Shari’ah Corporate Governance and Fraud Prevention: A Framework for Ethical Accountability, Compliance, and Stakeholder Protection

Shari’ah Corporate Governance and Fraud Prevention: A Framework for Ethical Accountability, Compliance, and Stakeholder Protection

Maslinawati Mohamad

Faculty of Accountancy, University Technology MARA, Puncak Alam Campus, Selangor Branch, Selangor, Malaysia

DOI: https://dx.doi.org/10.47772/IJRISS.2025.909000719

Received: 14 March 2025; Accepted: 20 March 2025; Published: 28 October 2025

ABSTRACT

This article discusses a conceptual framework for Shariah corporate governance regarding fraud prevention. The importance of adhering to Islamic ethical principles in corporate governance as well as the importance of the role of internal controls in reducing the risk of fraud have been highlighted in this article. Using a systematic review of the existing literature on Shariah corporate governance and fraud prevention, this article proposes a set of principles designed to foster ethical behavior and reduce the likelihood of fraudulent activities within organizations. The current corporate governance landscape faces many challenges that affect its integrity and increase the risk of fraud. These challenges include CEO duality, insufficient levels of exposure, inappropriate board sizes, lack of adherence to Islamic ethical practices, and concerns about the independence of directors and executives, as well as compliance with the Quran and Hadith. By prioritizing Shariah compliance and implementing robust internal controls, the proposed framework aims to address these challenges and promote a culture of ethics and accountability within organizations.

Keywords— Corporate governance, Shari’ah  governance, Board of Directors, Fraud, Islamic Principles.

INTRODUCTION

This article delineates Shari’ah governance and highlights its critical role within the realm of Islamic finance. Its discusses the intersection of accounting, climate change, and earnings management represents a rapidly evolving area of study. As corporations face increasing pressures to address climate-related risks and opportunities, the importance of financial reporting and earnings management in communicating these issues to stakeholders becomes more pronounced. Future research should focus on establishing comprehensive frameworks for the integration of climate considerations into financial reporting and examining the implications of climate-related disclosures on earnings management practices. The subsequent section will explore the factors contributing to vulnerabilities in corporate governance and their implications for the incidence of fraud within the sector. Additionally, it will examine the various types of fraud prevalent in the industry and underscore the necessity of adopting Shari’ah governance as a comprehensive framework for fraud prevention. The proposed conceptual framework aims to aid organizations in effectively identifying and mitigating potential fraud risks while ensuring compliance with Shari’ah principles.

In conclusion, this article emphasizes the paramount importance of a robust commitment to Shari’ah governance and fraud prevention in promoting the long-term growth and stability of the Islamic finance industry. It is essential for organizations to proactively identify and mitigate fraud risks while strictly adhering to Shari’ah principles, thereby safeguarding the integrity of the industry and maintaining stakeholder trust.

LITERATURE REVIEW

Past research on CEO duality produces inconclusive results. Several studies demonstrate a positive correlation between CEO duality and firm performance, whereas others indicate no significant effect or even adverse outcomes (Ismail & Abdelmoniem, 2013; Rostami & Rezaei, 2021; Emelia et al., 2014). Notable literature by Ismail & Abdelmoniem (2013), Maliah et al. (2015), and Lubis & Lubis (2020) underscores the essential role of adequate and transparent disclosure in enhancing capital market efficiency and safeguarding stakeholder interests. Corporations should strive to provide timely and accurate information to promote informed decision-making and cultivate trust within the market.

The impact of board size on corporate performance can vary based on the organization’s size, complexity, and governance practices (see, e.g., Girau et al., 2022; Maulidi, A., 2022; Hosen et al., 2019). While larger boards may provide certain benefits, they can also present considerable governance challenges. Therefore, boards need to thoughtfully assess these trade-offs when determining the ideal number of directors (Mesni & Othman, 2016).

