islamic business and business as usual -...

Development in Practice Volume 11 Number 1 February 2001

Islamic business and business asusual a study of firms in Egypt

Karen Pfeifer

Fifteen Egyptian firms producing goods and services were classified into two sets by methodof finance ie profit sharing for the seven Islamic versus debt-at-interest for the eight non-Islamic firms Interviewed in 1993 and 1994 the two groups were found to be similar incustomer relations and market behaviour and in paternalism towards employees However thenon-Islamic firms had a significantly higher average profit rate while the Islamic firms paida significantly higher average wage suggesting that cultural institutions shape economicbehaviour even in a well-established market economy

Introduction

Egypt underwent massive structural adjustment in the 1990s in order to privatise and liberalisedomestic economic activity and to open up further to international trade and investment Neo-classical economic logic suggests that there would be little difference in behaviour orperformance between Islamic and non-Islamic firms in this context because they face acommon set of competitive pressures and a common if evolving institutional and legalenvironment The research described here compares two such sets of productive (ie non-financial) firms to see what differences there might be if any Egypt was chosen as the venuefor the study because it has the largest and most diverse economy in the Arab world a growingprivate sector and a well-developed Islamic business sub-sector (El-Ashker 1987 Oweiss1990)

Proponents of lsquoIslamic economicsrsquo argue that it can effectively promote both economicdevelopment and social welfare in predominantly Muslim societies Avoidance of contractsinvolving interest is only the beginning One study surveys the many techniques of Islamicbanksrsquo investment finance in various countries (Ahmad 1994) Two other authors (Siddiqi1979110ndash114 El-Ashker 1987) describe in detail the possible organisational forms andmethods of finance of Islamic enterprises Each argues that the entrepreneurrsquos decisions aboutinvestment and production should be made primarily in terms of the needs of the communitywith profit maximisation a secondary consideration Aziz (1993 50ndash55) and Said (1972) alsoprescribe rules for Islamic firmsrsquo behaviour These include precepts such as lsquothe best and mostfaithfulrsquo should be hired wages should be fair and enable workers to support their familiesemployers should be responsible for the health and other basic needs of their employees andbuyers should be well informed about the features of the product

Islamic theorists express faith that the moral environment of Islam will guide theentrepreneur and that zakah (a tax on capital designated for funding social welfare projects)

20 ISSN 0961-4524 printISSN 1364-9213 online 01010020-14 copy 2001 Oxfam GB

DOI 10108010961452002001992 0 Carfax Publishing

A study of firms in Egypt

and a relatively strong government will ensure adequate income redistribution and protectionfor employees Some like Aziz (1993) and Said (1972) have argued that workers beconsidered partners to the business and included in management and profit sharing Choudhury(199214ndash18) goes perhaps the furthest and recommends industrial democracy not just formoral reasons but also because it would enhance economic growth through the dispersion ofrisk and the diversification of investment Siddiqi (1979) and others argue that entrepreneurialprofits are a variable return to risk and recommend against profit sharing with employees onthe grounds that workers need a steady and predictable income to support their families In anycase the desire for wealth and power is considered contrary to Islam so moderation and moralcommitment by entrepreneurs will ensure an equitable standard of living for all

This study offers some preliminary evidence on how Islamic business firms meet theseexpectations in a dynamic economic environment that is shared with non-Islamic firms

Method

The inquiry was conducted in 1993 and 1994 via interviews with the owners or generalmanagers of 15 non-financial companies operating in agriculture industry and the servicesector Banks and financial firms were deliberately excluded from the sample The firms werethen separated into two groups Islamic (IFs) and non-Islamic (NIFs) based on their methodsof finance They were loosely matched into pairs by type of product and industry andcompared along several dimensions of economic viability and social accountability

The ideal method for this type of research would have been to choose the sample eitherrandomly or by a set of strict matching criteria While some Egyptian economists such asSamiha Fawzi at Cairo University are developing this methodology for studying firmbehaviour our research had to begin with the case study method asking the same questions ofall of the firms but also treating each firm as a unique entity Starting with suggestions fromfellow social scientists doing related work as well as bankers and leaders of businessorganisations a network of contacts for possible introductions was built The non-randomnessof the sample was the inevitable result of the fact that meeting and gaining the confidence ofan owner or manager of a firm was contingent on personal contacts and introductions amethodology shared with El-Ashker (198799ndash100)

Foreign researchers were forbidden to use formal questionnaires So meetings with firmstook the form of systematic lsquoconversationsrsquo each about two hours in duration1 None of thefirms except Automotive-NIF provided an annual report to verify their responses to accountingquestions Therefore the calculations derived from the accounts obtained (Appendix B1 ndash allappendices are available from the author on request) are imprecise but provide some sense ofrelative magnitudes While not conclusive they can serve as fodder for further research

Preliminary interviews were conducted with three firms in autumn 1993 Longer and morethorough interviews were conducted with 12 more firms in the summer of 1994 Several ofthese involved trips to industrial centres outside Cairo as well as a visit to a farm in the deltawhere parts of the interviews entailed a tour of production facilities

Islamic financial contracts versus commercial bank loans

The defining variable used to assign firms to one group or the other was method of finance ofinvestment While recent work on the criteria for investment comparing lsquogreenrsquo or lsquosociallyresponsiblersquo investment in the West with haramhalal investment under Islam argues that theyare functionally similar (Wilson 1997) there is a clear distinction between IFs and NIFs in oursample Appendix Table Cndash1 provides information on methods of finance and profit

