Shari'ah compliance requirements and the cost of equity capital

This study examines if adoption of Shari'ah Compliance Requirements (SCR) effects on the cost of equity capital of the firms. We estimate the cost of equity capital implied by market prices and analyst forecasts, and account for changes in growth expectations around adoption of SCR. Our results show that transitional implications of Shari'ah compliance can diverge depending on the information spread. The findings reveal that getting a Shari'ah compliance certificate initially increases the cost of equity for a firm, potentially due to higher financial constraints and other burdens associated with Shari'ah requirements. However, with greater exposure and awareness in Islamic markets, Shari'ah compliance eventually leads to a fall in the cost of equity. We also find that at the industry-level, SCR adoption effects are stronger in relatively tangible sectors. In our analysis to measure the impact of Shai'ah compliance on COE, we employed a treatment/control study, (difference in differences analysis) of both Shari'ah and conventional firms to conduct robustness checks. Our robustness analyses confirm that becoming Sharia compliant increases the stock liquidity of SCR adopted firms, which in turn impacts the cost of equity negatively.