The determinants of ṣukūk issuance in GCC countries

Guermazi, Imene Article The determinants of ṣukūk issuance in GCC countries Islamic Economic Studies (IES) Provided in Cooperation with: Islamic Development Bank Institute, Jeddah Suggested Citation: Guermazi, Imene (2020) : The determinants of ṣukūk issuance in GCC countries, Islamic Economic Studies (IES), ISSN 2411-3395, Emerald, Bingley, Vol. 28, Iss. 1, pp. 25-45, https://doi.org/10.1108/IES-08-2019-0026 This Version is available at: https://hdl.handle.net/10419/316467 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ The determinants of S · uk uk issuance in GCC countries Imene Guermazi Imam Muhammad ibn Saud Islamic University, Riyadh, Saudi Arabia Abstract Purpose –This paper focuses on S uk uk issuance determinants in Gulf Cooperation Council (GCC) countries. Given the dual characteristic of debt and equity of S uk uk as well as their unique benefits of social responsibility, the author questions whether the theories of capital structure, the trade-off and the pecking order are able to well explain the S uk uk issuance. Design/methodology/approach –First, the author verifies these theories using capital structure determinants and regresses the S uk uk change on these determinants. Second, the author tests the trade-off theory with the target debt model and third, verifies the pecking order theory using the fund flow deficit model. Findings –The empirical results show that capital structure determinants fail to explain both theories. The author confirms that the S uk uk change is significatively linked to the deviation from a S uk uk target. So, issuing firms balance the marginal costs of S uk uk and their benefits of religiosity and social responsibility toward a target debt. The author finds no evidence of the pecking order theory. Research limitations/implications –This study contributes to corporate finance theory and corporate social responsibility. It verifies if capital structure theories proved in conventional financing can well explain Islamic bonds issuance given their social responsibility benefits. Practical implications –Managers and investors would pay attention to the social factors explaining S uk uk issuance in their finance and investment decisions. They would be enhanced to use this financing tool knowing its social unique benefits. This also should encourage governments to enhance this socially responsible financing. Rating agencies would be motivated to evaluate S uk uk and firms would improve the quality and relevance of disclosure to get the best rating. Social implications –The author highlights the social factors explaining S uk uk issuance and enhances corporate social responsibility (CSR). Originality/value –The author extends the few literature testing capital structure theories for Islamic bonds and highlights the specific social responsible features of S uk uk that would bridge their issuance to capital structure theories. So the author enhances the concept of Islamic CSR. Tying capital structure theories to CSR would also help developing Islamic finance theory as a unique social responsible framework. Keywords Social responsibility, Pecking order theory, S uk uk issuance, Trade off theory Paper type Research paper 1. Introduction Financing decision involves decision on the composition between debt and equity and the decision on type of financial securities to be issued. Many studies on corporate finance have dealt with debt-equity choice and associated shareholders’wealth effect. Researchers have focused on the determinants of bond issuance. They have proved theories of capital structure, mainly the pecking order theory and the trade-off theory. The trade-off theory predicts that there is an optimal debt ratio maximizing the value of a firm. This optimal leverage is determined by a trade-off between the marginal costs and benefits. In contrast, the pecking order theory suggests instead a pecking order of financing choice generated by the problem of information asymmetry (Myers and Majluf, 1984;Rajan and Zingales, 1995; S uk uk issuance determinants in GCC countries 25 JEL Classification —G110, G120, G320. KAUJIE Classification —K16, I73, L4 © Imene Guermazi. Published in Islamic Economic Studies. Published by Emerald Publishing Limited. This article is published under the Creative Commons Attribution (CC BY 4.0) license. Anyone may reproduce, distribute, translate and create derivative works of this article (for both commercial and non-commercial purposes), subject to full attribution to the original publication and authors. The full terms of this license may be seen at http://creativecommons.org/licences/by/4.0/legalcode The current issue and full text archive of this journal is available on Emerald Insight at: https://www.emerald.com/insight/1319-1616.htm Received 27 August 2019 Revised 17 November 2019 Accepted 21 June 2020 Islamic Economic Studies Vol. 28 No. 1, 2020 pp. 25-45 Emerald Publishing Limited e-ISSN: 2411-3395 p-ISSN: 1319-1616 DOI 10.1108/IES-08-2019-0026 Al-Sakran, 2001;Kayo and Kimura, 2011;Psillaki and Daskalakis, 2009;Vasiliou et al., 2009; Shyam-Sunder and Myers, 1999;Frank and Goyal, 2003). There is a scarcity of empirical research dealing with the choice involving another debt type security, i.e. the s uk uk. Compared to conventional bonds that promise to pay interest, which is prohibited in Shar ıʿah, s uk uk allow ownership in the underlying economic assets and