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When and why firms issue sukuk?

Article in Managerial Finance · May 2018

DOI: 10.1108/MF-06-2017-0207

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MF
44,6 When and why firms
issue sukuk?
Hasib Ahmed, M. Kabir Hassan and Blake Rayfield
Department of Economics and Finance, College of Business Administration,
774 University of New Orleans, New Orleans, Louisiana, USA
Received 7 June 2017
Revised 8 August 2017 Abstract
Accepted 6 September 2017
Purpose – The purpose of this paper is to analyze whether investors perceive the issuance of sukuk
differently than they do in case of conventional bonds, by using event study with superior data. Then, it
analyzes whether financial characteristics of issuers can explain the abnormal return and likelihood of sukuk
issuance. Finally, the paper proposes a testable model explaining the investor reaction.
Design/methodology/approach – This paper uses market model event study to assess investor reaction
to the issuance of sukuk. Then, linear and logistic regressions are used to test whether financial
characteristics of issuers can explain the abnormal return and likelihood of sukuk issuance. To investigate
the differences between sukuk issuers and bond issuers, this paper tests the difference in means of issuer
characteristics. Finally, the sample is subdivided into good and bad firm prospects according to
dividend/earnings ratio and book-to-market ratio. The subdivisions are used to test the proposed model
explaining the investor reaction.
Findings – The study finds that a large variety of firms issues sukuk. The event study reports significant
negative abnormal returns around the announcement date of sukuk issuance. The study also reveals that the
earning prospect of issuer firms affect the investor reaction. Firms with lower earning prospect receive a
negative reaction from the investors. Also, smaller, or financially unhealthy firms are more likely to issue
sukuk. Smaller and riskier firms issue sukuk, because participation in the market is less constrained. In other
words, the risk-sharing nature of sukuk might imply that the firm is not confident about the future prospect.
However, if the firm has good earnings prospects, investors react to the issuance of sukuk negatively.
Research limitations/implications – Reliability and availability of data is a hurdle to test the investor
reaction model. As more data become available, the models implications can be further tested.
Originality/value – This paper uses the most complete set of data to study sukuk, making it the most
selection bias-free and complete study. Moreover, the proposed investor reaction model will enrich the theory.
Keywords Islamic finance, Market reaction, Firm investment decision, Sukuk issuance
Paper type Research paper

