Does being Shariah-compliant affect capital structure decision: evidence from emerging markets

Purpose - This paper aims to examine the relationship between Shariah compliance and corporate capital structure decisions. This study explores the variation of capital structure speed of adjustment. Design/methodology/approach - The authors’ sample includes a sample of the largest 200 nonfinancial firms trading in the Malaysian and Pakistan stock markets. This study uses ordinary least squares and dynamic two-step system generalized method of moments to test the hypotheses of the study. Findings - The results show that Shariah-compliant firms use a lower level of leverage than the noncomplaint firms. Moreover, while both types of firms have optimal capital structures, the speed of adjustment toward the targets is slower for Shariah-complaint firms than non-Shariah-compliant firms. This variation can be seen through the different levels of market imperfection experienced by the two types of firms. Shariah-compliant firms follow Islamic rules that restrict the type and degree of leverage, thus affecting the availability of external funding to Shariah-compliant firms. Research limitations/implications - The findings call for more development and innovation of financing instruments that comply with Shariah rules that will increase of supply of external funds for Shariah-compliant firms and, thus, reduce market imperfections that are faced by Shariah-compliant firms. Originality/value - The study contributes to the limited number of studies that examine the nexus between conventional corporate theories and Islamic corporate finance.