pay either profit or rent of those assets. Thus, s uk uk have unique benefits of religiosity and making socially responsible finance embedded in them. Besides, the profit-sharing principle implies that s uk uk represent fractional ownership in an underlying asset or project. S uk uk holders receive part of the profit proportional to their fractional ownership, which confers them the dual status of lenders and investors. So, s uk uk have the hybrid nature of debt and equity. Given these features of religiosity, embedded Islamic corporate social responsibility (CSR) and the hybrid nature of debt and equity, we question if capital structure theories can well explain s uk uk issuance. Researchers have regressed s uk uk amount on capital structure determinants to examine if s uk uk issuance is explained by these theories. Nagano (2016) finds no evidence of pecking order theory but does not confirm the trade-off theory. Other authors find some evidence of trade-off theory (Shahida and Saharah, 2013;Hanifa et al., 2014;Mohamed et al., 2015). However, Azmat et al. (2014) find no evidence of debt ratio target in Malaysian s uk uk. Very few studies have tested if the theories of capital structure explain s uk uk issuance in GCC countries. Using capital structure determinants, Grassa and Miniaoui (2018) find mixed results supporting both the trade-off and the pecking order theories. Existence of only few studies focusing on s uk uk, with little evidence of capital structure theories, make it difficult to stipulate that s uk uk issuance can be well explained by either trade-off or pecking order theories. In this paper, we contribute to fill this gap by testing these theories in GCC countries using not only capital structure determinants but also the debt target model and the fund flow deficit model. We address the research question of whether capital structure theories can explain s uk uk issuance in GCC countries. We use the accounting data of GCC s uk uk issuing firms for the period 2005–2016. Our results show that capital structure determinants fail to confirm either the trade-off theory or the pecking order theory. Indeed, the amount of s uk uk depends significantly and negatively on profitability and significantly and positively on earning volatility which is contrary to the trade-off theory. Thus the trade-off theory is rejected. Besides, the pecking order theory is not confirmed since it also predicts a negative sign of the coefficient of earning volatility. However, the trade-off theory is proved using the target level debt model. In fact, we find that the s uk uk change is significantly linked to the deviation from as uk uk target. So, s uk uk issuance aligns toward an optimal leverage. This target is determined by a trade-off between the marginal costs and social responsibility benefits of the s uk uk, which confirms the trade-off theory. We also perform the fund deficit flow model to test the pecking order model. But the results reject the pecking order theory. This study contributes to corporate finance theory and CSR. It checks if the capital structure theories proved in conventional finance can as well explain Islamic bonds issuance given their social responsibility benefits. It would help defining the social factors that encourage S uk uk issuance. This would reasonably lead to Islamic finance and Islamic CSR development. The remainder of this paper is organized as follows: the first section deals with the conceptual approach and literature review. The second section presents the methodology. Section three presents the sample study, while section four reports the descriptive statistics. Section five is about results and section six is about discussion. 2. Conceptual approach and literature review This paper verifies if capital structure theories are able to explain s uk uk issuance. We present the theoretical and empirical literature on capital structure theories and s uk uk. IES 28,1 26 2.1 Capital structure theories Many corporate finance studies have pointed out that trade-off theory and pecking order theory are major determinants of conventional bond issuance. The trade-off theory has contradicted the theorem of Modigliani and Miller (1958) that postulated no leverage impact on firm’s value. On the contrary, the trade-off theory predicts that there is an optimal debt to equity ratio maximizing the value of a firm. This optimal leverage is determined by a trade-off between the marginal costs and benefits (Kraus and Litzenberger, 1973;Myers, 2001;Van Binsbergen et al., 2011). In contrast, the pecking order theory does not predict a target debt ratio. It suggests instead a pecking order of financing choice generated by the problem of information asymmetry. The information asymmetry concerns the bigger knowledge of shareholders/managers about the value of the firm assets and future growth prospect. To overcome this problem, shareholders/managers prefer internal financing to external financing. Besides, in case of external financing, they opt for debt prior to equity to reduce information cost (Myers and Majluf, 1984;Rajan and Zingales, 1995;Al-Sakran, 2001;Kayo and Kimura, 2011;Psillaki and Daskalakis, 2009;Vasiliou et al., 2009). A first part of these researches in this field has tested these theories using determinants related to capital structure, which are mainly profitability, growth opportunities tangibility, non-debt tax shields, volatility and size. Another part assumes that firms target a particular leverage induced by a trade-off between the securities costs and benefits. A third part uses the funds flow deficit model to assume that in case of deficits, the firm will only issue or retire equity as a last resort. The major part of these researches deals with conventional bonds, while very few authors focus on Islamic bonds. 