1. Introduction
Sukuk serves as an alternative debt instrument to conventional bond. From January 2001 to
October 2015, 10,786 sukuks amounting $857 billion have been issued. A majority of these
issuances occurred in Muslim-majority countries. Sukuk has been particularly popular
among Islamic communities as the instrument is Shari’ah (Islamic codes) compliant.
The issuer uses the proceed from sukuk to buy a particular asset. Investors receive a claim
on the asset, rather than a claim on the issuing firms’ debt. Our purpose is to study how
equity investors react to sukuk issuance. Because of the unique characteristics of sukuk
(profit and loss sharing among others), investors should react differently to the issuance of
sukuk. Our results show that investors overall react negatively to the issuance of sukuk.
Furthermore, we present and test a model explaining why a negative market reaction is
logical when an investor considers the firm value.
In recent years, the sukuk market has expanded significantly. This expansion could be
attributed to a high demand for shari’ah-compliant debt instruments in the markets of
Muslim-majority countries. But sukuk is no longer confined to such markets. It has reached
Managerial Finance
Vol. 44 No. 6, 2018
pp. 774-786 JEL Classification — G14, Z12, G32, G10
© Emerald Publishing Limited This research did not receive any specific grant from funding agencies in the public, commercial, or
0307-4358
DOI 10.1108/MF-06-2017-0207 not-for-profit sectors. The authors declare that they have no conflict of interest.
the markets of non-Muslim-majority countries such as Singapore, UK, and Hong Kong. When and why
Thus, we can assume that as well as Shari’ah compliance, other characteristics of sukuk are firms issue
also contributing to its expansion. sukuk?
In this study, we analyze why publicly traded companies issue sukuk. We use an event
study to see how investors perceive the issuance of sukuk in the Malaysian market.
We choose Malaysia because the country has issued the lion’s share of sukuk so far.
The Malaysian market has a well-functioning bond market as well. Such balance will allow 775
us to compare the reactions of bond and sukuk announcement. We estimate the cumulative
abnormal return (CAR) of sukuk issuance by publicly traded firms and find that investors
do not take the issuance of sukuk as a good signal.
Sukuk and conventional bonds are different regarding their properties and structure.
First, traditionally sukuk is seen as the analog to a debt contract. However, sukuk is a
contract of participation in an asset ownership, whereas a conventional bond is a debt
contract. Because sukuk offers equity type participation in the returns of an asset, the
market reaction should differ between bonds and sukuk. Bonds and sukuk also differ in
the type of interest they pay. For example, while bonds pay a fixed interest percentage,
sukuk pays based on the cashflows of the project or asset, it is funding. Furthermore,
sukuk also allows ownership in a real asset, making it virtually free of bankruptcy risks
(Hidayat, 2013) and providing some diversification advantage (Cakir and Raei, 2007).
Sukuk is also less volatile than the conventional bonds. Second, sukuk is a
shari’ah-compliant instrument. Demand for such fixed income instrument is high
among Islamic banks, financial institutions, and investors.
First, we focus our analysis on how the market reacts to the announcement of issuance
of sukuk, and what causes such reactions. We provide the most compressive study of
sukuk market reaction. We find the significantly negative market reaction to seven-day
and 40-day event windows. This result might arise from the fact that profit-loss sharing
status makes sukuk somewhat similar to equity. Moreover, the participation in sukuk
market is more open than participation in the bond market. Easier access allows even the
financially unhealthy firms to issue sukuk. Interest from such firms will cause downward
pressure on CARs.
Second, we further test whether financial characteristics of firms can explain the CARs
we observe by a linear regression model. We find that higher price-earnings ratio of firms
causes a lower abnormal return. Investors do not appreciate firms with less earning
prospective issuing sukuk. We also use a logistic regression to see whether firm
characteristics can predict the likelihood of sukuk issuance. We find that growth firms are
less likely to issue sukuk. Also, smaller firms with weaker financial conditions are more
likely to issue sukuk. Our findings imply that the market reaction is strongly related to the
financial condition of issuing firm. Financially sound firms will issue sukuk as an
alternative to conventional debt, whereas financially weak firms will issue sukuk because
issuing sukuk is less constrained than issuing a conventional bond.
Finally, based on our empirical results, we propose a testable model explaining investors’
reactions. Our model shows that sukuk is more valuable to firms with poor growth
prospects. Conversely, firms with high growth prospects face higher costs issuing sukuk.
Therefore, our model predicts that firms with good growth prospects should face negative
market reactions. We test our model by dividing our sample using market-based proxies
and find evidence to support our model.
The paper proceeds as follows. The next section discusses the prior work surrounding
the issuance of sukuk. Section 3 presents the “data and methodology” section of our paper.
In Section 4, we present the results of our empirical analysis. In Section 5, we present our
model and its predictions for firm value. Also included in Section 5 is empirical support for
our model. In Section 6, we present our conclusions.
MF 2. Literature review
44,6 Sukuk has attracted many researchers in recent years. Several studies compare sukuk with
conventional bonds. One such study, Karatas and Nienhaus (2015) ask whether the market
perceives sukuk as a unique asset or the same as conventional bonds. They report that
conventional investors would not value the shari’ah potency of sukuk separately.
Conventional bonds had higher credit quality and traded on a “spread-basis,” whereas
776 sukuk are traded on a “price-basis.” A conventional investor might get excess profit from
selling sukuk to Islamic investors, because of the lack of liquidity. International investors
are usually involved in large issuance.
Recently, more firms prefer sukuk over conventional bonds. Klein et al. (2015) study why
more firms prefer sukuk over conventional bonds. Their analysis follows information
asymmetry (firm are uncertain about their future prospects and the firms want to share
losses) and adverse selection (riskier and less profitable firms). They agree with Godlewski
et al. (2013) that investors perceive issuance of sukuk as a negative signal.
Hassan et al. (2017) show, using a multivariate GARCH framework, that sukuk and
conventional investment-grade bonds have a lower reaction of conditional volatility to
market shocks and higher persistence, and sukuk returns are much less volatile than US
and EU investment-grade bonds. They also find significant behavioral shifts in the
sukuk-bonds relationship, which are explained by market liquidity, crude oil prices, US
credit information, and stock market uncertainty.
Alam et al. (2013), using sukuk and conventional announcement, show that market
reaction is negative for sukuk announcement before and during 2007 financial crisis, but
positive for conventional bond before financial crisis and negative after crisis. The size of
bond offerings has a negative impact on CAR for sukuk but positive for conventional bonds.
Nagano (2016) provides more insights into this matter. Nagano (2016) argues that
information costs influence sukuk issuance. The author uses probit regression for the
determinants of sukuk issuance choice. He also argues that once a firm issues sukuk, the
firm continues to prefer it. Also, firms issue sukuk under a low degree of financial
constraint, and undervalued firms consider market timing to issue sukuk. Both firm and
issuer expect the earnings to rise.
Hassan and Oseni (2014) state that commercial transactions are closely regulated to
ensure maximum or a meaningful level of Sharī‘ah compliance with a view to promoting the
original value proposition of Islamic economics. While Islamic law promotes investment
activities and profit-driven transactions, such transactions must be kept within the bounds
of Sharī‘ah rules applicable to commercial transactions which include the prohibition of riba
(interest-bearing transactions), gharar (excessive risk), and trade in unlawful commodities.
The inhibitions are based on these parameters which represent the “red line” limits for
Islamic finance products.
Wilson (2008) compares return and yield of sukuk and conventional bonds. He argues
that the sukuk structure mimic return and yield of a conventional bond. Karatas and
Nienhaus (2015) do a similar analysis on the Malaysian market and report that sukuk and
bond markets are closely related.
The literature finds some firms experience a positive reaction, and some firms experience a
negative reaction from the market after announcing an issuance of sukuk. Godlewski et al.
(2016) use a comparative analysis between different asset class and scholar reputation. They
find that the type of sukuk and the recognition of scholar affect the market value of issuing firm.
Oseni and Hassan (2015) argue that as part of Islamic finance documentation involved in
the process of structuring a Sukuk transaction, one important thing the parties must get right
from the beginning is the governing law clause. With the increasing provision of English law
as the governing law, a question that readily comes to one’s mind is whether it is possible to
have an alternative governing law while retaining the choice of jurisdiction clause.
 Hidayat (2013) takes a qualitative approach to conducting a comparative analysis When and why
between asset-based and asset-backed sukuk structures from the shari’ah perspective. He firms issue
argues that asset-backed instrument transfers risks to the third party and holders are free sukuk?
from bankruptcy risks. Also, most sukuk are asset-based (90 percent by Pasha, 2012).
These might be priced higher as asset-backed sukuk structure is complex.
The literature confirms that market reacts depending on the issuing firm and sukuk
structure. Usually, larger and profitable companies attract more scholars to endorse their 777
sukuk. If the issuing firm is in good health, investors bid the stock value up after issuance of
a debt instrument.

