Firm risk and corporate policies: From the shariah certification perspective

Abstract

In this study, we show that Shariah certification leads to risk-reduction benefits. Shariah-compliant firms are negatively related to firm risk; and tolerate lower risk than non-Shariah-complaint firms. This evidence is in line with Shariah principles that prohibit controversial business activities and uncertainties. In brief, excessive risk-taking is discouraged. Therefore, Shariah-compliant firms need to be selective in making investment decisions. We further find that the negative relation applies particularly to Shariah-compliant firms that managed to retain their Shariah-compliant status in the subsequent reviews. This implies that these firms consistently maintain lower level of risk to retain their Shariah status. In terms of the corporate policies, we do not find evidence that Shariah-complaint firms employ conservative financial and operating leverages to mitigate their firm risk. Instead, Shariah-compliant firms emphasize on capital expenditures that lead to lower firm risk. Taken together, our results recommend that Shariah-screening process can be a significant mechanism to mitigate excessive risk.

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