Impact ofshariah-compliant status on firms’ decision to practice forex hedging

Ruzita Abdul-Rahim, Adilah A. Wahab and Nor Amalina Yusoff

Journal of Islamic Accounting and Business Research, 2019, vol. 10, issue 5, 756-769

Abstract: Purpose - The purpose of this paper is to investigate whether theshariah-compliant status of the firms negatively influences their use of foreign exchange hedging instruments. Design/methodology/approach - This paper uses a logit panel regression on 350 firm-year observations from 70 nonfinancial listed firms over the period from 2010 to 2014.Shariah-compliant companies account for about 84 per cent of the sample firms. Findings - Preliminarily, the results show that none of the samples of theshariah-compliant firms report any use of Islamic hedging instrument, either in the form ofwa’dortawarruq. The results of the study’s logit panel regression contradict the authors’ prediction that theshariah-compliant status negatively influences firms’ decision to hedge. In contrast,shariah-compliant companies are twice as likely as their conventional counterparts in adopting forex hedging. Research limitations/implications - This study is limited to information disclosed in the items 31, 36 and 37 of financial management policies in the annual report. However, given thatshariah-compliant firms must abide by the limit of 5 per cent profits before tax from clearly prohibited activities (includingriba’), the need for exclusive disclosure on the adoption of Islamic or conventional hedging appears to be imperative for the viability of the Malaysian Islamic capital market. Practical implications - In evaluating theshariahcompliance of a company, investors (individual or institutional) must look further than just interest-basedriba’in mixed-business companies to ensure that they comply with the 5 per cent maximum requirement on the non-halal business contribution to profit. This is because the finding of this study indicates thatshariah-compliant companies are twice as likely to adopt forex hedging, when none of them reports the use of Islamic hedging tools. Investors must therefore give ample allowance toriba’that can be induced through the use of conventional forex hedging instruments. This is until the security market regulator imposes a requirement onshariah-compliant companies an explicit disclosure of the use of Islamic versus conventional hedging tools, as they had done in the case of Islamic versus conventional debt instruments. Social implications - Muslim and socially responsible investors rely on the Shariah-compliant status of the company in ensuring that their wealth grows according to theShariahprinciples. To sustain and develop the Islamic capital market which the firms have been relying on for external capital,Shariah-compliant firms and the authority awarding the status are equally responsible for honoring the trust that these investors by ensuring the permissibility (halal) of the business and the conduct of their business. Originality/value - Conventional forex hedging instruments are criticized for violatingas-sarf, ashariahprinciple, which requires the exchanges of particular assets (gold, silver and currency) to be delivered on the spot, and thereby infusingriba’ al-fadhl. Although Islamic (wa’d- ortawarruq-based) hedging instruments are widely available by Islamic banks in this country since they were introduced by Bank Negara Malaysia in 2010, paradoxically, the authors’ observation indicates that none of the studied firms reports the adoption of these instruments in their annual reports.

Keywords: Shariah-compliant companies; Foreign exchange exposure; Forex hedging; Malaysian Islamic capital market; Tawarruq; Wa’d (search for similar items in EconPapers)
Date: 2019
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jiabrp:jiabr-06-2016-0076

DOI: 10.1108/JIABR-06-2016-0076

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