3. Data and methodology

To investigate the reaction of investors after the issuance of sukuk, we collect sukuk and
conventional bond issuance data from the Bloomberg database. We gather 10,786 issuances of
sukuk that total USD857 billion. Our data span from 2001 to 2015. After gathering all sukuk
issuances from Bloomberg, we identify all publicly traded firms. Some firms offer multiple
sukuks on one date. We collect these issuances and consider them as one issuance. To measure
the market reaction to a sukuk issuance, we collect daily price data from Thompson Reuters
Datastream. We also use Thompson Reuters to collect firm fundamentals, such as the number
of shares outstanding (shares), total assets, total debt, and the book value of equity (book value).
We clean our sample by requiring firms have at least 180 days of trading before the
announcement of new sukuk. This cleaning procedure is required to estimate a baseline beta
properly. We also require the firm have complete shares outstanding, total assets, total debt,
and book value of equity at the time of the sukuk issuance. Our final sample consists of 5,516
sukuk issuances across 307 publicly traded firms. Of the 307 publicly traded firms, 142 issue
sukuk, 203 issue conventional bonds and 77 firms issue both sukuk and conventional during
the sample period. Summary statistics are presents for the final sample in Table I.
Table I displays the summary statistics for our full sample. Statistics are divided into
three parts: whole sample, issuers of sukuk, and issuers of conventional bonds. Market
equity, book equity, total assets, total debt, sales, earnings before interest, taxes,
depreciation, and amortization (EBITDA), and income are reported in millions. Market
equity is closing stock price at the time of new capital announcement price multiplied by