Research elucidating the shortcomings in Islamic ethical practices emphasizes the imperative for robust ethical cultures and governance frameworks to ensure compliance with Islamic principles (Salin et al., 2017; Mukhibad et al., 2021; Maulidi, A., 2022). Investigations into board independence reveal that independent directors and senior managers are more proficient in monitoring and advising management, thus enhancing corporate performance and governance (see e.g., Rostami & Rezaei, 2021; Rizwan Chugtai, 2022; Abdullah & Said, 2018; Girau et al., 2022; Subramaniam & Chakrabati, 2022). Furthermore, the extant literature (Hosen et al., 2019; Hamzah et al., 2019; Ali & Khan, 2021) advocates for organizations and individuals to engage with the Qur’an and Hadith, establish clear ethical codes and governance practices, and promote accountability and transparency.

The Concept of Corporate Governance

Corporate governance is essential for the effective functioning of financial institutions, ensuring that organizations are managed with ethical integrity and transparency (Rostami & Rezaei, 2021). Islamic financial institutions are governed by a specific framework of rules and principles known as Shari’ah governance (Hosen et al., 2019; Sulaiman et al., 2015), which must be strictly followed to ensure compliance with Islamic law.

In the context of these articles, corporate governance is defined as the systems, processes, and principles by which an organization is directed and controlled (Ismail & Abdelmoniem, 2013; see also Hosen et al., 2019; Rostami & Rezaei, 2021; Sulaiman et al., 2015). This framework of rules and processes directs and oversees an organization’s operations. Effective corporate governance is crucial for advancing the interests of all stakeholders, including shareholders, employees, customers, and society at large.

The focus of corporate governance in these studies primarily examines the governance mechanisms within Islamic financial institutions and their role in fraud mitigation. The research assesses the effectiveness of these mechanisms in preventing fraudulent activities and identifies areas for improvement in the corporate governance practices of these institutions. Moreover, the studies propose strategies to enhance these practices, thereby promoting transparency and accountability and reducing the risk of fraud.

The three articles by Swandaru and Muneeza (2022), Ali & Khan (2021), and Hamzah et al. (2019) explore the role of Shari’ah governance in fraud prevention within Islamic financial institutions. Shari’ah governance involves adherence to Islamic law in the operations and offerings of these institutions, including compliance with principles such as the prohibition of interest and the promotion of social justice.

The articles advocate for the implementation of high standards of Shari’ah governance as a viable solution to combat fraud in Islamic financial institutions. Hamzah et al. (2019) argue that weak Shari’ah governance can exacerbate the occurrence of fraud, while Ali & Khan (2021) assert that the establishment of rigorous Shari’ah governance can enhance transparency and accountability, thus mitigating fraud risk. Swandaru and Muneeza (2022) further support the view that stringent Shari’ah governance can effectively reduce fraud by fostering transparency, accountability, and stability within the Islamic finance sector.

In summary, the articles highlight the importance of implementing high standards of Shari’ah governance to prevent fraud in Islamic financial institutions by promoting transparency, accountability, and compliance with Shari’ah principles. Key actions for preventing fraud in this context include: (1) Ensuring the accuracy and comprehensiveness of financial statements and reports while adhering to Shari’ah principles in all operations and practices, (2) Maintaining compliance with Shari’ah principles to ensure that the institution’s operations and financial products align with Islamic law and (3) Upholding lawful and ethical practices within Islamic financial institutions, which can enhance stakeholder confidence and facilitate the identification and resolution of potential issues that may lead to fraud.

Issues Leading to Weak Corporate Governance

A.CEO Duality

Past studies have examined CEO duality and its implications for corporate governance (Ismail & Abdelmoniem, 2013; Rostami & Rezaei, 2021; Emelia et al., 2014). Issues in CEO duality can lead to conflicts of interest and can affect the effectiveness of corporate governance, as a CEO must be accountable to an independent board. The authors of these studies underscore that CEO duality may present particular challenges in Islamic countries, where corporate governance practices are often underdeveloped.