2.2 Researches using capital structure determinants Authors in this field have observed the relation between debt and capital structure determinants relating to profitability, growth opportunities, tangibility, non-debt tax shields, volatility and size. 2.2.1 Profitability. Concerning profitability, the trade-off model argues that profitable firms are less likely to be subject to bankruptcy risk because of their increased ability to meet debt repayment obligations. Thus, they will demand more debt to maximize their tax shield at more attractive costs of debt. The pecking order theory predicts the opposite sign suggesting that high profitable firms will be able to generate more funds through retained earnings and then have less leverage. Compared with debt and equity, retained earnings have no adverse selection problem, and hence, they are the cheapest source of finance (Myers and Majluf, 1984; Rajan and Zingales, 1995;Al-Sakran, 2001;Kayo and Kimura, 2011;Psillaki and Daskalakis, 2009;Vasiliou et al., 2009). 2.2.2 Asset tangibility. The trade-off theory predicts that the risk of lending to firms with more tangible assets is expected to be low, given the higher liquidation value of these assets in the event of financial distress or bankruptcy. Therefore, a firm with a higher percentage of fixed assets is expected to borrow more as compared relatively to firms with smaller fixed asset. Thus, we expect a positive relationship between tangibility of assets and debt (Harris and Raviv, 1991;Rajan and Zingales, 1995;Hovakimian and Li, 2011). In contrast, the pecking order theory predicts that firms with few tangible assets are more sensitive to informational asymmetries. Thus, these firms will issue debt rather than equity when they need external financing, which leads to negative relation between asset tangibility and debt (Titman and Wessels, 1988). 2.2.3 Firm size. Under a trade-off framework, larger firms have higher debt capacity and can borrow at more favorable risk-adjusted interest rates than smaller firms. Also, they are more diversified and less susceptible to bankruptcy (Titman and Wessels, 1988). Therefore, we expect a positive relationship between size and debt (Harris and Raviv, 1991; S uk uk issuance determinants in GCC countries 27 Rajan and Zingales, 1995;Shyam-Sunder and Myers, 1999). However, according to the pecking order theory, larger firms are more closely observed by the investment community and thus less subject to information asymmetry than small firms (Rajan and Zingales, 1995).Thus, they should be more capable of issuing equity, which is more sensitive to information asymmetry and have lower debt (Rajan and Zingales, 1995). We suggest a negative relation between firm size and leverage. 2.2.4 Growth opportunities. According to the trade-off theory, low-growth firms should use debt because it has a disciplinary role to alleviate the free cash flow problem (Jensen, 1986; Stulz, 1990). Hence, we expect a negative relationship between debt and growth opportunities. Pecking order theory predicts that growth opportunities should be financed with equity instead of debt. In order to mitigate moral hazard, a negative relationship is expected between debt and growth opportunities (Smith and Watts, 1992). However other authors claim that internal funds may be insufficient for highly growing firms, which will tend to issue debt, thus leading to a positive correlation between debt and growth opportunities (Myers, 1977; Titman and Wessels, 1988). 2.2.5 Non-debt tax shield. In the trade-off scheme, firms consider non-debt tax shields, such as depreciation and investment tax credit deductions, as a substitute for the tax shield and will have less incentive to increase leverage for tax considerations. So, non-debt tax shields and debt should have a negative relationship (Titman and Wessels, 1988;Fama and French, 2002;Flannery and Rangan, 2006). On the other hand, pecking order theory does not offer any judgments on the relationship between debt and non-debt tax shield. 2.2.6 Volatility. In the context of volatility, the trade-off theory assumes that firms with high earnings volatility try to accumulate cash during good years to avoid under-investment problems in the future (Myers, 1977). As DeAngelo and Masulis (1980) point out, an adverse selection problem is more severe to firms with highly volatile earnings. To avoid adverse selection problem, firms with financial surpluses should retire debt or invest in cash or marketable securities, to preserve their debt capacity for future financing needs or to avoid issuing equities at higher costs (Myers, 1984). Higher volatility of earnings increases the probability of financial risk and these firms will face the difficulties in debt financing. According to Jensen (1986), the pecking order theory also suggests the negative relationship between leverage and earnings volatility. 