Whole sample Sukuk Bond

Variable Mean Median Mean Median Mean Median

Market equity 5.21 0.56 4.85 0.58 5.51 0.53

Book equity 16.70 0.97 7.31 0.92 24.50 1.08
Dividend-earnings ratio −0.52 0.19 −1.61 0.22 0.44 0.16
Price-earnings ratio −0.35 10.92 −21.61 11.14 18.72 10.83
Book-to-market equity 3.03 1.82 2.60 1.65 3.39 1.98
Leverage 1.40 0.87 1.16 0.80 1.61 0.93
Total assets 19.90 1.46 9.27 1.27 28.90 1.59
Total debt 3.83 0.45 2.26 0.46 5.14 0.44
Sales 2.20 0.55 2.20 0.56 2.19 0.55
EBITDA 0.48 0.10 0.41 0.09 0.55 0.10
Income 0.22 0.04 0.18 0.03 0.25 0.04
Notes: Descriptive statistics of financial variables from a sample of 307 firms issuing sukuk or conventional
bond or both during the period January 2001-October 2015. Statistics are divided into three parts: whole sample,
issuers of sukuk, and issuers of conventional bonds. Market equity, book equity, total assets, total debt, sales,
EBITDA, and income are reported in millions. Market equity is stock price multiplied by common shares
outstanding. Leverage is total debt divided by market equity. Book-to-market equity is calculated as the book Table I.
value of equity divided by the market equity, where book value is defined as net asset value of the firms Summary statistics
MF common shares outstanding. Leverage is the total debt divided by market equity.
44,6 Book-to-market equity is calculated as the book value of equity divided by the market
equity, where book value is defined as net asset value of the firms.
Table I shows a large dispersion for each of the variables. A median firm has market equity
of $0.56 million, whereas the mean is $5.21 million. It reflects the diverse sizes of the issuing
firms. Median leverage and B/M is also reflecting the presence of some extreme values in the
778 sample. The difference is similar for sukuk issuers and conventional bond issuers. However,
size and book equity measures are smaller for issuers of sukuk than issuers of bonds.
The means of dividend-earnings and price-earnings ratios are negative for sukuk issuers. The
negative ratio implies that there are some firms with very large negative earnings among sukuk
issuers. These statistics prove that issuance of sukuk is not confined to some specific type of
firms, although smaller firms with less income are more likely to issue sukuk than conventional
bonds. This is no surprise considering a finding of Nagano (2016) that firms face a low degree of
financial constraint to issue sukuk, once they have accessibility to the sukuk market.
To further investigate the differences between sukuk issuers and bond issuers, test the
difference in means found in Table I. The results of means testing can be found in Table II.
Table II shows that our sample of bond and sukuk issues is statistically different. The
results indicate that sukuk issuing firms are smaller, younger, and more capital constrained.
To estimate the market reaction of firms that issue sukuk, we employ an event study
methodology. Using the announcement dates from our sample of firms, we calculate CARs
around the announcement date.
First, we compute a firm’s abnormal returns before and after an announcement of sukuk
issuance. To do this, we use the market model to estimate abnormal returns. We find this
model the most desirable because of the presence of small firms in our sample. Furthermore,
data constraints prevent us from employing other popular methodologies. The statistical
market model to estimate expected return is:
h  
E Ri;t ¼ a^ i;t þ b^ i;t  E RM ;t (1)

where RM,t is the market return and Ri,t is the firm i’s return in year t. We estimate a^ i;t and
b^ i;t by OLS.

Sukuk – Bond Sukuk – Both Bond – Both

Variable Difference t-value Difference t-value Difference t-value

Market equity −642,244.00 −0.86 −2,354,473.00 −2.70 −1,712,229.00 −2.01

Book equity −16,800,000.00 −4.95 −20500,000.00 −5.45 −3,615,205.00 −0.79
Dividend-earnings ratio −1.89 −1.10 −2.07 −1.10 −0.18 −0.63
Price/earnings ratio −37.00 −1.15 −35.67 −1.02 1.33 0.29
Book/market equity −0.75 −3.33 −0.51 −2.34 0.24 1.02
Leverage −0.49 −2.50 −0.18 −1.20 0.31 1.58
Total assets −20,000,000.00 −5.06 −24,000,000.00 −5.51 −4,010,185.00 −0.76
Total debt −2,885,859.00 −4.90 −3,404,029.00 −5.30 −518,169.40 −0.69
Sales 96,300.73 0.26 −675,576.60 −1.61 −771,877.40 −2.22
EBITDA −238,762.20 −2.27 −411,452.50 −3.36 −172,690.30 −1.45
Income −117,794.70 −2.14 −211,830.70 −3.27 −94,036.03 −1.46
Notes: The difference in means testing of financial variables from a sample of 307 firms issuing sukuk or
conventional bond or both during the period January 2001-October 2015. Market equity is stock price
Table II. multiplied by common shares outstanding. Leverage is total debt divided by market equity. Book-to-market
Difference in equity is calculated as the book value of equity divided by the market equity, where book value is defined as
means testing net asset value of the firms
Our estimation window is 180 to 30 days before the announcement of a sukuk or a bond. When and why
We compute log returns and use a value-weighted market return. After the estimation of firms issue
Equation (1), we then compute abnormal return using the following: sukuk?
 
