Theory and evidence of the impacts of Shariah debt screening on firm behaviour

Mohd Edil Abd Sukor and Asyraf Abdul Halim

Journal of Islamic Accounting and Business Research, 2022, vol. 13, issue 8, 1137-1154

Abstract: Purpose - The paper aims to construct a theoretical framework to investigate whether the Shariah debt ratio screening in contemporary Shariah stock screening methodologies results in a bias towards a certain set of corporate financial behaviour for Shariah-compliant firms in the USA where access to a liquid Islamic debt market is non-existent. Design/methodology/approach - The paper extends the earnings valuation approach of Modigliani and Miller (1963) to theoretically asses the impacts of the 33% conventional debt limit on Shariah-compliant firms’ corporate financial behaviour. Then, supporting evidence is shown via empirical stylised facts of samples of Shariah-compliant firms in the USA. Findings - A theoretical floor limit to investment cut-off rates is found for US Shariah-compliant firms so that lesser projects pass their internal rate of return versus conventional firms. Subsequently, such firms consistently show the following corporate financial characteristics: above-average size, larger marginal change in size and profitability in response to a given marginal change in investments, low book-to-market ratio and lower investment rates. Research limitations/implications - The findings of this paper may not hold where access to a liquid Islamic capital market is present. Practical implications - Caveat emptor. These findings may be inconsistent to the investor’s risk preferences. Social implications - The findings suggests that Shariah-compliant firms are more conservative compared to their conventional counterparts. Originality/value - The paper is the first to introduce a theoretical framework to address consistent biasness in corporate financial behaviour due to the Shariah debt screening. It may prove useful for future academic studies as well as investment managers.

Keywords: Shariah-compliant firms; Shariah stock screening methodologies; Shariah debt ratio screening; Corporate financial behaviour; US firms (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jiabrp:jiabr-01-2022-0016

DOI: 10.1108/JIABR-01-2022-0016

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