Islamic business scorecard and the screening of Islamic businesses in a cross‐country setting

Abstract

Screening of shari'ah compliant firms is incomplete without the inclusion of ethical and social responsibilities. The existing “activity screen” does not directly capture the ethical and social footprints of firms. The purpose of this study is to create and test an Islamic business scorecard that combines activity, ethical, and social responsibilities that Islamic businesses must comply with. This new Islamic business scorecard replaces the existing activity screens and is added to the financial screens to create an integrated business screening mechanism to identify shari'ah compliant firms. This study utilizes data from a sample of 410 shari'ah compliant companies listed with stock exchanges in Malaysia, Pakistan, and Bangladesh. Out of the five newly developed constructs of the Islamic business scorecard, the results indicate Islamic firms are less committed to social responsibilities and tend to push forward economic responsibilities that focus on profitability and growth. Of the three countries, this study reports Malaysian firms have the highest compliance scores, while Bangladesh displays characteristics of the “next‐big shari'ah destination”. Financial screens are more important than the Islamic business scorecard for firms in the construction, industrial, technology, and trading/services sectors. Because of its connection with the economic, ethical, and social dimensions, the scorecard helps to identify the true nature of shari'ah compliance as a useful decision tool for investors and policymakers.

Islamic labeled firms: Revisiting Dow Jones measure of compliance

“…5,6 Moreover, researchers described Islamic law-compliant institutions as ethical, responsible, and philanthropic (Ullah et al, 2018), having broader objectives covering social values and ethical conduct (Belal et al, 2015), promoting a social and ethical identity (Haniffa & Hudaib, 2007), and giving equal attention to social goals and profit making (Aribi & Arun, 2015). Hassan et al (2019) describe Islamic firms as "caretakers" of social and financial resources that must promote ethical and socially responsible activities (see also Dusuki, 2008;Nienhaus, 2011). Similarly, HSBC defines Islamic finance as "a unique form of investment which corresponds with the values of socially responsible investing."…”

“…More interestingly, DJIM and S&P, which were created by the same institute, use different liquidity thresholds (while DJIM uses 33%, S&P uses 49%). Hassan et al (2019) claim that these stark differences led to the distrust and insecurity of Islamic investors and the emergence of fatwa (religious ruling) shopping, which can hinder the credibility of the entire Islamic finance industry. To fully understand the practical difficulties that can emerge from such severe disparities among indices, we compare four of the most famous Islamic law compliance indices.…”

“…For example, Derigs and Marzban (2008), among others, argue that the holy Quran (scripture of Islam) and Hadith (statements of Mohammed the prophet of Islam) do not explicitly state which thresholds for financial analysis are acceptable. 3 This led Islamic scholars to rely on personal interpretations (Ijtihad) which in turn resulted in a lack of standardization and inconsistencies (Hassan et al, 2019), and the use of debatable and out-of-context commands (Obaidullah, 2005). As an example of the severity of disparity between different indices, Derigs and Marzban (2008) find that indices use liquidity ratio thresholds that range between 33% and 80%.…”

“…As an example of the severity of disparity between different indices, Derigs and Marzban (2008) find that indices use liquidity ratio thresholds that range between 33% and 80%. Hassan et al (2019) claim that such disparity has led to distrust and insecurity of Islamic investors regarding Shariah compliant investments. Ashraf (2016) claims that the Islamic finance profession and researchers need to streamline the quantitative screening criteria to avoid confusion among the investing public and to help attract more faith-adhering investors to invest in capital markets.…”

“…This paper makes several contributions to the Islamic finance research and industry. First, it contributes to the ongoing discussion on the drawbacks of the threshold-style methods that have been employed by financial institutions for several decades (Obaidullah (2005), Derigs and Marzban (2009), and Hassan et al (2019)). Second, to the best of our knowledge, this is the first paper that reveals to the Islamic finance industry that Shariah-compliant stocks (as currently identified by DJIM and other indices) do not have superior CSR scores, lower risk, or lower likelihood of bankruptcy as they tend to be described by researchers and professionals.…”