ARi;t ¼ Ri;t E Ri;t (2)

X 779
CARt ¼ ARt (3)

Equation (2) represents the abnormal return for firm i’s return in year t. The CAR is
computed by summing the firms’ abnormal return (Equation (3)).
The large dispersion in the financial characteristics of these firms as shown in Table I
might produce diverse CARs. So, we are interested to see whether these characteristics
can explain the CARs we estimated earlier. For example, a firm’s financial constraints may
explain the investors’ reactions. Table II shows that firms which issue sukuk and bonds
differ in their fundamental characteristics. We hypothesize that the firms participate in the
sukuk market because the market barriers are lower. We test whether financial
characteristics of the firms can predict the outcomes of CAR. We regress firm characteristics
on the CARs as follows:

CARi;t ¼ X Ti b þ A i (4)

where X ti is a vector of size, book equity, dividend-earnings ratio, price-earnings ratio,

book-to-market equity, leverage, total asset, total debt, sales, EBITDA, and income. leverage
is defined as the total debt divided by market equity, book-to-market equity is calculated as
the book value of equity divided by the market equity, and size is the natural logarithm of
market equity. Leverage is a proxy for the firms’ financial risk that might arise from a
higher amount of debt. Investors may react negatively if a firm increases its financial risk by
issuing more debt. Book-to-market reflects the performance of a firm in the market.
The lower the ratio, the better performing is the stock. Thus, the coefficient will be positive,
if the issuing firms are trying to signal that the stocks are undervalued. Sales, EBITD, and
income represent firm earning potential. Total asset, total debt, sales, EBITDA, and income
variables are normalized by using natural logarithm of reported values.
Finally, we test whether any of these financial characteristics can predict the likelihood
of sukuk issuance. A logit regression will show what firm characteristics are more
associated with sukuk issuing firms. We use a logistic regression for this purpose, with
dependent variable equal to 1 if the firm issues sukuk and 0 otherwise.

4. Results
4.1 Investor reaction to issuance of sukuk
We want to investigate how investors react to the issuance of sukuk. Also if investors react
differently to sukuk issuances compared to bond issuances. To do this, we estimate a firm’s
CARs for three days before and after (−3, +3) the announcement of a new capital issue. We
assume that the market absorbs any new information within seven days. But there is a
potential for quicker absorption, because of information leakage. To control for this, we also
estimate CAR for (−3, 0) and (−29, 10). These results might be influenced by very high and
very low market capitalization of firms. So, we winsorize the upper 5 percent and the lower
5 percent of issuers for market capitalization to get rid of possible outliers. After
winsorization 307 firms and 5,516 total capital issues remain.
We estimate the investor reactions for the issuance of conventional bonds, Sukuk, and
issuers of both. The results are presented in Table III.
MF Conventional bonds (%) Sukuks (%) Both (%)
44,6 Observation 2,502 2,256 2,736

Statistics
(−3, 0) 0.00 −0.18 −0.10
(−3, +3) −0.02 −0.44* −0.17
(−29, +10) 0.43 −0.98* −0.53
780 Notes: Cumulative abnormal returns (CAR) are estimated using the market model for a sample of 5,516 event
days from 307 firms for the period January 2001-October 2015. Three event windows (seven, four, and 40) are
Table III. used for the estimation. CARs are reported for the issuance of conventional bonds, Sukuks, either instrument
Investor reaction for issuers of both instruments, bond for issuers of both instruments and sukuk for issuers of both
of new issues instruments. *p-value o0.10; **p-valueo 0.05; ***p-value o0.01

Like Godlewski et al. (2010), we find significantly negative CARs for seven-day and 40-day
event windows. Godlewski et al. (2010) use a very small sample of firms issuing both
conventional bond and sukuk. We contribute to their findings by studying more bond and
sukuk issuances. The results show that overall issuing firms experience a 0.44 percent value
loss within the first three days of sukuk issuance. When we expand the event window to one
month, the firm’s loss increases to (0.98 percent) in one month.
We conclude firms who issue sukuk on average experience a negative market reaction
around the announcement of sukuk. When we expand the event window, firms continue to
experience a negative market reaction. A larger market reaction following the
announcement of sukuk is not surprising. Tables I and II show that small firms are more
likely to issue sukuk. Furthermore, those firms may be less liquid than are bond issuing
firms. Therefore, any negative market reaction that firms may experience can last longer.
Investors of small firms may take a longer time to react to new information.
The market reaction for bonds is also reported in Table III. Considering the bonds
market reaction, we do not find any significant reaction. We find a similar result when we
consider firms that issue both conventional bonds and sukuk. The absence of a significant
market reaction for bond issuing firms reinforces the argument of Nagano (2016). The
author finds that participation in sukuk market is less constrained. Thus, it allows
financially weak firms, who are more likely to be punished by the market for the issuance of
the debt instrument, to participate in the market. This explanation can justify the negative
CAR for the sukuk issuer, while insignificant CAR for issuers of both instruments when
they issue sukuk. Furthermore, we believe that the absence of a significant result in the
sample of both bond and sukuk issuers could simply be because our sample is too noisy.
Investors have both a neutral or positive reaction to the issuance of bonds.