Development in Practice Volume 11 Number 1 February 2001 21

Karen Pfeifer

distribution in our sample The two groups are about equal in terms of the predominantimportance of personal savings to the firm which is understandable given the small size ofmost private-sector firms in Egypt What most clearly distinguishes the two groups is that theownermanagers of all IFs indicated that their firm never borrows (or lends) at interest Incontrast the eight NIFs all have outstanding loans at interest Another difference is that threeNIFs rely on retained earnings while only one IF does so Just one firm in the sample an IFraises capital on the stock market Bank lending or investment aside then the two sets of firmsare rather similar in other methods of finance and do not differ at all in methods of profitdistribution

Assets and profits

El-Ashker (1987198ndash202) offers accounting guidelines for Islamic business firms reasoningthat there is significant overlap with Western accounting practices For one thing profit can beaccounted for as revenues minus costs This is appropriate to both systems as is the consistentuse of either historical or replacement cost in determining the value of assets For Islamicfirms though he argues replacement cost is more relevant because the market value of assetsis the base on which zakah is calculated Another study argues that Tobinrsquos Q would serve asa proper basis for measuring the cost of capital without using an interest rate (Mirakhor 1996)Tobinrsquos Q equalling the market value of a companyrsquos stock divided by the book value of thestockholdersrsquo equity

Other differences between Western and Islamic accounting concepts involve deductionsfrom profit such as interest and zakah respectively El-Ashker (1987202ndash205) composes oneformula for the cost of capital in the Western enterprise with interest as a variable and one forthe Islamic enterprise with zakah as a variable Since each is a deduction from expected

22 Development in Practice Volume 11 Number 1 February 2001

Table 1 Fixed assets 31 December 1992 and outstanding debt midndash1993 in LE million

Islamic firms Non-Islamic firms

Fixed assets Loans Fixed assets Loans

Plastics-IF 400 0 Plastics-NIF 700 0

Filters-IF 140 27 Automotive-NIF 992 896

Clothing-IF na na Clothing-NIF 564 160

Meat-processing-IF 500 0 Poultry-NIF 600 120

Publishing-IF 15 0 Publishing-NIF 290 120

Food services-IF 503 0 Tourist services-NIF 1420 180

Appliances-IF 100 0 Carpets-NIF 4000 na

Chemicals-NIF 50 na

Mean assets of six IFs 276 Mean assets of eight NIFs 1077


returns the impact on the cost of capital formula is similar This implies a reasonable degreeof comparability in the two accounting systems Appendix B presents accounting variables forthe firms in the sample The data presented in Tables 1 and 2 are fixed assets determined byreplacement value at the end of 1992 and profits calculated as total revenues minus total costsfor 1993 The rate of profit is then expressed as profits relative to fixed assets

Table 1 presents the values for fixed assets and loans outstanding With the possibleexception of Meat-processing-IF the NIFs all have greater assets than their matched IFs Themean value of fixed assets of the six IFs for which we have data is 2763 million while themean value of fixed assets of the six NIFs for which we have data is 10778 million the latterabout four times as large as the former However five of those six NIFs are also carryingsignificant debt loads Automotive-NIF having a stunning debt-to-asset ratio of 90 per cent

Table 2 presents profit volumes and rates of profit for five IFs and six NIFs The numeratorprofit equals total revenues minus total costs for 1993 after deducting for interest and feepayments It does not take account of taxation zakah donations or profit distribution Thedenominator of the rate of profit is total fixed assets at endndash1992 (from Table 1) In derivinga profit rate it is standard practice to cite profits from a given year relative to assets from theprevious year on the reasoning that investment takes time to bear fruit This is what is donefor example in the annual report of US-affiliated Automotive-NIF

The mean rate of profit of the five IFs for which we have information is 18 per cent Forcomparison El-Ashker provides a profit rate for another Islamic firm the Fatteh Company aproducer of haberdashery and fabrics which is in the same range This firm had a rate of profit(measured as dividends to nominal capital) ranging from 12 to 17 per cent over the 1971ndash1985period (El-Ashker 1987187ndash188)

Table 2 indicates that rates of profit of NIFs are higher than those of IFs in three out of fourpairs Furthermore the mean rate of profit is 486 per cent for the six NIFs about 26 times


Table 2 Profits and rate of profit (ratio of profits to fixed assets) 1993


Profits(LE million)

Rate ofprofit ()

Profits(LE million)

Rate ofprofit ()




Meat-processing-IF na na Poultry-NIF 87 145


Food services-IF ndash009 ndash02 Tourist services-NIF 935 658

Appliances-IF 154 154 Carpets-NIF na na

Chemicals-NIF na na

Mean profit rate five IFs 180 Mean profit rate six NIFs 486

Karen Pfeifer

greater than that of the five IFs An Independent Samples Test of the difference between thesetwo means indicates that this difference is significant at the 10 per cent (literally 59 per cent)confidence level (see Table 6 below)