2.3 Researches using target leverage model Authors of these papers assume that firms target a particular leverage. If the actual ratio differs from the target, the firm would adjust its debt or equity to achieve the target. Researchers in this field have regressed the long-term debts change scaled by the total asset on the deviation of the debt ratio from its target value (Bradley et al., 1984;Long and Malitz, 1985;Rajan and Zingales, 1995;Titman and Wessels, 1988;Taggart, 1977;Marsh, 1982; Auerbach and King, 1983;Jalilvand and Harris, 1984;Opler and Titman, 1994;Graham and Harvey, 2001;Marsh, 1982,Hovakimian et al., 2001;Ozkan, 2001;Fama and French, 2002; Flannery and Rangan, 2006;Lemmon et al., 2008;Huang and Ritter, 2009). 2.4 Researches using fund flow deficit model Researchers in this field regress the firm’s net debt issues on its net financing deficit. The financing deficit is defined using the cash flow identity, as the growth in assets less the growth in current liabilities (except the current portion of long-term debt) less the growths in retained earnings. According to this identity, this deficit must be filled by the net sale of new securities. Except for firms at or near their debt capacity, the pecking order predicts that the deficits will be filled entirely with new debt issues. Authors in this field find that the estimated coefficient on the deficit variable is close to one and interpret this result as evidence IES 28,1 28 supporting the pecking order theory because a shortfall in funds is first met by debt (ShyamSunder and Myers, 1999;Frank and Goyal, 2003). 2.5 Capital structure theories for Islamic bonds To state capital structure theories for s uk uk, we begin by analyzing their specific features 2.5.1 Hybrid nature of s uk uk. The word s uk uk is the plural of Arabic word s akk which has the literal meaning of legal instrument/certificate, deed or cheque. The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI, 2017) defines s uk uk as follows: “S uk uk are certificates of equal value representing undivided shares in ownership of tangible assets, usufruct and services or (in the ownership of) the assets of particular projects or special investment activity.”In other words, s uk uk provide ownership of a part of the underlying asset to the holders. These certificates are rewarded with a pre-agreed profitsharing rate and thus avoiding any interest-based transaction. So, s uk uk combine characteristics of conventional bonds and stocks. Like bonds, they have a face value, a maturity date, a remuneration rate and provide a regular stream of cash flows to investors including capital refunding with a margin. However, unlike bonds, the return on the s uk uk is generated from an underlying asset, not from the obligation to pay interest. Thus, they share some common features with capital-like instruments as they give the right of a stream of revenue from an investment project (Miller et al., 2007;Nathif and Thomas, 2004;Klein and Weil, 2016;Wilson, 2008). This hybrid nature is influenced by the s uk uk types. In fact, some s uk uk are more debt-like s uk uk as Mur abah ah s uk uk and Ij arah s uk uk, while Mush arakah s uk uk and Mud   arabah s uk uk are more partnership-like s uk uk. 2.5.2 Benefits of s  uk uk: religiosity and corporate social responsibility. S uk uk are desirable by Shar ıʿah-conscious investors and entrepreneurs for their religious content. Hence, s uk uk offer unique benefit of strong adherence to Islamic financial directives. Shafron (2019) and Paltrinieri et al. (2019) explain the effect of this religious benefit on the choice of s uk uk investment using the theory of “investor tastes”of Fama and French (2007). According to this theory, “investor tastes”are persistent in nature and exist when certain investors “get direct utility from their holdings of some assets, above and beyond the utility from general consumption that the payoffs on the assets provide”. Specifically, investors with a taste for Shar ıʿah-compliant investments achieve a higher utility from investing in Shar ıʿah-compliant investments even with lower expected cash flows, than they would if they had instead held non-Shar ıʿah-compliant investments with higher expected cash flows. The investors’tastes of religiosity should encourage firms to meet these needs by issuing s uk uk. Moreover, the Islamic entrepreneurs may themselves have a taste for Shar ıʿah-compliant financing and thus a higher utility from issuing s uk uk, than they would if they issue instead non-Shar ıʿahcompliant securities. So, religiosity influences the behavior of stock market investors and issuers. These unique benefits should encourage firms to choose to issue s uk uk. Besides, s uk uk presents another unique benefit of Islamic CSR. CSR is the recognition on the part of management of an obligation to the society it serves not only for maximum economic performance but for humane and constructive social policies as well (Heald, 1957). The most notable theory inherent to this concept is Freeman’s (1984) stakeholder theory. This theory assumes that sharing values with stakeholders is necessarily and explicitly a part of doing business (Freeman, Wicks and Parmar, 2004). Islamic finance implements a variation of the conventional CSR, the Islamic CSR. Indeed, it is based on the ethical principles embodied in the Shar ıʿah (Islamic legal and ethical system), where its underlying objective are generally aimed at realizing overall human wellbeing and social justice (Ullah and Jamali, 2010). One of the most important ethical principles is the ban of interest. Thus, investors of s uk uk are paid dividends on the outcome of