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Yusnidah Ibrahim, Md Mohan Uddin and Mohd Sobri Minai World Islamic Banking, Finance and Investment Conference 17 – 18 December, 2012; Hotel Istana, Kuala Lumpur, Malaysia
Continuous Innovativerestructuring and of financial diversified market by alternative govt. securities High High degreeconcentration of earningof ownership management
CoexistenceDominance of Islamic of Islamic andsecurities conventional bonds Debt Growing financing bond marketencouraged
Since 1997 crisis, domestic private debtsecurities has been an important substitute ofbank loan and equity financingSince 2000, the corporate bond market hasbeen growing at an average rate of 8%Current share of corporate bond market in totaldebt financing is 2.5 times compared to what itwas in 1997The Islamic segment of the private debt securitymarket is growing rapidly. Currently, 39% oftotal bond outstanding in Malaysia are Islamicbonds
Malaysia is the largest Islamic capital market in the world Outstanding Islamic As percentage of Year Bond outstanding (billion RM) corporate bond 2008 152.8 57 2009 167.73 58.2
Response to continuousIncreasing dependence on regulatory initiatives and debt financing influencesCorporate bond issuance Drift developed toward debtrelative to GDP is highest financing/Islamic debt financingamong emerging marketsIncreasing dominance of Islamic bond ? Motive for wealth maximization
Islamic debt issues Capital structure changes Effect on shareholder wealth
Knowing the determinants of the debt issue performance is necessary to Test theIdentify the Guide applicability of source of corporate capital wealth financing structure creation decision theories
Short term announcement effect of security issuance is the subject matter of many studies, for instance, Antweiler and Frank (2006), and Eckbo and Norli (2004). However, Malaysian market may not be efficient enough (Kim & Shamsuddin, 2008; Hoque, Kim, & Pyun, 2007) to capture future implications of capital structure changes in the short run. Scholars link long run underperformance of security issuances to market timing behavior combined with slow reacting investors’ (Wu and Kwok, 2007; Coakley, Hadass, & Wood, 2008; Farinós, García, & Ibáñez, 2007; Autore, Bray, & Peterson, 2009). Therefore, the better way to appraise present debt choice decision is to investigate long run stock return performance.
Available empirical studies of long run value effects in the emerging markets are limited in number, and restricted to the study of equity issuances, particularly to the study of initial public offerings (IPO). No study is found to uncover the long run value effect of Islamic debt issuance in the emerging markets. Moreover, some recent methodological development are yet to be implemented.
The sources of wealth effects in Islamic debt financing can be studied by examining the relationship between firm characteristics and the wealth effects. The literature is scant and inconclusive on the determinants of wealth effect of capital structure changes (Masulis, 1983; Myers, 2001; Carpentier, 2006; Rahim, Nor, Alias, & Yaakob, 2009). The capital structure theories such as the agency theory may also explain long run value effect of firms’ financial actions. The link between capital structure changes and the actions of both the inside agents and the outside parties is supported by many studies (Campello, 2006).
↑ • AD ↑ but is mitigated by debt covenants Debt • AE ↓ Effect on shareholder wealth Debt • AD ↓ • AE ↑ and lack of ↓ mitigating AEHowever, very rare studies, if any, have used the agency theory toexplain the long run value effect of capital structure changes followingIslamic debt security issuance.