Characteristics of the sample of fifteen firms

A set of Appendix tables C2ndashC61 systematically organises the non-numeric information fromthe interviews and makes qualitative comparisons possible These tables are available from theauthor upon request Appendix Table Cndash2 arrays the sample firms into two sets Islamic andnon-Islamic giving their product form of ownership location and date of founding The firmsare loosely paired by type of product

Plastics-IF Plastics-NIFFilters-IF Automotive-NIFClothing-IF Clothing-NIF (textiles and ready-to-wear)Meat-processing-IF Poultry-NIFPublishing-IF Publishing (and printing)-NIFFood services-IF Tourist services-NIFAppliances-IF Carpets-NIFndash Chemicals-NIF

Three of the Islamic firms Clothing-IF Food services-IF and Meat-processing-IF indicatedthat choice of product was influenced by Islamic moral considerations More tellingly thefirms co-founded by an Islamic bank or group Filters-IF Meat-processing-IF Food services-IF and Appliances-IF were influenced by their respective financial backer in the choice ofproduct

A majority of the Islamic firms in our sample take the form of a joint stock company whilealmost all of the non-Islamic firms are partnerships This difference is due to the fact that thefour Islamic joint stock companies were founded by and remain connected to Islamic banks orinvestment groups while Automotive-NIF takes a corporate form from its home country theUSA A second difference is that a higher proportion of NIFs in the sample is dominated byforeign capital four out of eight NIFs versus two out of seven IFs

All of the firms in the sample have offices in Cairo Production on the other hand isconcentrated in the 10th of Ramadan and other industrial cities The six Islamic firms forwhich we have information were all founded within a few years of each other 1980ndash1985apparently in tandem with the rise of Islamic banks and investment companies in EgyptIgnoring the Nasser-era incarnations of Clothing-NIF and Publishing-NIF the non-Islamicfirms for which we have information were all founded within a period of eight years1976ndash1984 reflecting the infitah the legal changes beginning in 1974 which encouragedforeign and then local private capital to invest in Egypt

In sum there seem to be small differences in choice of product and some differences inlocation and founding date Perhaps more interesting is the greater role for foreign capital inNIFs versus the greater role for Islamic banks or investment groups in IFs with date offounding influenced by these roles These differences may be related to differences in a firmrsquosbehaviour and performance below

Market structure and competition

Market structure and relations between the sample firms and their respective industries arepresented in Appendix Table Cndash31 The firms are categorised as lsquoprimaryrsquo referring to the



extraction or production of raw materials lsquointermediatersquo meaning a step or set of steps in themiddle of the chain of production processes and lsquofinalrsquo meaning the assembling of theproduct in the form in which it will be used by its purchaser (no further processing is needed)From this distribution it appears that the IFs are about as well represented across the spectrumof economic activities as are the NIFs

There seem to be only minor differences between the two sets of firms with regard to marketstructure and behaviour Responses to questions about relationships with customers weresimilar eg regarding advertising Competitiveness in the various industries can be classedaccording to the respondentsrsquo own judgements the number of firms in the industry and thesize of a firmrsquos market share The NIFs have greater representation in the four-firms-or-lesscategory This market power may be important for the high profitability of Publishing-IFAutomotive-NIF and Tourist services-NIF On the other hand Poultry-NIF is in the four-firms-or-less category but it has a significantly lower profit rate Furthermore there are firmsin the more-thanndash10-firms category (lsquostrongly competitiversquo) that have high and moderatelyhigh rates of profit Plastics-NIF Plastics-IF Clothing-NIF and Publishing-NIF

In an example of market power the plastics industry had been an oligopoly of four firmsuntil 1990 after which time the number of firms in the industry grew to 17 leading to fiercecompetition So the original four firms a mixture of Islamic and non-Islamic formed a cartelwhich after six months collapsed due to the lsquocheatingrsquo that typically undermines sucharrangements In another case six firms make up the industry for filters Of the two largestone is Christian-owned and the other is Filters-IF in our sample These two firms openly ledthe collaboration until their powerful customers (such as Automotive-NIF) objected The foodindustry organisation the Restaurant and Hotel Association provides a third example Usingits monopsony (big buyersrsquo) power it helps members obtain better terms from suppliers

The Egyptian economy boomed in the 1980s and then underwent a deep and powerfulcontraction from 1990 to 1994 Most of our sample firms were hit hard with capacityutilisation rates falling to precipitously low levels by 1994 ranging from 60 per cent in printingdown to 20 per cent in tourist services Most firms reported that they made profits in theseyears but at least one Food services-IF admitted making losses and would have gonebankrupt without a transfusion from its Islamic-group parent company

International trade and the response to liberalisation

Appendix Table Cndash31 also contains information on the sample firmsrsquo imports and exportsNone of the firms in the sample except Poultry-NIF produces primary inputs or capital goodsfor purchase by other firms Both Islamic and non-Islamic firms are strongly dependent onimports of primary inputs and capital goods However 10 of the 15 firms in the sampleindicated that they export at least a small amount of their product participating in Egyptrsquosexport-promotion programme Among the firms that do not export at all three were establishedexplicitly to serve the Egyptian market Appliances-IF Automotive-NIF Chemicals-NIF andFood services-IF In contrast the firms that export more than 50 per cent of output Touristservices-NIF and Carpets-NIF organised their operations deliberately to target foreigncustomers and to compete in international markets Overall however more NIFs engage inexporting ndash six out of eight NIFs versus four out of seven IFs ndash and they tend to export agreater proportion of their output