4.2 Determinants of investor reaction and on likelihood of sukuk issuance

Abnormal returns may be affected by many factors such as firm size, growth, leverage,
profitability, industry, and age. To study what factors affect abnormal returns for sukuk
issuing firms, we regress CARs on firm size (market equity), leverage, relative firm
performance (book-to-market equity), price-earnings ratio, sales, EBITDA, and income. Size,
sales, EBITDA, and income are normalized using the natural logarithm. The results in
Table IV show that price-earnings ratio is negatively related to abnormal return. It means
that investors do not appreciate issuance of sukuk by firms with lower earnings. As for
other variables, we do not find any significant relationship. The results of this investigation
are reported in Table IV.
The results in Table IV show that price-earnings ratio is negatively related to the
abnormal return. A negative coefficient for the price to earnings ratio could mean that firms
 CAR(−3, 3) CAR(−3, 0) CAR(−29, 10)
When and why
CAR (1) (2) (3) firms issue
sukuk?
Market equity 0.06% (0.31) 0.03% (0.1) 0.50% (0.78)
Price-earnings ratio −0.0007%** (−2.43) −0.001%** (−2.3) −0.0017%* (−1.78)
Book-to-market equity −0.04% (−0.5) −0.19% (−1.6) −0.30% (−1.12)
Leverage 0.16% (0.99) 0.19% (0.75) −0.05% (−0.09)
Sales 0.08% (0.41) 0.38% (1.23) 0.29% (0.43) 781
EBITDA −0.13%* (−1.8) −0.10% (−0.87) −0.09% (−0.34)
Income 0.03% (0.5) 0.01% (0.14) −0.13% (−0.59)
Intercept −1.01% (−0.56) −4.62% (−1.68) −8.34% (−1.35)
Notes: Descriptive statistics of financial variables from a sample of 307 firms issuing sukuk or conventional
bond or both during the period January 2001-October 2015. Statistics are divided into three parts: whole
sample, issuers of sukuk, and issuers of conventional bonds. Market equity is stock price multiplied by
common shares outstanding. Leverage is total debt divided by market equity. Book-to-market equity is
calculated as the book value of equity divided by the market equity, where book value is defined as net asset Table IV.
value of the firms. Size, sales, EBITDA, and income are normalized using natural logarithm. Values in Linear regression on
parenthesis are t-values. *p-value o0.10; **p-valueo0.05; ***p-valueo 0.01 firm characteristics

with a higher price to earnings ratios experience a larger negative reaction. As we develop in
the following section, the adverse reaction could be because companies that do not face high
capital constraint (high P/E ratio) experience large negative sukuk vacations. Sukuk
imposes more costs on firms and sukuk requires shareholder cashflow. Therefore, investors
should react negatively to the issuance of sukuk.
To further analyze whether the financial characteristics can predict the likelihood of
issuance of sukuk, we use a logistic regression. We regress the issuance of sukuk on of firm
size (market equity), leverage, relative firm performance (book-to-market equity),
price-earnings ratio, sales, EBITDA, and income. In this specification, the dependent
variable is 1 if a firm issues sukuk, and 0 otherwise. The results are presented in Table V.
Table V shows that market equity, book-to-market, leverage, and income are negatively
related to the issuance of sukuk. We conclude that larger firms are less likely to issue sukuk
and smaller firms are more likely to issue sukuk. Small firms may face restrictions to issue
conventional bonds. Small firms may face larger capital constraints and significant flotation
costs. Large firms are less likely to suffer from different financial constraints or risks.

Dependent variable Sukuk issuance

Market equity −0.56*** (−8.53)