profit-sharing agreements between issuers and investors instead of fixed interest installment payments as in normal bonds (Siddiqi, 1987). Therefore, s uk uk S uk uk issuance determinants in GCC countries 29 integrate social concerns building justice between the money holder and the entrepreneur. On the one hand, the s uk uk holder is not unfairly assured of a positive return without doing any work or sharing in the risk, while the entrepreneur, in spite of his management and hard work, will bear all the risk to provide guaranteed return to the capital provider. On the other hand, Islamic finance presents schemes of risk management and insurance of s uk uk respectively by special purpose vehicle (SPV) and Takaful. The SPV maintains the underlying asset to ensure the returns stream while Takaful alleviates the risk of asset loss. So, Islamic bonds further social benefits beyond financial interest with requests for collective welfare. Empirically, authors focusing on ethical activities prove the beneficial effect of social responsibility on the raise of the corporate value through an increase in additional equity investment from the external investors. They find significant relation between CSR indicators and measures of financial performance such us ROA, ROE, market-to-book ratio, Tobin’sqand cost of equity (Jensen et al., 2002;Heinkel et al., 2001;Graff Zivin and Small, 2005;El Ghoul et al., 2011;Lee and Faff, 2009;Eccles et al., 2013;Dixon-Fowler et al., 2013; Marti et al., 2013;Hu, 2019). Other authors deal with the unique benefits of religiosity and Islamic CSR. Shafron (2019) shows that investors with Islamic beliefs tend to invest more in s uk uk than they would without such beliefs. Specifically in Ramadan, Klein et al. (2017) and Bialkowski et al. (2012) assert that religiosity can influence the investor behavior and find that investors react more positively to the s uk uk issuance than conventional bonds. Similarly, some authors suggest positive market reaction to s uk uk issuance (Nagano, 2010;Mohamed et al., 2017). Although other authors find evidence of negative market reaction to s uk uk issuance (Ahmed et al., 2018;Ameer and Othman, 2010;Modirzadehbami and Mansourfar, 2011;Godlewski et al., 2013;Hasib et al., 2017). Mohamed et al. (2017) relate these latter findings to the longer time taken by investors to absorb the information from the s uk uk announcement. Indeed, they prove a significantly positive reaction 30 days after the announcement of s uk uk issuance. 2.5.3 Capital structure determinants of s uk uk. The hybrid nature of s uk uk and their unique benefits of Islamic CSR and religiosity address the issue of whether capital structure theories can explain s uk uk issuance. Some authors argue that the profit-sharing type of this financing tool depends on greater internal information of the issuers when investors would like to receive maximum dividends. Therefore, the information cost of s uk uk issuance is predicted to be between normal debt finance and equity issuance. Thus, the choice of s uk uk is accordingly subordinated to normal debt finance but prior to equity issuance according to pecking order theory (Nagano, 2010;Nagano, 2016;Azmat et al., 2014). However, other authors reject the pecking order theory and claim that firms choose to issue s uk uk independently of the internal funding and the information cost. So, according to the trade-off theory, the firm opts for a target ratio of s uk uk to assets to maximize its value. This optimal leverage is determined by a trade-off between the marginal costs and benefits of the s uk uk (Shahida and Saharah, 2013; Mohamed et al., 2015). As s uk uk benefits are inherent to religiosity and social responsibility, the trade-off prediction supposes that issuing firms balance the costs and the benefits of religiosity and social responsibility benefits of s uk uks. 2.6 Researches dealing with determinants of Islamic bonds issuance Very few studies focus on the determinants of s uk uk issuance. Islamic corporate finance research has investigated whether capital structure theories explain s uk uk issuance. Some authors have performed logit and probit models to analyze the determinants of s uk uk and conventional bonds issuance. They have tested if these determinants relate to pecking order, trade-off or timing theory. One of these researchers, Nagano (2010) finds evidence that Malaysian firms choose to issue s uk uk prior to bank borrowing and other external IES 28,1 30 financing tools. He shows that s uk uk issuance does not relate to the issuer’s internal funds or to the information cost, but that Islamic bank borrowing always does. The author explains the results by the fact that firms issue s uk uk to obtain other benefits no matter how large the information cost is. He shows that firms obtain an increase in the corporate value by issuing s uk uk, which must be due to its ethical benefits. He concludes that s uk uk issuance is preferentially chosen as a funding scheme because it brings unique financial and ethical benefits. Nagano (2016) did not find any evidence of the pecking order theory in a comparative study concerning Malaysia, Saudi Arabia and the United Arab Emirates. His findings show that the possible determinants of s uk uk are firm size and past s uk uk issuance. The insignificant relationship with other variables also indicatesthat s uk uk is considered to be chosen prior to the normal bond issuance regardless