All firms expressed concern about the recessionary impact of liberalisation and structuraladjustment and about the implied threat of import competition On the one hand they all arguethat the government should keep restrictions on imported final goods in order to give themmore time to adjust Without irony the general manager of Automotive-NIF (a firm with a high


Karen Pfeifer

proportion of foreign capital) complained that lsquoEgypt has become a dumping ground forimportsrsquo On the other hand these same firms want the freedom to import inputs and exportoutput without bureaucratic interference or tariffs Similarly firms are happy with the freeingup of currency exchange but bemoan the pain of high interest rates (or in the case of IFs bankfees)

Although equal numbers of IFs and NIFs (four each) were optimistically planning for theintroduction of new products expansion of capacity or reorganisation of their facilitiesIslamic firms seem to have a gloomier perception of liberalisation and structural adjustmentthan do non-Islamic firms This fits with their lesser tendency to export

Choice of technology and the labour process

Information on technology and the labour process is shown in Appendix Table Cndash41 Thirteenof the sample firms including five Islamic firms purchase their basic capital-good inputs fromEurope or the USA These include items like plastic extruders lsquograndparentrsquo breedingchickens metal-pressing and -stamping machines and computers Several firms sendengineers and foremen to Europe for retraining in new technologies or bring European trainersto their plant including the plastics filters automotive and appliance firms

Computers had made important contributions to improving the efficiency of Food services-IF Publishing-NIF and Tourist services-NIF the last-named having reduced skilled staff suchas accountants from 80 to 19 in three years Only Food services-IF and Tourist services-NIFsaid that they had laid off workers recently due to either the recession or technological changeAll other firms said that the number of workers they employ has stayed the same or increasedin recent years asserting that new technology did not displace workers

NIFs seem to place more emphasis on their own innovations in technology or organisationof the labour process such as larger more luxurious cruise ships able to navigate shallowsouthern-Nile waters in the dry season and more efficient card-punching technology forweaving designs into carpet fabrics The latter technology embodied in machines built inBelgium with Belgian patents had raised labour productivity dramatically Clothing-NIFproudly displayed their self-designed complex vertically integrated set of three factories at10th of Ramadan City

Only Automotive-NIF prided itself on its deliberately lsquolow-techrsquo production process TheEgyptian general manager had been trained in a new lsquoteam approachrsquo at the companyrsquosEuropean headquarters This approach makes the best use of cheap local labour Wages arealready very low in Egypt he said and cannot be lowered so in order to reduce costs and raiseprofits the firm must increase real output per labour hour This may help explain why this firmhas the second highest rate of profit in the sample Indeed innovation may be important inexplaining the NIFsrsquo higher rate of profit overall

Labour relations

Information about labour relations is contained in Appendix Table Cndash51 Employment policiesseem to be driven mainly by the needs of the industry and to be rather similar among firmsClothing-IF is the only firm to have specified a social characteristic it requires all employeesto be Muslim In addition to hiring skilled workers and technicians most firms trainedunskilled workers on the job The proportion of female employees varies widely While all thenon-Islamic firms employ some women four of the seven IFs have a policy of not employingwomen at all One major reason for the variation is the type of work considered suitable forfemales the highest was Food services-IF with 20 per cent because women specialised in



certain jobs greeting and serving the public The highest among the non-Islamic firms wasClothing-NIF at 55 per cent because of the important role for women in the textile andgarment trades The lowest non-Islamic firm was Poultry-NIF at 1 per cent because workershave to live in dormitories at the work site an unthinkable situation for women Both Clothing-NIF and Poultry-NIF are incidentally Christian-owned

The IFsrsquo and NIFsrsquo attitudes towards and treatment of workers seem to share a commonpaternalistic framework This framework on the one hand calls for treating employees lsquolikefamilyrsquo and makes it hard to fire them but on the other hand dismisses the notion of workersrsquoindependent organisations as unnecessary and undesirable Only five firms in the sampleindicated that their workers were organised in some sort of union Except for the unionisedfirms general managers said that they settle disputes themselves in person

There appears to be a difference between the two groups of firms with regard to salary Table3 indicates that average monthly salaries of employees in the Islamic group are higher and thatthe average for the group as a whole LE 465 is startlingly higher than the average for the non-Islamic group LE 290 An Independent Samples Test of the difference between these twomeans indicated that it was significant at the 5 per cent level (see Table 6 below)

Table 4 shows the salary range and the ratio of highest to lowest salaries Several NIFs forvarious reasons excluded their highest paid executives from their responses If these threeNIFs are included in the comparison giving a set of six the breadth of the range is similarbetween NIFs and IFs 281 and 271 respectively If these cases are excluded giving a set ofthree the breadth of the range is greater in the non-Islamic than the Islamic group 491 versus271 Both the average monthly salary and the salary range data then suggest that Islamicfirms are characterised by greater distributional equity

Table 5 presents another measure of relative equity the ratio of profits to the wage andsalary bill This ratio indicates the distribution between the owners and the workers of the netproduct (or value added) produced by the firm The lower the ratio the more equitable thedistribution The ratio is lower on average for the Islamic group than for the non-Islamic


Table 3 Average monthly salary in LE 1993 calculated by (wage-and-salary bill)(number ofemployees12 months)


