Testing the financial distress models for sukuk issuing companies in Malaysia

Abstract

Research on financial distress is relatively young in Malaysia, especially with respect to the sukuk companies. Debate on the unique characteristics of sukuk and its increasing cases of defaults has pointed to the need for extended and deepened research on financial distress. This thesis, therefore investigate characteristics of sukuk companies, in comparison to bonds companies. The existing financial distress models, namely Altman (1968), Ohlson (1980) and Shuwmay (2001) models is tested to examine its prediction power on sukuk samples. New financial distress model for sukuk companies is developed which incorporated predictors based on characteristics of sukuk companies and cash flow variables. In addition to that, the thesis also investigates whether destruction of the US dollar cause financial distress to companies that issued dollar-denominated sukuk and bonds. Logit regression and hazard regression are the main statistical techniques applied in this study. Not only this study is one of the relatively few studies on sukuk, but to the author’s best knowledge it is the first to provide forecasts of financial distress for sukuk companies using both static and dynamic models. This study is significant at least for four new discoveries. The first is, sukuk companies can be distinguished from bonds companies in term of liquidity, size and leverage (hereby, LSL). It is common in financial distress study to identify that size and leverage as significant predictors. However, it is surprise to see that liquidity is more important to sukuk companies rather bonds companies. It is argue that liquidity is closely related to sukuk companies because characteristic of sukuk itself that is depending on the cash flow of the underlying assets. Second, this study reveals that logit model is more suitable for sukuk companies, while hazard model is more suitable for bonds companies. Third, this study developed a new model for sukuk and discover that liquidity measured using cash flow variables are significant to sukuk companies. Addition of cash flow variables in sukuk model has increased the prediction power and lower the Type I error. Interestingly, when the same set of predictors used in sukuk samples is applied in bonds samples, none of the predictors are significant for bonds. This has supported earlier arguments that liquidity is the most suitable predictors for sukuk. The empirical analysis supports the well-known theory of trade-off theory and bankruptcy costs. The fourth is, the thesis uncovers that US dollar destruction; proxy by US stock index and US property index, has less impact on the probability of financial distress of dollar sukuk and bonds companies. Nevertheless, the negative coefficient sign for property index is mind stimulating; supporting the understanding that sukuk is closely connected to performance of the fixed assets.