The impact of Shariah finance compliance level on the cost of debt

Abstract

Purpose

Does Shariah finance have any impact on the cost of debt? The existing literature on Shariah finance revolves around its effect on the macroeconomic level but remains poor when looking at its impact on the corporate level. The purpose of this paper is to strengthen the latter by examining the relationship between the Shariah compliance level and the interest rate.

Design/methodology/approach

The authors have used a sample of 600 companies, all Shariah-compliant but with different levels of compliance, from 2002 to 2015. A variable determining the level of Shariah compliance was created in accordance with the methodology by S&P 500 Shariah and its underlying index S&P 500; then, a Probit relapse study was conducted to identify the impact of Shariah level on the cost of debt.

Findings

Consistent with the theoretical predictions of the authors, the findings reveal that there is a positive relationship between the level of Shariah compliance and the cost of debt, suggesting that the higher the level of Shariah compliance of a firm, the higher the interest rate.

Research limitations/implications

One important portfolio implication of this study is that the level of Shariah compliance plays a major rule in the cost of debt determination besides the firm-specific factors. The revealed results can be of interest to actors in the fields of corporate finance, corporate governance, decision-makers and investors.

Originality/value

Islamic finance has been one of the most studied and researched topics in the finance world. However, the interest of scholars thoroughly assessed the dynamics of Islamic banking. The effect of Shariah compliance on corporate finance can still be more explored. To the best of the authors’ knowledge, this is a first attempt to capture the effect of Shariah compliance on the cost of debt through the use of a large scope to enrich the literature and at the same time analyzing the effects of Islamic characteristics on firms’ fundamentals.

Citation

Satt, H., Bendriouch, F.Z. and Nechbaoui, S. (2020), "The impact of Shariah finance compliance level on the cost of debt", Journal of Islamic Accounting and Business Research, Vol. 11 No. 6, pp. 1211-1226. https://doi.org/10.1108/JIABR-04-2018-0056