Plastics-IF 417 Plastics-NIF 191

Filters-IF 500 Automotive-NIF 432

Clothing-IF na Clothing-NIF 167

Meat-processing-IF 606 Poultry-NIF 300

Publishing-IF na Publishing-NIF 195

Food services-IF 273 Tourist services-NIF 455

Appliances-IF 528 Carpets-NIF na

Chemicals-NIF na

Average of five IFs 465 Average of six NIFs 290

Karen Pfeifer

group for every pound paid out to employees as wages and salaries the Islamic owners takejust LE 088 in profit on average while the non-Islamic owners take LE 1355 An IndependentSamples Test of the difference between the means of the two groups indicated that this valuewas significant at the 5 per cent (literally 11 per cent) level (see Table 6 below) Like thefindings on salaries above this suggests that there is a more egalitarian distribution onaverage among Islamic firms than non-Islamic

Table 6 presents the results of the lsquocomparison of meansrsquo statistical tests performed on thekey variables These results lend credence to the notion that Islamic and non-Islamic firms aredifferent in basic measures of performance (rates of profit) and behaviour (average salaries andprofitwage ratios)

Appendix Table Cndash61 indicates that there are few differences between the Islamic and non-Islamic firms in provision of most benefits including healthcare retirement programme paidvacations sick leave bonuses and a miscellaneous category of services to employees The onebenefit in which there appears to be an important difference is profit sharing while just oneof the seven non-Islamic firms shares profits with workers profits are shared with workers byfour out of six Islamic firms

It was still the case in 1994 that profit sharing was required by law for joint stock firms inthe private sector with more than 50 employees The four IFs and one NIF that share profitswith workers are all joint stock companies and said that profit sharing is lsquorequired by lawrsquo Theother firms although they employ more than 50 workers and operate on a comparable orgreater scale are legally lsquopartnershipsrsquo and do not have to share profits It appears that moreIslamic than non-Islamic firms defined themselves as joint stock companies presumably withthe knowledge that they would have to share profits This feature may have more to do with


Table 4 Salary range and ratio in LE per month 1993


Salaryrange

Ratiotop tobottom

Salaryrange

Ratiotop tobottom


Filters-IF 4000100 401 Automotive-NIF na



Publishing-IF na Publishing-NIF 8333150 561


Appliances-IF 2500120 211 Carpets-NIF na 61

Chemicals-NIF na na

Mean ratio of five IFS 271 Mean ratio of six NIFS 281

Mean ratio of three NIFS 491


the legal origins of the firms (Islamic banks or investment groups US corporate structure) thanwith any deliberate benevolence towards workers

Interpretation

The Islamic and non-Islamic firms in our sample have many important traits in common Nomeaningful differences appeared between the two groups of firms in how they relate to theircustomers for example or in their import of capital goods Furthermore all firms seem


Table 5 Ratio of profits to wage and salary bill in LE million 1993


Profitwages

Ratiovalue

Profitwages

Ratiovalue



Clothing-IF na Clothing-NIF 13930 462

Meat-processing-IF na Poultry-NIF 8718 483



Appliances-IF 15419 081 Carpets-NIF na

Chemicals-NIF na

Mean ratio of four IFS 088 Mean ratio of six NIFS 1355

Range of these four IFs ndash007ndash156 Range of these six NIFs 462ndash228

Ratio top to bottom 149 Ratio top to bottom 494

This means that for every pound of wages or salary paid the owners lost 7 piastres

Table 6 Results of Independent Samples Test of means

Variable No ofobservations

Degrees offreedom

t-test valueabsolute

Significancelevel

Rate of profit 5 6 89 2166 0059

Average monthly salary 5 6 87 2271 0050

Profitwage ratio 4 6 51 3878 0011

Karen Pfeifer

equally driven by the force of market competition equally terrified by the prospect of the moreopen competition expected from liberalisation and equally willing to contemplate joiningtogether with other firms in the industry to set prices and output at more profitable levels Theyare also similar in their paternalistic attitude towards employees and in their employmentpolicies although a majority of IFs explicitly prefer not to employ women

The Islamic firms in our sample are as well distributed across the spectrum of economicactivities and industries as the non-Islamic firms This may be the outcome of a deliberatepolicy on the part of Islamic banks and investment groups an illustration of their efforts atchannelling capital to targeted industries (Gazzareen 1994 El-Rabbat 1994) If so it givescredence to the idea that Islamic financial institutions engage in a kind of indicative planninga practice reminiscent of the Japanese and Korean models of development However theoutcome so far appears not to differ from the non-Islamic and presumably unplanneddispersion of private firms across sectors


There were distinct differences between our two sets of firms in terms of fixed assets andprofit rates with the NIFs higher on both dimensions There are several possible factors atwork that may help explain these disparities First the profit rate may be positively correlatedwith asset size although we do not have enough data to test this proposition

A second factor may be longevity and the lsquolearning curversquo operative in starting a newbusiness All of the NIFs either have an earlier starting date or some heritage from a firm thatstarted early The Clothing-NIF and Publishing-NIF both have family firm histories going backto the pre-Nasser days The Poultry-NIF and Plastics-NIF are owned by Lebanese andPalestinians from previously well-established business families Automotive-NIF andChemicals-NIF are affiliates of long-established US firms Only Tourism services-NIF andCarpets-NIF are start-up firms