of the availability of firms’internal funds. In another study concerning Malaysia and Indonesia, Nagano (2017) proves that the pecking order theory explains s uk uk issuance decision in case of large funding demand. Indeed, he finds that, under high information asymmetry, a firm with a highstock price and a large demanding fund prefers s uk uk issuance to conventional debt. Focusing on specific s uk uk type, Azmat et al. (2014) performed probit model on utility function to test Malaysian issuers’choice of Islamic bonds. They show that Islamic joint venture bonds do not align with debt-equity target, while secured against real estate these s uk uk do not always represent ownership of the underlying asset. Shahida and Saharah (2013) use OLS, fixed effect and random effect models to prove that s uk uk issuance depends on firm size, past s uk uk issuance experiences and finally the government tax incentive. These findings are consistent with trade-off theory; however, leverage and profitability remain insignificant for s uk uk issuance decisions. Hanifa et al. (2014) perform the partial adjustment model to find the firm specific determinants of target debt ratio. Using s uk uk and conventional bond issuance dataset for the period 2000 to 2012, the results of the dynamic panel data estimators provide strong support for trade-off theory. However, when the authors took consideration of bond and s uk uk types, they show, on the one hand, that partnership-based s uk uk and convertible bonds follow pecking order theory. On the other hand, straight bonds and exchange-based s uk uk align toward a target debt. In GCC countries, Grassa and Miniaoui (2018) use capital structure determinants and find mixed results. Aligning with the pecking order theory’s predictions, they document a positive relation between growth opportunity and s uk uk issuance and a negative correlation between size and s uk uk issuance. However, concerning asset tangibility, their results support the positive sign of the trade-off theory. These studies provide little evidence that capital structure theory can explain s uk uk issuance. 3. Methodology In this paper, we test first the trade-off theory and the pecking order theory using capital structure determinants. Second, we apply the target debt model to verify the trade-off theory. Third, we use the fund flow deficit model to test the pecking order theory. In the current section, we present the methods of each model. To deal with the problems of heteroscedasticity and serial correlation in the residuals, we use techniques of panel estimation: fixed effects model and random effects model. We also use the instrumental variable technique to resolve the problem of lagged independent variable 3.1 The capital structure model This model aims to verify if s uk uk issuance is explained either by trade-off theory or by pecking order theory using capital structure determinants. We will examine if s uk uk amount S uk uk issuance determinants in GCC countries 31 is influenced by determinants of capital structure, which are profitability, growth opportunities, tangibility, non-debt tax shields, volatility and size. 3.1.1 Hypotheses. Some authors argue that the profit-sharing type of s uk uk depends on internal information of the issuers when investors would like to receive maximum dividends. However, the information cost of s uk uk issuance is predicted to be inferior to equity issuance. Thus, the choice of s uk uk is prior to equity issuance according to pecking order theory. However, according to trade-off theory, the firm opts for a target ratio of s uk uk to assets to maximize its value. This optimal leverage is set by a trade-off between the marginal costs and benefits of the s uk uk (Nagano, 2010;Nagano, 2016;Shahida and Saharah, 2013;Azmat et al., 2013). The trade-off theory anticipates a positive relation between leverage and the capital determinants tangibility, size and profitability and a negative relation with growth opportunities, non-debt tax shields and volatility. However, the pecking order theory predicts that leverage depends positively on growth opportunities and negatively on profitability, tangibility, size and volatility. Hence, we posit the following hypotheses: H1. According to the trade-off theory, s uk uk issuance is positively influenced by tangibility, profitability and size and negatively related to growth opportunities, non-debt tax shields and volatility. H2. According to the pecking order theory, s uk uk issuance is positively influenced by growth opportunities and negatively related to size, profitability, tangibility and volatility. 3.1.2 Econometric models. To test Hypothesis 1, we regress s uk uk on these lagged determinants using the following model ⊿s uk uk=assetsit ¼aþb1Profitabilityit−1þb2Tangilityit−1þb3nondebt tax shieldsit−1 þb4Volatilityit−1þb5Sizeit þb6Growrhit þ ε it To test Hypothesis 2, we regress s uk uk on these lagged determinants using the following model ⊿s uk ukit=assetsit ¼aþb1Profitabilityit−1þb2Tangilityit−1þb3Volatilitit−1þb4Sizeit þb5Growthit þ ε it 3.1.3 Variable measures. In the two econometric models, the dependent variable is s uk uk, while the independent variables are capital structure determinants, notably profitability, growth opportunities, tangibility, non-debt tax shields, volatility and size. (1) S uk uk S uk uk is measured by the ratio of the amount of s uk uk divided by total assets (2) Profitability This variable