Essays on Shari'ah compliant equities : a dissertation presented in partial fulfilment of the requirements for the degree of Doctor of Philosophy in Finance at Massey University, Albany, New Zealand
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Date
2020
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Massey University
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Abstract
This dissertation presents three essays on Shari’ah Compliant Equities. The
reported work analyses the impact of Shari’ah Compliant Requirements (SCR) on
the capital structure of the firms and its effect on the cost of equity capital, payout
policy and mitigation of firm-level political risk.
The first study examines if the adoption of SCR affects the cost of equity capital
for firms. It estimates the cost of equity capital, implied by market prices and
analyst forecasts, and account for changes in growth expectations around the adoption of
SCR. The results of the study show that the transitional implications of Shari’ah
compliance can diverge depending on information spread. The findings reveal that
getting a Shari’ah compliance certificate, initially increases the cost of equity for a
firm, potentially due to higher financial constraints and other burdens associated
with Shari’ah requirements. However, with greater exposure and awareness in
Islamic markets, Shari’ah compliance eventually leads to a fall in the cost of equity.
The industry-level, SCR adoption effects are stronger in relatively tangible sectors.
Robustness analyses confirm that becoming Shari'ah-compliant increases the stock
liquidity of SCR adopted firms, which co-varies negatively with the cost of equity.
The second study examines if and to what extent the adoption of SCR affects
the payout smoothing policy of firms. More importantly, this study aims to identify
and assess a possible mechanism behind such linkage and measure the amount of
fluctuations of earnings absorbed by investment, borrowings, and payout policies.
Variance decomposition strategy that enables to empirically analyse the adjustments
of borrowings and investment policies to comply with payout smoothing in order to buffer net income fluctuations in the environment of Shari’ah compliance is
employed. Using a new approach in the literature, this chapter measures the extent
of intertemporal payout smoothing across business cycles to test the permanent
income hypothesis for firms. Accordingly, the impacts of temporary vs. permanent
net income shocks on the payout policy of firms are distinguished. The study also,
documents that even though their payout ratios are mostly independent from the
year by year net income growth (temporary shocks), dividends are impacted deeply
by long term net income growth (permanent shocks). Interestingly, being Shari'ah-compliant makes dividends more dependent on permanent income growth.
The third study, using a novel Economic Policy Uncertainty (EPU) firm-level political risk index as a proxy for political risk and uncertainty firms face,
examines the impact of firm-level risk on the cost of equity and dividend payouts
policy of firms. The paper aims to shed light on the transitional implications of Shari’ah
compliance on firms exposed to firm-level political risk. It analyses if the adoption of
SCR mitigates the firm-level political risk and their impact on the cost of equity and
dividend policy. Benchmark results show that 1% increase in the exposure of
political risk contributes to a rise in its cost of equity capital by 0.2% and in
dividend payout by 13%. Shari’ah compliance eventually leads to a fall in the cost
of equity and a rise in dividend payouts, despite the exposure of the firm to political
risk. These findings have important policy implications that are relevant to Shari’ah
compliant equities and beyond.
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Keywords
Corporations, Finance, Capital costs, Dividends, Risk management, Political aspects, Religious aspects, Islam