The IFs on the other hand were all set up in the first half of the 1980s joining establishedmarkets While some had the support of banks or large umbrella groups of companies thebackers had not been previously active in the chosen industries The new firms may havegenerally been at a competitive disadvantage as relative latecomers Indeed groups ofcompanies like the one to which Meat-processing-IF and Food services-IF belong do muchof their business with each other perhaps to overcome their competitive disadvantage aslatecomers

A third factor that may help to explain the asset and profit rate differentials is the possibilitythat Islamic banks and investment companies do not invest sufficiently in Islamic productioncompanies If we assume for the moment that IFs and NIFs operate in the same competitiveenvironment in Egypt this environment would be likely to favour NIFs over IFs because thelatter are viewed as more risky The lsquoprincipalrsquo the provider of capital to the firm has lessaccess to information than the lsquoagentrsquo the entrepreneur responsible for shepherding thatcapital Principals may be more reluctant to invest in an Islamic company if they cannot becertain of what the agent is actually doing with their investment funds because unlike theWestern system they can lose their capital completely if the firm or project does not succeedEven if it does succeed the principal gets no returns until proprietary profits are realised anddistributed

In the Western system the lender is first in line to get his or her money back even if the firmgoes bankrupt and the lenderrsquos return interest is paid by the firm as a cost of doingbusiness prior to profit distribution No such guarantees exist in the profit-and-loss-sharingsystem (PLS) That is both its attraction (spreading risk more equitably) and its weakness(greater risk owing to greater uncertainty) For example one banker reported that about 60per cent of his Islamic investment departmentrsquos business went to financing low-riskmurabahah transactions while another 20 per cent financed various trade and supplier


credits (short-term musharakah ) Only the remaining 20 per cent was devoted to high-riskdirect investment in production facilities through long-term musharakah While somestudents argue that Mudarabah is no longer practised at all because it is too risky (Ali1994 Kazarian 1993) others argue that the very concept of lsquoriskrsquo is not necessarilyrelevant to Islamic finance insofar as the growth of assets in investment accounts allowsthe bank to increase its net worth and shareholdersrsquo rates of return with no additionalfinancial risk (Al-Deehani et al 1999) Some Islamic economists (eg Ul Haque andMirakhor 1987) argue that this problem can be overcome at least in theory with thedevelopment of supportive legal and regulatory institutions

NIFs may be more efficient on average a possible fourth reason for them to be moreprofitable conforming with their greater tendencies to innovate and to export Firms that areable to compete in the world market are believed to be more efficient in terms of output perlabour hour and better able to capture economies of scale because of the larger size of theirmarkets While the NIFs do export more (six of them export more than 10 per cent of theiroutput as compared with three IFs) it is significant that 9 out of the 15 firms in our wholesample (or 60 per cent) are exporting more than 10 per cent of their output This suggests thatprivate investment is responding to liberalisation and that IFs are playing their part in thisdevelopment although to a lesser extent than NIFs

A fifth possible factor in explaining their lower profit rates is that the IFs in our sample onaverage do as Islamic economists exhort and pursue social objectives that constrain profitmaximisation If one accepts the idea that externalities occur among intra-firm economicactors and that income distribution and property ownership are interdependent then theconception of the Islamic business firm and the income shares resulting from the firmrsquos activitymust be different from those of the West (Toutouchian 1998ndash1999) Of course one must alsotake care to acknowledge that at least some NIFs might also have multiple objectives andrespond to social constraints For example facilitating personal loans for employees is acommon practice for both IFs and NIFs An extraordinary example of socially responsibleinvestment is provided by a firm owned by Christians Clothing-NIF which kept on a wholefactoryrsquos worth of idle employees for six months while a burned-down facility wasreplaced

However Islamic firms as a group do appear to pay higher salaries to present more equityin salary distribution and to have more balance between the profit and wage shares of outputThey are also more likely to share profits with workers But except for the director of Filters-IF no IF owner or manager expressed explicit concerns about distributional equityadministered through the wage system or about social utility determining price and quantity inan Islamic economy In fact none of the IF respondents in the sample had been aware of anyactual profit rate salary level or profitwage ratio differentials between themselves and theNIFs

The results described here conform to the expectations of the Islamic economicsliterature that Islamic business generates greater distributional equity than non-Islamicbusiness Because of the small sample size and the possibility of sampling error theseresults must be used tentatively of course But they suggest that the different behaviourand performance of Islamic firms could conceivably reflect different internalised norms ora different type of decision-making apparatus from non-Islamic firms Or the Islamic andnon-Islamic firms may operate in two distinct albeit overlapping cultural environments inwhich different economic behaviours are expected and rewarded If so then this studyprovides empirical support for the non-neo-classical theoretical argument that variablesocial and moral institutions frame and buttress economic activity even in a well-established market economy


Karen Pfeifer

Acknowledgements

This research was assisted by a grant from the Joint Committee on the Near and Middle Eastof the Social Science Research Council and the American Council of Learned Societies withfunds provided by the National Endowment for the Humanities and the Ford Foundation Theauthor would also like to thank Robert Buchele Samiha Fawzi Clement Henry David KotzVickie Langhor and Denis Sullivan for their generous and timely interventions

