The Role of Ownership and Capital Structure on Compliance : The Case of Regulatory Changes for Shariah Screening Methodology

In this study, we examine the impact of regulatory changes in Shariah screening guidelines as introduced by the Financial Services Act 2013 in Malaysia. The adoption of new regulations for Shariah-screening methodology affects the Shariah-compliance status of firms resulting in a considerable number of firms who either become non-compliant and removed from the list of Shariah-compliant firms or switched to Shariah-compliant. We investigate underlying determinants that governed such a switching behavior including the capital structure and ownership structure. Our results after controlling for size and financial performance indicate that financial leverage and owners' equity play a key role in explaining the switching behavior of Shariah firms. We also found that ownership structure plays a vital role in a firm's decision to stay Shariah-compliant. Specifically, shares held by institutional investors (unit trust, endowment funds) and individual/family play an essential role for firms to stay Shariah-compliant. The empirical findings suggest that demand for Shariah-compliant investment in Malaysia emerges from the smaller investors investing in mutual funds/unit trust and overall composition of the population