They propose that CEO duality could facilitate stock options fraud. When the CEO concurrently serves as the chairman of the board, they may exert disproportionate control over stock option allocations, potentially abusing this authority for personal gain or to benefit affiliates, thereby jeopardizing the interests of the company and its shareholders. The authors contend that the implementation of stricter corporate governance regulations, such as the separation of the roles of CEO and chairperson, could help mitigate the risk of stock options fraud. With a CEO simultaneously holding the chairperson position, oversight and accountability regarding financial reporting may be inadequate, leading to potential manipulation of financial statements that misrepresent the company’s profitability. This misrepresentation can create a misleading impression of robust company performance, ultimately threatening the interests of investors and stakeholders.

The articles further emphasize that CEO duality poses a significant challenge in Malaysia. In such instances, a CEO may exert excessive control and engage in fraudulent activities, such as embezzlement or misappropriation of funds, without adequate oversight due to deficiencies in management control. These conditions can result in substantial financial losses and potential legal repercussions for the company.

Low level of disclosure

Several scholarly articles examine the issue of inadequate disclosure related to stock options fraud prevention and corporate governance in Islamic countries. The authors assert that effective corporate governance is crucial for mitigating stock options fraud and the adverse consequences associated with insufficient governance practices (Ismail & Abdelmoniem, 2013). In the absence of robust corporate governance frameworks, the identification and prevention of stock options fraud become increasingly problematic, as management may exploit opportunities to manipulate financial statements and other relevant information to obscure their actions. This scenario can lead to significant financial losses for shareholders and damage the organization’s reputation.

The literature also highlights the necessity for a deeper understanding and awareness of the importance of corporate governance in Islamic financial institutions, particularly in countries such as Malaysia. This lack of comprehension and awareness may contribute to the persistence of inadequate corporate governance practices within these institutions, ultimately resulting in financial losses and reputational harm (Maliah et al., 2015).

Furthermore, the articles emphasize that insufficient disclosure of fraud within Islamic commercial banks can foster public mistrust towards these financial institutions, which may subsequently undermine public confidence in the sector. This erosion of trust can result in financial detriment for shareholders, customers, and the banks themselves (Lubis & Lubis, 2020). The authors contend that corporate governance plays a critical role in preventing fraud related to stock options, with factors such as a lack of transparency, weak internal controls, and inadequate independent oversight contributing to the low levels of disclosure observed in Islamic countries.

Size of Board of Directors in the Organization

One factor contributing to inadequate corporate governance in organizations is the size of the board of directors. Girau et al. (2022) demonstrate that companies with larger boards are more likely to engage in fraudulent activities compared to those with smaller boards. A larger board complicates the company’s ability to ensure that all members fulfill their responsibilities and are held accountable for their actions. This lack of individual accountability stems from the challenges of effectively engaging and coordinating a larger group. Consequently, an increase in board size correlates with a higher risk of poor governance and fraudulent behavior.

Research by Girau et al. (2022), Maulidi (2022), and Hosen et al. (2019) indicates that smaller boards may be more effective in preventing fraud. Smaller boards promote better communication and collaboration among members, facilitating the identification and resolution of potential issues while establishing effective checks and balances to mitigate fraud risks. Additionally, a smaller board size may enhance earnings management by streamlining oversight and controlling management actions.

In contrast, a study titled “The Impact of Corporate Governance Mechanisms on Earnings Management in Islamic Banks in the Middle East Region” suggests that a larger number of board directors can provide the necessary knowledge and experience to effectively monitor management actions and curtail earnings management practices. Mesni and Othman (2016) found that larger boards are more effective in deterring earnings management than their smaller counterparts.

Lack of Islamic Ethical Practices

Several studies indicate that a lack of adherence to Islamic ethical principles in the corporate sector may lead to concerns such as corporate fraud. The literature emphasizes the crucial role of Islamic ethics in mitigating corporate fraud, suggesting that a strong commitment to principles like fairness, justice, and transparency can foster a corporate culture that deters unethical behavior and promotes ethical conduct (Salin et al., 2017). Without these ethical guidelines, organizations may be more likely to engage in unethical or illegal practices, including financial misrepresentation and insider trading.