Note

1 A copy of the detailed lsquoFramework Formrsquo Appendix A used to guide these interviews canbe obtained from the author upon request as can the other Appendices referred to in thispaper

References

Al-Deehani Talla Karim Rifaat Ahmed Abdel and Victor Murinde (1999) lsquoThe capitalstructure of Islamic banks under the contractual obligation of profit sharingrsquo InternationalJournal of Theoretical and Applied Finance 2(3)243ndash283Ahmad Ausaf (1994) lsquoContemporary practices of Islamic financing techniquesrsquo IslamicEconomic Studies 1(2)5ndash52Ali Mahmud Abdel-Hafez (1994) Director Credit and Investment Department Saudi-Egyptian Bank for Finance interviews 19 July and 10 AugustEl-Ashker A A (1987) The Islamic Business Enterprise London Croom HelmAziz A (1993) lsquoFirm level decisions and human resource development in an Islamiceconomyrsquo in Ehsan Ahmed (ed) Economic Growth and Human Resource Development inIslamic Perspective Herndon VA The International Institute of Islamic ThoughtChoudhury M A (1992) lsquoThe Islamic profit sharing system in comparative perspectiversquoMiddle East Business and Economic Review 4(2)14ndash18Gazzareen Adil (1994) Chair Federation of Egyptian Industrialists interview 8 AugustKazarian Elias G (1993) Islamic versus Traditional Banking Financial Innovation in EgyptBoulder CO Westview PressMirakhor Abbas (1996) lsquoCost of capital and investment in a non-interest economyrsquo IslamicEconomic Studies 4(1)35ndash46Oweiss I M (1990) lsquoEgyptrsquos economy the pressing issuesrsquo in Ibrahim M Oweiss (ed) ThePolitical Economy of Contemporary Egypt Washington DC Center for Contemporary ArabStudiesEl-Rabbat Khairy (1994) General Manager Della Misr interview 9 AugustSaid H M (1972) The Employer and the Employee ndash Islamic Concept Karachi The TimesPressSiddiqi M N (1979) The Economic Enterprise in Islam Lahore Pakistan IslamicPublications LtdToutounchian I (1998ndash1999) lsquoLaborrsquos income share in an Islamic economic framework aproposalrsquo Humanomics 14ndash15(4ndash1)136ndash165Ul Haque N and A Mirakhor (1987) lsquoOptimal profit sharing contracts and investment in aninterest-free economyrsquo in M S Khan and A Mirakhor (eds) Theoretical Studies in IslamicBanking and Finance Houston Institute for Research and Islamic StudiesWilson R (1997) lsquoIslamic finance and ethical investmentrsquo International Journal of SocialEconomics 24(11)1325ndash1342



The author

Karen Pfeifer is Professor of Economics at Smith College and is an editor of Middle EastReport She served from 1995 to 1999 as series editor for Research in Middle East EconomiesShe is beginning a new study into the economic components of conflict generation and conflictresolution in three Arab countries Contact details Department of Economics Smith CollegeNorthampton MA 01063 USA Fax + 1 413 585 3389



and a relatively strong government will ensure adequate income redistribution and protectionfor employees Some like Aziz (1993) and Said (1972) have argued that workers beconsidered partners to the business and included in management and profit sharing Choudhury(199214ndash18) goes perhaps the furthest and recommends industrial democracy not just formoral reasons but also because it would enhance economic growth through the dispersion ofrisk and the diversification of investment Siddiqi (1979) and others argue that entrepreneurialprofits are a variable return to risk and recommend against profit sharing with employees onthe grounds that workers need a steady and predictable income to support their families In anycase the desire for wealth and power is considered contrary to Islam so moderation and moralcommitment by entrepreneurs will ensure an equitable standard of living for all

This study offers some preliminary evidence on how Islamic business firms meet theseexpectations in a dynamic economic environment that is shared with non-Islamic firms

Method

The inquiry was conducted in 1993 and 1994 via interviews with the owners or generalmanagers of 15 non-financial companies operating in agriculture industry and the servicesector Banks and financial firms were deliberately excluded from the sample The firms werethen separated into two groups Islamic (IFs) and non-Islamic (NIFs) based on their methodsof finance They were loosely matched into pairs by type of product and industry andcompared along several dimensions of economic viability and social accountability

The ideal method for this type of research would have been to choose the sample eitherrandomly or by a set of strict matching criteria While some Egyptian economists such asSamiha Fawzi at Cairo University are developing this methodology for studying firmbehaviour our research had to begin with the case study method asking the same questions ofall of the firms but also treating each firm as a unique entity Starting with suggestions fromfellow social scientists doing related work as well as bankers and leaders of businessorganisations a network of contacts for possible introductions was built The non-randomnessof the sample was the inevitable result of the fact that meeting and gaining the confidence ofan owner or manager of a firm was contingent on personal contacts and introductions amethodology shared with El-Ashker (198799ndash100)

Foreign researchers were forbidden to use formal questionnaires So meetings with firmstook the form of systematic lsquoconversationsrsquo each about two hours in duration1 None of thefirms except Automotive-NIF provided an annual report to verify their responses to accountingquestions Therefore the calculations derived from the accounts obtained (Appendix B1 ndash allappendices are available from the author on request) are imprecise but provide some sense ofrelative magnitudes While not conclusive they can serve as fodder for further research