DV • One, two, and three year buy and hold abnormal returns (BHAR) • Growth Opportunity (GO) [Myers, 1977; Jensen, 1986; Frank & Goyal, 2009] • Managerial Ownership (MO) [Jensen & Meckling, 1976; Douglas, 2006] IVs • Ownership Concentration (OC) [Lins, 2003; Earle et al., 2005; Bena & Hanousek, 2008] • Free Cash Flow (FCF) [Jensen, 1986; Opler & Titman, 1993; Gangopadhyay & Yook, 2009]Interaction • Capital structure change (CSCH) 13
1) Growth opportunity (GO) The higher the GO the higher is the agency cost of debt lower performance- -ve relationship with long run performance2) Managerial ownership (MO) Firms with low MO have high agency cost of equity (Jensen and Meckling, 1976) and they benefit more from debt monitoring imposed by debt issuance- - ve relationship with long run performance
1) Ownership concentration (OC) OC can effect the conflict of interest between minority shareholders and insider large shareholders’ (Earle et al. 2005; Lin, 2003)- Debt can mitigate this type of agency cost- +ve relationship with long run performance2) Free cash flow (FCF) firms with high FCF have higher agency cost- increase in debt can reduce the agency cost- +ve relationship with long run performance
→ Initial Sample: all bond issuances during January 2001 to October 2009 → extracted from the Securities Commission Malaysia website. → comprises a total of 720 in one year performance sample, 675 in two year performance sample, and 591 in three year performance sample.→ Exclusions: → Conventional bonds → convertible issues → non-listed companies → banks and financial institutions → absence of Bursa Malaysia announcement → multiple issues during analysis period and on the same day → data unavailability→ Final sample size: → 113 for one year sample → 101 for two year sample → 86 for three year sample 17
› Non-event firms that are very similar to the event firms based on size and book-to-market are used as benchmark firms (Barber and Lyon, 1997)› The similarity is measured by Euclidean distances between each of the issuers in the sample and the benchmark candidates.› For each sample firm, two closest firms matching firms are used. 18
¤ Growth Opportunity (GO) ¤ (Total Assets – Equity Capital + Market Capitalisation) / Total Assets¤ Managerial Ownership (MO) ¤ the percentage of total outstanding shares held by the executive or managing directors of the debt issuing firm during the last year before the issue¤ Ownership Concentration (OC) ¤ Herfindahl Index which is calculated as the sum of the squared percentage of shares held by the five largest shareholders¤ Free Cash Flow (FCF) ¤ (operating income – current tax + change in deferred tax – interest expense – preferred dividend – ordinary dividend)/net tangible asset 21
∆ Three models are tested for each of the one, two, and three year analysis periods. ∆ Model 2 is formed by adding the interaction terms with Model 1. ∆ The final model is the restricted models derived from stepwise omission of insignificant variables from Model 2.∆ Heteroscedasticity test is conducted by Breusch-Pagan test ∆ Heteroscedasticity robust standard error has been used to correct the heteroscedasticity problem.∆ Multicollinearity is tested by variance inflation factor. ∆ No significant multicollinearity problem is observed 23
ThscAnalysis Sample Tbsa Jegadeesh and BHAR tcPeriod Size Lyon et al. (1999) Karceski (2009)1 Year 113 0.1073 1.91* 1.51 0.882 Year 101 0.1765 2.14** 2.77*** 1.683 Year 86 0.3725 2.90*** 1.61 2.43* Thus, although not strongly supported by all statistical tests, the issuers of Islamic debt experience significantly positive performance in two and three year period following the issue.
3 Year Sample 2 Year Sample 3 Year Sample (Excl. Outl.) Coeff. t-Stat Coeff. t-Stat Coeff. t-Statconst. -0.1740 -1.58 -0.1766 -0.92 -0.0214 -0.20CSCH 1.4101 2.18 ** 4.8276 2.24 ** 3.6676 1.96 **GO 0.1000 2.73 ***MOOCFCFCSCH*GO -0.7877 -3.38 ***CSCH*MOCSCH*OCCSCH*FCF -55.05 -2.55 ** -51.59 -2.39 ** No. of obs. 101 86 85 F-stat. 8.62*** 3.28** 2.95** R-squared 0.0176 0.0865 0.1173 The model specification is based on the sequential elimination of insignificant variables from the model in equation 2. The dependent variable is the in two and three years following the debt issue. CSCH is the capital structure change, GO is the growth opportunity, MO is the managerial ownership, OC is the ownership concentration, and FCF is the free cash flow of the debt issuer. *, **, and *** indicate 10%, 5%, and 1% level of significance, respectively. The t-ratios are based on heteroscedasticity robust standard error as a remedy for the heteroscedasticity problem
Debt issuers with high growth opportunity are found to create significantly more wealth in two year period o If capital structure does not increase, no increase of agency cost of debt due to GO o positive influence of the utilization of growth opportunities o reduction of free cash flow problem Opposite effect of growth opportunity when the issue of Islamic debt is associated with capital structure change o growth opportunity increases agency costs of debt.
Debt issuing firms with higher free cash flow and increased leverage experience low performance in three years. o in Malaysia debt issuances do not induce performance by means of limiting management’s discretionary use of free cash flow o Zhang (2009), who provides evidence that debt and executive stock options are substitutes in attenuating the free cash flow problem of a firm. o Most probably, Malaysian firms already control the agency costs by employee stock option schemes (ESOS) (Ghazali, 2008; Bacha, Zain, Rasid, & Mohamad, 2009). o issuance of debt may result further increase of cash flow, which may inflate the agency problem to result in a net effect of negative performance