Furthermore, the literature clarifies that insufficient adherence to Islamic finance principles can result in poor governance and financial fraud (Mukhibad et al., 2021). Islamic finance is based on the tenets of sharia law, which prohibits interest-based transactions and mandates equitable profit and loss sharing among all parties involved. Failing to uphold these principles undermines oversight and accountability, creating an environment conducive to fraudulent activities.

Additionally, an article by Maulidi (2022) explores the implications of inadequate diversity on corporate boards, which can lead to a lack of varied perspectives and experiences necessary for identifying and preventing fraud. Within the context of Islamic ethical practices, a lack of diversity—encompassing gender, culture, and background—can similarly hinder the inclusion of diverse viewpoints. Islam promotes the equitable and respectful treatment of all individuals, regardless of race, ethnicity, place of birth, or skin color. Collectively, these studies advocate that adherence to Islamic principles and practices—including fairness, justice, transparency, compliance with sharia law, risk-sharing in Islamic finance, and fostering diverse perspectives—can significantly help prevent corporate fraud.

Independence of Directors and Top Executives

Rostami and Rezaei (2021) and Rizwan Chugtai (2022) explore the relationship between corporate governance mechanisms and fraudulent financial reporting. They suggest that a higher number of independent directors correlates with a reduced likelihood of such reporting. This indicates that an independent board of directors can mitigate financial crimes committed by top executives and ensure accountability for their actions. Furthermore, these studies highlight that an independent board can help restore a company’s legitimacy following instances of fraud, underscoring its role in preventing future financial misconduct.

In contrast, the paper by Abdullah and Said (2018) argues that both corporate governance mechanisms and individual ethical behavior are essential in reducing the incidence of financial crimes by directors and top executives. However, it does not specifically address the independence of these individuals. Collectively, the articles emphasize that having a board composed of independent directors is a critical component of corporate governance that can deter financial crime, hold top executives accountable, and restore legitimacy after fraud.

Regarding the independence of directors and top executives, Girau et al. (2022) and Subramaniam and Chakrabati (2022) both assert that an independent board of directors is vital for effective corporate governance and can help prevent financial crime and fraud committed by top executives in emerging markets. Subramaniam and Chakrabati note that the absence of independent directors and ineffective boards in India has contributed to financial misconduct, while Girau et al. emphasize the significance of robust corporate governance structures, including independent directors, in reducing the risk of financial crime and fraud by top executives in Malaysia.

Shari’ah Governance not aligned with Al-Quran and Hadith

The relationship between corporate governance and Sharia governance in Islamic banking is of paramount importance, as it significantly influences the integrity and sustainability of financial institutions. Discrepancies exist between the operational practices of Islamic banks and the Sharia governance principles delineated in the Al-Quran and Hadith. Such inconsistencies may lead to serious issues, including fraud and mismanagement (see, e.g., Hosen et al., 2019; Hamzah et al., 2019; Ali & Khan, 2021). The literature underscores the necessity of aligning corporate governance practices with Sharia principles to mitigate the risks of fraud and mismanagement within Islamic banks in Indonesia.

Fraudulent activities are more likely to arise when the principles enshrined in the Al-Quran and Hadith are inadequately integrated into banking operations. This misalignment can ultimately compromise the bank’s reputation and financial stability. For example, if an Islamic bank’s corporate governance structure lacks appropriate checks and balances, it may permit top executives and directors to make decisions that contravene Sharia principles.

In conclusion, a failure to align Sharia governance with the teachings of the Al-Quran and Hadith can have significant repercussions for the integrity and sustainability of Islamic banks and the broader Islamic banking system. Islamic banking operates within a framework that is distinct from conventional banking and must adhere to Sharia principles and regulations. Non-compliance with the Al-Quran and Hadith may result in legal violations and regulatory breaches, potentially leading to legal action and financial penalties.

Fraud Prevention Through Shari’ah  Corporate Governance

Numerous studies underscore the significance of effective governance practices—such as clearly defined rules and regulations, robust monitoring and reporting mechanisms, and strict adherence to Shari’ah principles—in mitigating fraud within Islamic financial institutions. Clearly defined rules and regulations necessitate the establishment of policies and procedures specifically designed to deter fraudulent conduct. For instance, institutions may implement policies that explicitly prohibit employees from engaging in activities such as insider trading or embezzlement, thereby augmenting the difficulty of committing fraud as employees become acutely aware of the repercussions associated with such actions.