Preliminary interviews were conducted with three firms in autumn 1993 Longer and morethorough interviews were conducted with 12 more firms in the summer of 1994 Several ofthese involved trips to industrial centres outside Cairo as well as a visit to a farm in the deltawhere parts of the interviews entailed a tour of production facilities

Islamic financial contracts versus commercial bank loans

The defining variable used to assign firms to one group or the other was method of finance ofinvestment While recent work on the criteria for investment comparing lsquogreenrsquo or lsquosociallyresponsiblersquo investment in the West with haramhalal investment under Islam argues that theyare functionally similar (Wilson 1997) there is a clear distinction between IFs and NIFs in oursample Appendix Table Cndash1 provides information on methods of finance and profit


Karen Pfeifer


Assets and profits














Chemicals-NIF 50 na











Profits(LE million)

Rate ofprofit ()

Profits(LE million)

Rate ofprofit ()








Chemicals-NIF na na


Karen Pfeifer





















Karen Pfeifer








Labour relations



















Chemicals-NIF na


Karen Pfeifer








Salaryrange

Ratiotop tobottom

Salaryrange

Ratiotop tobottom








Chemicals-NIF na na





Interpretation





Profitwages

Ratiovalue

Profitwages

Ratiovalue








Chemicals-NIF na







Degrees offreedom


Significancelevel

Rate of profit 5 6 89 2166 0059



Karen Pfeifer
















Karen Pfeifer

Acknowledgements


Note


References




The author



Karen Pfeifer


Assets and profits














Chemicals-NIF 50 na











Profits(LE million)

Rate ofprofit ()

Profits(LE million)

Rate ofprofit ()








Chemicals-NIF na na


Karen Pfeifer





















Karen Pfeifer








Labour relations



















Chemicals-NIF na


Karen Pfeifer








Salaryrange

Ratiotop tobottom

Salaryrange

Ratiotop tobottom








Chemicals-NIF na na





Interpretation





Profitwages

Ratiovalue

Profitwages

Ratiovalue








Chemicals-NIF na







Degrees offreedom


Significancelevel

Rate of profit 5 6 89 2166 0059



Karen Pfeifer
















Karen Pfeifer

Acknowledgements


Note


References




The author












Profits(LE million)

Rate ofprofit ()

Profits(LE million)

Rate ofprofit ()








Chemicals-NIF na na


Karen Pfeifer





















Karen Pfeifer








Labour relations



















Chemicals-NIF na


Karen Pfeifer








Salaryrange

Ratiotop tobottom

Salaryrange

Ratiotop tobottom








Chemicals-NIF na na





Interpretation





Profitwages

Ratiovalue

Profitwages

Ratiovalue








Chemicals-NIF na







Degrees offreedom


Significancelevel

Rate of profit 5 6 89 2166 0059



Karen Pfeifer
















Karen Pfeifer

Acknowledgements


Note


References




The author



Karen Pfeifer





















Karen Pfeifer








Labour relations



















Chemicals-NIF na


Karen Pfeifer








Salaryrange

Ratiotop tobottom

Salaryrange

Ratiotop tobottom








Chemicals-NIF na na





Interpretation





Profitwages

Ratiovalue

Profitwages

Ratiovalue








Chemicals-NIF na







Degrees offreedom


Significancelevel

Rate of profit 5 6 89 2166 0059



Karen Pfeifer
















Karen Pfeifer

Acknowledgements


Note


References




The author












Karen Pfeifer








Labour relations



















Chemicals-NIF na


Karen Pfeifer








Salaryrange

Ratiotop tobottom

Salaryrange

Ratiotop tobottom








Chemicals-NIF na na





Interpretation





Profitwages

Ratiovalue

Profitwages

Ratiovalue








Chemicals-NIF na







Degrees offreedom


Significancelevel

Rate of profit 5 6 89 2166 0059



Karen Pfeifer
















Karen Pfeifer

Acknowledgements


Note


References




The author



















Chemicals-NIF na


Karen Pfeifer








Salaryrange

Ratiotop tobottom

Salaryrange

Ratiotop tobottom








Chemicals-NIF na na





Interpretation





Profitwages

Ratiovalue

Profitwages

Ratiovalue








Chemicals-NIF na







Degrees offreedom


Significancelevel

Rate of profit 5 6 89 2166 0059



Karen Pfeifer
















Karen Pfeifer

Acknowledgements


Note


References




The author



Karen Pfeifer








Salaryrange

Ratiotop tobottom

Salaryrange

Ratiotop tobottom








Chemicals-NIF na na





Interpretation





Profitwages

Ratiovalue

Profitwages

Ratiovalue








Chemicals-NIF na







Degrees offreedom


Significancelevel

Rate of profit 5 6 89 2166 0059



Karen Pfeifer
















Karen Pfeifer

Acknowledgements


Note


References




The author





Interpretation





Profitwages

Ratiovalue

Profitwages

Ratiovalue








Chemicals-NIF na







Degrees offreedom


Significancelevel

Rate of profit 5 6 89 2166 0059



Karen Pfeifer
















Karen Pfeifer

Acknowledgements


Note


References




The author



Karen Pfeifer
















Karen Pfeifer

Acknowledgements


Note


References




The author










Karen Pfeifer

Acknowledgements


Note


References




The author




The author



islamic business and business as usual -...

Documents