Price-earnings ratio 0.0015 (1.34)
Book-to-market equity −0.13*** (−8.26)
Leverage −0.22*** (−5.03)
Sales 0.50*** (9.39)
EBITDA 0.05 (0.61)
Income −0.16** (−2.40)
Intercept 2.28*** (5.79)
Notes: Descriptive statistics of financial variables from a sample of 307 firms issuing sukuk or conventional
bond or both during the period January 2001-October 2015. The dependent variable is 1 if firm issues sukuk,
and 0 otherwise. Market equity is stock price multiplied by common shares outstanding. Leverage is total
debt divided by market equity. Book-to-market equity is calculated as the book value of equity divided by the Table V.
market equity, where book value is defined as net asset value of the firms. Size, sales, EBITDA, and Logistic regression on
income are normalized using natural logarithm. Values shown in parenthesis are t-values. *p-valueo 0.10; sukuk vs bond
**p-valueo0.05; ***p-valueo 0.01 issuance
MF Issuing debt does not significantly increase the chance of future turmoil for large firms. So,
44,6 increasing firm size decreases the likelihood of sukuk issuance. Moreover, firms with a
higher book-to-market equity and leverage are less likely to issue sukuk. Higher income also
discourages firms to issue sukuk. On the other hand, firms with higher sales are more likely
to issue sukuk.
Our results indicate that entry restriction in the conventional bond market for smaller
782 firms with poorer financial health can persuade them to issue sukuk instead. Usually highly
risky and technology firms are growth firms. Issuance of sukuk by such firms means that it
wants to share profit and loss. When a growth firm wants to share profit and loss, it does not
send a good signal to the market. Investors bid the price of such firms down if the firms
announce the issuance of sukuk. Another issue might be the information content of the sukuk.
There is a possibility that investors see the risk-sharing status of sukuk as an indicator for an
unfavorable future prospect from the firm’s point of view. As Klein and Weill (2016) reports,
there is information asymmetry and adverse selection with sukuk issuance. However, if that
were the only concern, then healthier or larger firms would not issue sukuk.

5. Discussion and model proposal

The results from the previous section seem to indicate that small firms, or firms with high
barriers to entry into the bond market, tend to offer sukuk more than do large firms.
Furthermore, firms that face may be more capital constraints are also more likely to issue
sukuk. Smaller firms may be more likely to issue sukuk.
In the next section, we propose a model to explain the reaction of investors’ sukuk
issuance compared to bonds. The model gives insights into when firms would choose to
issue bonds and when they would choose to issue sukuk. The simple model begins by
assuming firms have the choice of issuing a bond or sukuk. After choosing to issue a firm is
either a good firm (α ¼ 1) or a bad firm (α ¼ 0). We assume firms choose between bonds and
sukuk based on the probability of the funded project being successful (α). The selection of
sukuk or a bond is illustrated in Figure 1.
At the end of each terminal node, we compute the payoff to the firm (top) and the payoff
to the debt investor (bottom). Pg represents the project profit, g represents the project or
assets salvage value, i represents the interest rate on a bond, rs represents the rate paid by
sukuk, and X represents the face value of a bond. If a firm chooses to issue sukuk and the
project is successful (α ¼ 1), then the payoff to the firm is Pg − rs or the payoff of the project
less the value required by the issued sukuk. Similarly, if a firm chooses to issue a bond the
payoff to a firm is Pg − i or the payoff of the project less the interest paid on the bond.

Firm
Bo
k
ku

nd
Su

(1 – ) (1 – )
Figure 1.
Modeling sukuk Pg – rs 0 Pg – i – X
vs bonds X– 
rs  i
From the perspective of a firm, our model reveals one key difference if a firm is a bad firm, it When and why
would prefer to issue sukuk. If a firm chooses to issue a bond and the project is not firms issue
successful, then a firm suffers in value g−X or the salvage value less the value of the bond. sukuk?
In most cases, this value is sure to be negative.
Next, we consider the preference of a firm to issue sukuk or bonds based on the value
maximizing principle. In an extreme situation when α ¼ 1 meaning the firm investment is
guaranteed to be successful the value to a firm is: 783
   
a ¼ 1 : E ½u ¼ 0:5 P g rs þ 0:5 P g i (5)
If we assume r s 4i, then:
   
P g rs o P g i (6)
Thus a good firm will always prefer to issue bonds. Furthermore, if we consider the reverse
situation α ¼ 0, then:
a ¼ 0 : E ½u ¼ 0 þ0:5ðgX Þ (7)

ðgX Þo 0 (8)
Therefore, a firm with poor prospectus will always prefer sukuk. We can develop one more
type of firm, one that has mixed investment opportunities 0 < α <1. In this situation, the
payoff to the firm would be:
   
