Interest-bearing Debt and Islamic Debt vs. Shariah-compliant firms’ Performance: Empirical Evidence from Malaysia

Abstract

Capital structure is a major field in corporate finance with a wide range of theoretical and empirical studies. However, the Islamic capital structure is relatively a new area with fewer studies. This study is the first in its kind to apply separated debt data i.e.,  interest-bearing debt and Islamic debt in order to examine the effects of total interest-bearing debt and total Islamic debt on the performance of 305 continuously listed shariah-compliant firms on the Main Market of Bursa Malaysia over the period of 2010 to 2017. The study employs panel data analysis namely fixed effects model due to being the appropriate model according to Breusch-Pagan LM and Hausman tests. It also adopts return on equity as an accounting performance measure and a dependent variable.

The findings indicate that the both total interest-bearing debt and total Islamic debt have negatively affected shariah-compliant firms’ performance, but it is not a significant. Meaning that shariah-compliant firms tend to prefer retained earnings over debt financing. The study also reports that current ratio and asset turnover ratio are positively and significantly associated with the performance of shariah-compliant firms. In addition, the descriptive analysis suggests that the average total Islamic leverage of the sampled shariah-compliant firms accounted 15.7 percent of total financing implying that the equity financing represents 84.3 percent of total financing. Based on these grounds, the shariah-compliant firms are largely dependent on internal financing i.e., retained earnings and equity and therefore, the findings are in line with pecking order theory assumptions.

The study encourages the financial regulatory authorities in Malaysia namely Bank Negara Malaysia  and Securities Commission Malaysia to review the Malaysian capital market and improve the efficient level of equity and bond market, which in part will improve the participation of Islamic leverage in debt-equity structure of shariah-compliant firms.