is measured by the ratio of earnings before interest and taxes to the total assets (Following Titman and Wessels, 1988;Rajan and Zingales, 1995). (3) Growth opportunities Following Rajan and Zingles (1995) and Bevan and Danbolt (2002,2004), we use the ratio of market-to-book value as a proxy for growth opportunities. IES 28,1 32 7. Robustness check We check the robustness of our results in many ways. First, we use techniques of panel estimation: fixed effects model and random effects model to deal with the problems of endogeneity of lagged dependent variable, heteroscedasticity and serial correlation in the residuals. For each regression we perform the two methods. Then, we perform the Hausman test to choose the appropriate model for the sample. We also use the Wooldridge autocorrelation to verify if there is a need for autoregressive panels. Second, we test capital structure theories using three models to corroborate our findings. The model of capital structure determinants tests if s uk uk change depends on capital structure determinants. The debt target model verifies if the firm targets a ratio of s uk uk to assets determined by a trade-off between the marginal costs and benefits of the s uk uk. The fund flow deficit model predicts that the firm will fill its deficit by using only debt only letting issuing equity as a last resort. We deal with the endogeneity problem using the instrumental variable technique. The capital structure model fails to prove either the trade-off theory or the pecking order theory. The debt target model proves the trade-off theory, while the funds flows deficit model rejects the pecking order theory. Thus, our findings are robust. However, we do not use alternative measures of the significant independent variables. Indeed, the variables measures are chosen according to the review of previous researches, which used specific measures. 8. Discussion of results We test if capital structure theories can explain s uk uk issuance using three models; the capital structure determinants model, the debt target model and the fund flows deficit model. The model of capital structure determinants fails to confirm either trade-off theory or pecking order theory. We find that some of the coefficients of the variables measuring these determinants present signs conform to the predicted signs while other coefficient have signs contrary to the predicted signs. These mixed results are in line with those of Grassa and Miniaoui (2018).In fact, the authors document a positive relation between growth opportunity and s uk uk issuance and a negative correlation between size and s uk uk issuance, which confirm the pecking order theory’s predictions. However, they report a positive sign of asset tangibility, which verify the trade-off theory while leverage and profitability remain insignificant for s uk uk issuance decisions. Our results conform also those of Nagano (2010) and Nagano (2016) that s uk uk issuance is not related to the issuer’s internal funds or the information cost and that size is a possible determinant of s uk uk. Though, our findings differ from the one of Nagano (2016) that, under high information asymmetry, a firm with a high stock price and a large demanding fund prefers s uk uk issuance to equity, thus proving the pecking order theory. Our findings are also different from those of Shahida and Saharah (2013) that s uk uk issuance depends on firm size. Dependent variable S uk uk it Independent variables DEF it 0.003 (0.248) Constant 1.89 (0.006)** R2 Hausman test chi2 Prob > chi2 Note(s): *Significant at 5% level, **Significant at 1% level DEFitðFunds flow deficitÞit Table 5. Fund flow deficit model Model 3: S uk ukit ¼ aiþγDEFit ðFunds flow deficitÞit þ ε i S uk uk issuance determinants in GCC countries 39 But unlike them, we do not prove that s uk uk issuance depends on past s uk uk issuance experiences and the government tax incentive. To deal with our mixed results, we perform the leverage target model and then the fund flow deficit model. The results of the target s uk uk model show that the amount of s uk uk converges to a target level confirming the trade-off theory. This evidence implies that s uk uk is a desirable financing tool and the firm aims to have a mixed financial structure of equity and s uk uk. We explain this attraction by the unique benefits of s uk uk. In fact, the hybrid nature of s uk uk and its interest-free scheme of outcomes made them an Islamic CSR way to rise funds. This suggestion aligns the findings of authors focusing on ethical activities, which have proven that social responsible activities not only improve the consumer’s credibility, but also increase corporate value through an increase in additional equity investment from the external investors (Jensen et al., 2002;Heinkel et al., 2001 and Graff Zivin and Small, 2005;El Ghoul et al., 2011;Lee and Faff, 2009;Eccles et al., 2013;Dixon-Fowler et al., 2013;Marti et al., 2013;Hu, 2019). Nagano (2010) and Mohamed et al. (2017) have also suggested that s uk uk brings unique benefits by increasing issuer’s stock returns. However, the results of the fund flows deficit model reject that funds deficit is filled by using only debt. So, pecking order theory is rejected. These findings are contrary to those of Shyam-Sunder and Myers (1999) and Frank and Goyal (2003) that fund deficit is filled by the net sale of new conventional debt securities. As our results confirm the trade-off theory and reject the pecking order theory, we assume that firms do not choose to issue s uk uk because of asymmetric information or its cost, but for their social unique benefits that other external financing don’t afford. 