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Financial constraints and Islamic finance: Lesson learned from external financing perspective

Author

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  • Achmad Tohirin
  • Mohd Adib Ismail

    (Post Graduate Program, Faculty of Economics, Universitas Islam Indonesia, Yogyakarta, Indonesia.
    Research Centre for Islamic Economics and Finance, Universiti Kebangsaan Malaysia, Bangi Selangor, Malaysia.)

Abstract

This study examines the presence of financial constraints and explores the role of profitloss sharing (PLS) in mitigating the problem of the financial constraints stemmed from the capital market imperfections. Using Malaysian listed companies’ data, this study finds that the financial constraints are present in the capital market. This finding implies the imperfect capital market. In Islamic PLS framework, there are two options of financing contracts that may be enforced in the capital market as financing mechanisms, i.e. al-musharakah and al-mudharabah. These schemes promote sharing of information and mutual trust between financiers and ‘borrowers’. In these contracts, there are strict terms and conditions to be adhered to by both parties so that the contracts pursue to be valid. Besides, PLS mechanism may reduce the cost of capital since the profit and loss are shared rather than be burdened only on one shoulder. In this regard, the imperfect market problems namely asymmetric information, agency problem and transaction cost can be reduced if not be overcome.

Suggested Citation

  • Achmad Tohirin & Mohd Adib Ismail, 2016. "Financial constraints and Islamic finance: Lesson learned from external financing perspective," Economic Journal of Emerging Markets, Universitas Islam Indonesia, vol. 8(2), pages 98-108, April.
    • Handle: RePEc:uii:journl:v:8:y:2016:i:2:p:98-108
    DOI: 10.20885/ejem.vol8.iss2.art2
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    More about this item

    Keywords

    Financial constraints; profit-loss sharing; al-musharakah; al- mudharabah; mutual trust.;
    All these keywords.

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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