Does compliance with screening standards affect the performance of firms?

Thematic investments, such as sustainability and ESG, are often opaque because they have proprietary screening criteria that are not visible to investors. A transparent screening criterion based on publicly available information is desirable to help firms know what investors seek from their business activities. Screening criteria developed for Muslim investors serve this purpose; however, adherence to any such screening criteria requires significant business transformation and may affect the fundamental and market performance of firms. To empirically investigate this hypothesis, this paper examines the changes in screening criteria introduced by the Malaysian Financial Services Act 2013 as a case study. The empirical findings suggest that firms that switch between compliance and non-compliance not only underperform but also experience volatility and loss of shareholder value as compared with those firms that remained Shari'ah-compliant throughout the sample period. This suggests that being Shari'ah-compliant is not simply meeting some objective criteria. It is more about developing a business culture that is long-term oriented as being in and out of Shari'ah compliance in the short term does not serve the purpose of shareholder value maximization. The findings of this paper are important for regulators, firm managers, and investors' confidence in the screening process when transparent, rules-based screening criteria are in place.