Effective monitoring and reporting mechanisms are also imperative for fraud prevention (Kaseem, 2022). This encompasses the establishment of systems capable of detecting and reporting suspicious activities. For example, institutions may employ software designed to automatically flag anomalous transactions, thereby facilitating the early identification of potential fraudulent activities and enabling timely intervention.

Adherence to Shari’ah principles is equally critical in fraud prevention. This entails ensuring that all transactions are conducted ethically and transparently, in accordance with the institution’s laws and regulations. In the context of Zakat institutions, for example, funds must be allocated exclusively for their intended purposes, such as assisting the impoverished, to avert misuse or embezzlement (Wahyuni-TD et al., 2021).

Furthermore, several articles advocate for the establishment of a strong, independent board of directors in conjunction with an internal audit committee responsible for ensuring regulatory compliance, which can further alleviate fraud risks (Swandaru & Muneeza, 2022). These entities are tasked with overseeing the actions of management and employees, ensuring that they operate in the best interests of the institution. In summary, a substantial body of research indicates that by implementing sound governance practices and adhering to Shari’ah principles, Islamic financial institutions can significantly diminish the risk of fraud and enhance their performance by rendering fraudulent activities more difficult to perpetrate and easier to detect.

Avenue For Future Research

To enhance the understanding of the impact of CEO duality on fraud prevention, future research should prioritize the development of a comprehensive framework for Islamic Corporate Governance. This endeavor entails an examination of the underwhelming levels of corporate governance by assessing the influence of corporate governance disclosure frameworks within Islamic Financial Institutions. Furthermore, subsequent studies should investigate how board size influences the relationship between corporate governance disclosure levels and earnings management within these institutions.

In addressing the deficiencies in Islamic ethical practices concerning fraud prevention, research should examine the capacity of Islamic ethics to confront the moral and ethical challenges that contemporary societies encounter. Additionally, to evaluate the independence of directors and senior executives in fraud prevention, future research should establish standards or benchmarks for the selection of prospective directors and top management teams. Finally, to comprehend the potential misalignment of Shari’ah Governance with the teachings of the Al-Quran and Hadith, it is imperative for future research to advocate for revisions to corporate governance regulations grounded in Islamic principles.

CONCLUSION

This study suggest that the Shari’ah corporate governance provides a unique framework for the ethical and responsibilities of management in organisations. The emphasize on the fairness, transparency, and accountability are considered as essential components for deterring fraud and promoting integrity in business practices. The needs to implement fraud detection is considered as a critical aspect of corporate governance. Thus, by integrating Shari’ah principles can produce a robust strategy for mitigating fraud. Shari’ah law obviously prohibits any deception, embezzlement, and exploitation, all forms of fraudulent activity.

The proposed conceptual framework in this paper encompasses measures such as the implementation of good internal controls, the establishment of checks and balances to detect and prevent fraud the conduct of regular audits. By implementing Shari’ah principles, these measures can ensure that corporations operate ethically and responsibly while promptly addressing any occurrences of fraud. In conclusion, the incorporation of Shari’ah principles into corporate governance can provide a robust foundation for fraud prevention and the promotion of integrity in the business environment. By fostering a framework centered on ethical behavior and accountability, corporations can enhance stakeholder trust and credibility while nurturing a culture of integrity within the organization.

Furthermore, this framework can assist in ensuring compliance with Shari’ah law, the moral and ethical code of conduct in Islam, which holds significant relevance for numerous countries and communities worldwide.

ACKNOWLEDGEMENT

We would like to express gratitude to the Faculty of Accountancy at Universiti Teknologi MARA (UiTM), Cawangan Selangor Kampus Puncak Alam, for the financial assistance provided under Yuran Penerbitan Artikel Jurnal Berindeks (PYPA) which has greatly facilitated the dissemination of the research findings.

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