, according to Beasley (1996), as independent directors are the one that have employed externally, therefore the possibility of having fraudulent financial statement could be reduce as they have no personal gain in the organisation. While Peasnell, Pope and Young (2000) and Beekes, Pope, and Young (2002) found that the higher the number of external directors in the board, the lesser the earnings management incurs in the organization and the better the reporting conservatism.
While, in Fama and Jensen (1983), board that have larger proportion of external directors may have greater monitoring ability compared to larger proportion of internal director as they are not involved direct with the operation of the organization. However, there is an issue have been raised by the scholars which discussed on the gray area of independent director as there should be a distinction between truly independent director where the director having no relationship with management at all and the gray director where the director have affiliation with the management through family or business relation (Cheng and Courtney, 2006). Although there is no theory found regarding the association of gray directors' role with monitoring effectiveness, study by Carcello and Neal (1997) found the higher the gray directors' proportion in audit committee, the lower the monitoring effectiveness of audit committee due to their workload with other commitment. From this, it implies that higher proportion of gray directors in a board would result to the inadequate performance by the directors thus it would affect the performance of corporate governance tools as a whole.
Study by Akhtaruddin et al. (2009) have examine the relationship between corporate governance mechanism and voluntary disclosure of Malaysian public listed firm and it was found the board independence have positive association towards extent of voluntary disclosure which suggests that firms with higher proportion independent directors would voluntarily disclose their information. While, in study done by Khan, Muttakin and Siddiqui (2011), it was found that the proportion of independent directors is positive significant affected the corporate social responsibility disclosure in Bangladeshi company. They found it is more likely the company will emphasise on societal interest and disclose more corporate social responsibility activities. Similarly, in study by Bhasin, Makarov and Orazlin (2012) which examined the effect of corporate governance towards the voluntary disclosure determinants in Kazakhstan baking sector and it was found that board composition have positive significant impact towards the voluntary disclosure by Kazakhstan banks. On the other hand, in study on the effect of corporate governance on sustainability disclosure towards US and European company, Michelon and Parbonetti (2011) found there is no significant relationship between these variables. It may because of presence of independent directors are not good in terms of monitoring role, legitimacy and reputation.
Shar'iah Supervisory Board
According to Grais and Pallegrini (2006), presence of Shari'ah Supervisory Board in Islamic banks is one of the most significant differences between Islamic banks and conventional banks. Besides enhance the structure of corporate governance in Islamic banks, Shari'ah Supervisory Board also responsible in protecting the stakeholders' right such as investors, depositors and investment account holders therefore they are able to retain them in contributing their fund to the Islamic financial institution (Iqbal, 2008). The board must consist of at least three scholars who are knowledgeable in Islamic jurisprudence and usually most of Shari'ah Supervisory Board members in Islamic banks are consist of expertise that are well versed in Islamic commercial jurisprudence (Mohamed Ibrahim, 2009).
As prescribed in Guidelines on Governance of Shari'ah Committee of Central Bank of Malaysia, It propose the members of Shari'ah Committee should possess necessary qualification, expertise or experience in Islamic jurisprudence (Usul al-Fiqh) or Islamic commercial law (Fiqh al-Mu'amalat) and it also suggest the Shari'ah committee members should at least consist of three members, therefore the Shari'ah Committee would be able to function effectively and efficiently. Whereas, in AAOIFI Governance Standard for Islamic Financial Institution (GSIFI No. 1), Shari'ah Supervisory Board is responsible to direct, evaluate and supervise Islamic financial institution activities to ensure that all the activities carried by the institution are complied with the Shari'ah principles and the Islamic financial institution is obligated to follow Shari'ah ruling which issued by the Shari'ah Supervisory Board. This standard recommends the Islamic banks should have at least three members in Shari'ah Supervisory Board (AAOIFI, 2010). This requirement is similar with Central Bank of Bahrain's Corporate Governance Code, in which it suggests having at least three Shari'ah scholars in the Shari'ah Supervisory Board (Central Bank of Bahrain, 2011).
According to Chapra and Ahmed (2002), it is hard to retain the depositors if the Islamic banks failed to comply with Shari'ah principles and procedures since the depositors tend to withdraw their fund if those things happened. As Shari'ah Supervisory Board also is responsible to review financial statement of Islamic financial institution therefore the board have effective and efficient in executing their role as one of corporate governance mechanism with regard to the disclosure level in the financial reports of Islamic financial institution. Grais and Pellegrini (2006c) claimed that as part of corporate governance in Islamic financial institutions, Shari'ah Supervisory Board need to be independent and knowledgeable in giving opinion with regard to the compliance for each activity involved by the Islamic financial institutions, thus it may convince and enable the stakeholders in assessing and obtaining valid and right information on the operation of those institutions.
In discussing the issues of consistency, according to Percy, Stewart and Abdullah (2011), in order to ensure that the transparency level of those institutions is adequate enough and in accordance with the Shari'ah principles and standard issued by regulators, Shari'ah Supervisory board needs to be consistent in reviewing and evaluating the disclosure level of Islamic financial institution. The board also need to be consistent with the judgement issued by other Islamic banking scholars in other Islamic banks, worldwide. Besides, the Shari'ah Supervisory Board should consistent in practising standardised contract as well as other practices that issued by the regulator, By having consistency in evaluating, reviewing and disclosing all the Islamic banks' activities, it will definitely boost the confidence of stakeholders on the operation of Islamic banks (Grais and Pellegrini, 2006 a, b).