9. Conclusion In this paper, we verify if s uk uk issuance is explained by theories of capital structure. We extend the literature testing these theories for Islamic bonds. Previous research failed to find evidence of any capital structure theory outlining s uk uk issuance in GCC countries. Our study further tests these theories and adds theoretical and empirical contributions. Theoretically, we highlight the specific features of s uk uk that would bridge their issuance to capital structure theories. S uk uk are couched in the ethical principles embodied in the Shar ıʿah (Islamic legal and ethical system). The underlying objectives of Shar ıʿah are generally aimed at realizing overall human wellbeing and social justice. Indeed, s uk uk conform to the principle of no interest and risk sharing. This principle promotes social justice between s uk uk holders and issuing firms. Indeed, investors are not allowed to realize financial gains without being exposed to the risk of potential loss. So, in case of profits, they are paid dividends on the outcome of profit-sharing agreements. Therefore, Islamic bonds (s uk uk) have hybrid nature between debt and equity. Besides, they offer unique benefits of religiosity and socially responsible financing. This hybrid nature as well as the social and religious benefits are the specific features linking s uk uk issuance to capital structure theories. Methodologically, this study adds empirical evidence by using three models, in contrast to previous studies dealing with only one model. Using the model of capital structure determinants, our results show that s uk uk issuance is negatively and significantly linked to profitability. This sign confirms the pecking order theory. Nevertheless, s uk uk issuance is positively and significantly linked to earnings volatility, which is contrary to both trade-off theory and pecking order theory. Thus, the model of capital structure determinants does not permit to confirm or reject capital theories. So, we used the debt target model to test the tradeoff theory and the fund flow deficit model to test the pecking order theory. Our results show that s uk uk converge to a target level determined by a trade-off between the cost and the social responsibility benefits of s uk uk. These findings are consistent with the trade-off theory. In addition, the test of the fund flow deficit shows that funds deficit is not filled by using only IES 28,1 40 debt, thus rejecting the pecking order theory. Overall, we find evidence of the trade-off theory. We suggest that firms aim to have a target level of s uk uk in their financial structure due to their unique benefits of religiosity and Islamic CSR. Our findings present a number of implications for theory and practice. From the theoretical side, this paper contributes to the corporate finance theory and CSR. It highlights the important contribution of corporate Islamic finance to the development of CSR. Indeed, Islamic finance is embedded in ethical and social principles. One important principle is the ban on interest in financing and its replacement by profit-and-loss-sharing. The adoption of this principle in s uk uk induces unique social benefits with claims of social justice between s uk uk holders and issuing firms. These unique benefits, that other financing schemes do not give, link capital structure theories to CSR. Our research enhances the concept of Islamic CSR. Tying the capital structure theories to CSR would also help developing Islamic finance theory as a unique socially responsible framework. The socially responsible aspect is obvious as the unfair features such as the interest and risk bearing are replaced by the ethical principles of no interest and risk sharing. Therefore, the core of Islamic finance theory is to tailor conventional finance to socially responsible aims. The main practical implications relate to the actors intervening in the financing process. One important outcome is to encourage managers and investors to further contribute to promote this Islamic financing tool for its unique social and Shar ıʿahcompliance benefits. Our results would encourage governments to enhance firms to adopt this socially responsible financing. Moreover, it would motivate them to issue sovereign s uk uk, which constitutes a pricing benchmark and an anchor security for portfolio management and secondary trading. Furthermore, rating agencies would be motivated to evaluate s uk uk and ascertain the quality of issuance and subsequently attract more investors. To get the best rating, firms would improve the quality of disclosure and the relevance of their accounting information. This would reasonably lead to socially responsible financing development. References Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) (2017), Shar ı‘ah Standards, 2017, Dar AlMaiman for publishing and distributing, Manama. 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Corresponding author Imene Guermazi can be contacted at: [email protected] For instructions on how to order reprints of this article, please visit our website: www.emeraldgrouppublishing.com/licensing/reprints.htm Or contact us for further details: [email protected] S uk uk issuance determinants in GCC countries 45