The determinants of debt financing and firm performance : evidence on shariah approved firms

Abstract

The issue of high reliance on debt has raised major concern since it has created several downfalls of large US’s corporation such as Enron (2001) and Lehman Brothers (2008) and the 2009 Greek Depression. In Malaysia, statistic shows that after the 2008 global financial crisis, its average corporate debt-to-GDP increased tremendously for the period of 2009 to 2015—from 75.60% to 94.10%. This figure is alarming as financial crises in many emerging countries have been preceded by a rapid growth in debt level of the countries. Further, in the revised Shariah screening methodology in 2013, listed firms on Bursa Malaysia are now required to comply with 33% debt ratio benchmark if they are to be classified as Shariah-approved stocks. Therefore, the first part of analysis focuses on examining factors that affect debt level of Shariah-approved firms in Malaysia. This study covers a balanced panel of 239 Shariah-approved firms listed on the Bursa Malaysia from 2000 to 2014—which a firm must be Shariah-approved firms consistently during that period. The study employs a static panel regression model which includes the pooled OLS, random effect model (REM) and fixed effect model (FEM). The results show that growth opportunity, size, bankruptcy risk, and non-debt tax shield (NDTS) are robust evidence to determine debt level of Shariah-approved firms in Malaysia. Further, industry determinant proxies by Herfindahl-Hirschman (HH) Index and economic determinants that include inflation, GDP and economic crisis are also significantly affect firm’s debt level. The study also found that there is a variation of results across the industries that confirms industry nature plays a role in determining debt level of the firms. In the second part of the analysis, it was extended to the performance context aim to assess the impact of debt level on the performance of Shariah-approved firms in Malaysia. Using panel non-linear regression, the analysis proved that a non-linear relationship exists between ROA and debt level. The results are also robust to different performance indicator of ROI and ROE. This suggests that performance of Shariah-approved firms in Malaysia varies according to the debt ratio level. The results were also varied across industries which suggests the relationship between debt and performance depends on its industry. Further, the results suggest Shariah-approved firms in Malaysia, on average, perform better if their debt level is above 33%. Thus, the introduction of the 33% debt ratio benchmark can be concluded as did not enhance the performance of Shariah-approved firms in Malaysia. Due to the financial data only extends through 2014, it is possible that the model did not capture positive effects of debt ratio enforcement on firm performance in such period.