Further, in study by Farook et al. (2011), Shari'ah Supervisory Board is found as one of the predictors to the corporate social disclosure in Islamic banks which located in several countries, namely Bahrain, Jordan, Kuwait, Saudi Arabia, Qatar, Yemen, United Arab Emirates, Iran, Turkey, Sudan, Bangladesh, Pakistan and Malaysia. This result indicates that expert Shari'ah scholars are required in the Islamic banks' governance to interpret Islamic principles in order to be applied in our modern Islamic banks' environment. This highly significance of SSB indicates that the Shari'ah Supervisory Board is important influencing the ethical identity disclosure. Thus, that the existence of Shari'ah Supervisory Board members may results greater governance and monitoring and hence it would great result greater compliance with Shari'ah principles by the Islamic banks.
Investment Account Holder
According to Jensen and Meckling (1976), in determining monitoring level as well as disclosure level in the organization, the structure of ownership is important and need to be taken into account by the organization, as the ownership structure will influence and affect the any decision made by the board. In Islamic banks, majority of the bank perform investment management as the main service which provided for the investor as the banks are prohibited from dealing with any lending or borrowing money service which always associated with interest charge (Ahmad Ibrahim, 1997; Ahmad, 1994). As alternative, the Islamic banks have provide the service of profit sharing contract or Mudarabah contract where the Islamic banks mobilize funds received from investment account holder accounts and invest those fund to some investment project on behalf of the investors (Abd Rahman and Zainuddin, 2009; Ahmad, 1994). Archer and Karim, (2007) claimed that usually, the investment account holder's fund will be commingled with shareholders' fund and invest in the same investment portfolio under the Islamic banks' management.
On October 2012, Central Bank of Malaysia have issued new standard on Mudarabah contract, Shari'ah Standard on Mudarabah (Central Bank of Malaysia, 2012). The issuance of this standard is to enhance the Shari'ah and regulatory framework for Malaysian Islamic banks. According to this standard, investment on profit sharing Mudarabah contract consists of two types of investments, which are unrestricted investment portfolio and restricted investment portfolio, where in the unrestricted investment portfolio; the investment account holders may authorize the Islamic banks to invest their fund at banks' discretion without having any restriction from the holders. On the other hand, for the restricted investment portfolio, the investment account holder may specify several conditions to the banks before making the investment, such as the type of investment which their funds should be invested. If the aggregate investment portfolio turns to positive return, the profit will be distributed parties of the contract according to proportion amount of their investment in the portfolio. On the other hand, if the portfolio turns to negative return, therefore, the loss need to be borne by the investment account holders and the banks in accordance with contribution. However, if the loss incurred is due the Islamic banks misconduct or negligence, then such losses should be borne by the banks (Archer and Karim, 2009).
On the other hand, in Bahrain AAOIFI standard on Equity of Investment Account Holder and Their Equivalent (FAS 6) and Disclosure of Bases of Profit Allocation between Owners' Equity and Investment Account Holder (FAS 5) has prescribed the treatment for investment account holder. Similar with the one issues by Malaysian standard, the investment account holder consist of two types of investment which are restricted and unrestricted investment account holder. In this requirement, it has prescribed that the Islamic banks need to disclose information pertaining to the investment account holder. Several disclosure requirements that have been set by the AAOIFI are the banks should disclose the basis on the allocation of profits between the banks and the investment account holder also the basis of charging expenses as well as basis for charging provision. Besides, the Islamic banks also need to disclose the information on the administrative expense, the percentage if profit allocation and other sharing from any banking operation, if any. By following this requirement, the Islamic banks should not have any problem in dealing with the investment account holder (AAOIFI, 2010).
Ghayad (2008) stated that for both investments Mudarabah contract, the investment account holder cannot interfere on the operation of the investment and the contract will be nullified if this condition violated. Due to that, both investment account holders are exposed to the different types of risk with regard to their investment as they are not able to monitor their funds closely (Archer and Karim, 2009). As they do not have any right to interfere with the management of the funds, therefore the investment account holder are entitle to receive flow on information on the investment as well as information on the banks' operation activities and current development of the banks.
According to Farook et al. (2011), due to the profit sharing contract service provided by the Islamic banks, the Islamic investors are more likely to invest as investment account holders rather that as shareholders, as compared to having shares in the Islamic banks, investing their funds as the investment account holder is more accessible. Due to that, it is important for the Islamic banks to have a full compliance with Shari'ah principles and procedures and consistently disclosed all relevant information which may influence the economic decision of the investment account holders as well as pertaining to the Islamic banks operation. In Karim (1990), the author claimed that if a negative report were to be published in the Shari'ah Supervisory Board's reports, the investment account holders would start to think there is something wrong with the Islamic banks' management in their commitment to the Shari'ah principles. Such thought would give a negative and harmful impact to the banks image and would tarnish the banks' reputation as Islamic banks, thus the investment account holder are likely to avoid and reluctant from dealing with Islamic banks. This is because as investors, they believe that the Islamic banks should comply with the Islamic laws and principles. Due to this, the Islamic banks should comply, disclosed and presented all relevant information in appropriate manners as they know that the investment account holders may influence the operation in future.
As study by Farook et al. (2011) have used investment account holder is one of the determinants that may influence the disclosure of corporate social responsibility in Islamic banks, the result of the study shows investment account holder is one of the significant determinants that may influence the disclosure of corporate social responsibility in Islamic banks. It indicates that the investment account holder plays important role in influencing the Islamic banks transparency.
THEORETICAL FRAMEWORK
Referring to the framework, this study is going to examine the relationship between several determinants that unique to the Islamic banks and ethical identity disclosure. Those determinants are board composition that comprise of board size, board independence and Shari'ah Supervisory Board as well as Investment Account Holder that well be extracted from Islamic banks' annual report. We choose those determinants since they are assumed to influence the ethical identity di