0 oa o1 : E ½u ¼ a P g r s þ0 þa P g i þ ð1aÞðgX Þ (9)
Using the same assumptions as previously a firm would only prefer sukuk when:
ð1aÞðgX Þ4 ðrs iÞ (10)
Therefore, if a firm has uncertainty or mixed prospects, a firm would choose to issue sukuk
on a project by the project basis. A firm with poor (good) projects will want to invest using
sukuk (bonds), and investors should respond positively (negatively or neutral). If a firm has
mixed projects, it should consider each project individually, because investors should
respond to the issuances of sukuk based on the value gain to a firm. Our model indicates
that when firms have good prospects, investors will react negatively because a firm is
giving more equity or more cashflows than required. Conversely, if investors have poor
growth prospects, investors should react positively or neutrally. In this situation, a firm is
receiving more value by issuing sukuk.
We are limited by data to test the full empirical implications of our model. However, we
employ the same CAR regressions from the previous sections; however, we subdivide firms
into good and bad. We proxy good and bad firms by two financial ratios. Dividend/earnings
(D/E ratio) is one measure of financially constrained firms. A high D/E ratio means that a
firm is more likely to have better future growth prospects. Book-to-market is a similar
measure. A higher book-to-market value means investors value a company more relative to
its market value. Therefore, this signals better future growth prospects for a firm if the
predictions of our model are correct. Better firms should have a negative market reaction to
sukuk issuance, while firms with poor growth prospects will have a neutral or positive
reaction to sukuk issuance. The results of our analysis are presented in Table VI.
Table VI shows evidence for the prediction of our model. While Table III shows that overall
firms face a negative market reaction to sukuk issuance, Table VI shows that only good firms
face a negative market reaction. Looking at only sukuk issuing firms, during our event
window (−29, +10) when dividing firms by D/E ratio firms face a −2.1 percent negative
market reaction. The results are similar for firms when dividing by book-to-market equity.
MF Bottom quartile Top quartile
44,6 Statistics (−3, 0) (−3, +3) (−29, +10) (−3, 0) (−3, +3) (−29, +10)

Panel A: Dividend-earnings ratio

Both
Observation n ¼ 234 n ¼ 791
CAR (%) −0.10 −0.40 0.70 0.00 −0.20 −0.50
784 Bonds only
Observation n ¼ 293 n ¼ 701
CAR (%) 0.60 0.60 1.80 −0.4* −0.40 0.80
Sukuk only
Observation n ¼ 216 n ¼ 540
CAR (%) −0.20 −0.60 −0.60 0.00 −0.70 −2.1*
Panel B: Book-to-market equity
Both
Observation n ¼ 686 n ¼ 728
CAR (%) 0.00 0.40 0.50 −0.10 −0.60 −2.0**
Bonds only
Observation n ¼ 554 n ¼ 790
CAR (%) 0.40 0.50 0.90 −0.003* −0.30 −0.30
Sukuk only
Observation n ¼ 605 n ¼ 402
CAR (%) 0.10 0.10 0.30 0.30 −0.70 −2.7*
Table VI. Notes: Cumulative abnormal returns (CAR) are estimated using market model for a sample of 5,516
Investor reaction with event days from 307 firms for the period January 2001-October 2015. Three event windows (seven, four, and
different capital forty) are used for the estimation. CARs are reported for the bottom and top quartile by dividend-earnings
constraints ratio, and book-to-market equity ratio. *p-valueo0.10; **p-value o0.05; ***p-value o0.01

Furthermore, firms in the bottom quartile do not suffer from the same sukuk market reaction.
We hypothesize that this is because poor firms raising funds have little implications on
stockholders. If a poor firm fails to deliver on sukuk, they share the loss. However, if a
poor firm is successful, they are able to pay back sukuk holders as well as raise the value
of equity holders.

6. Conclusion
A large variety of firms issues sukuk. There are many small firms, as well as large firms
issuing sukuk. We conduct an event study to see why firms issue sukuk and how the
investors perceive the issuance of sukuk. We provide the most comprehensive study of
investor reaction to sukuk issuance. We select three different event periods and find
significant negative abnormal returns around the announcement date of sukuk issuance for
seven-day and 40-day event windows.
We use linear regression to see whether financial conditions of the firms can explain such
diverse investor reactions. We find that the earning prospect of issuer firms affects the
investor reaction. Firms with lower earning prospect receive a negative reaction from
the investors. We use logistic regression to see whether financials of a firm can predict the
likelihood of sukuk issuance. We find that smaller, or financially unhealthy, firms are more
likely to issue sukuk. Smaller and riskier firms issue sukuk, because participation in the
market is less constrained. In other words, the risk-sharing nature of sukuk might imply that
the firm is not confident about the future prospects. However, if the firm has good earnings
prospects, investors react to the issuance of sukuk negatively.
Our findings have important policy implications. Literature and conventional wisdom
consider conventional bonds and sukuk comparable. More importantly, the prior literature
considers sukuk a safer investment than bonds. However, the results of our model and When and why
empirical findings do not support this conclusion. Our findings suggest that conventional firms issue
bonds and sukuk are two distinct funding sources. Furthermore, they should be treated as sukuk?
unique investments. Currently, sukuk issuances are rated in a similar manner as an
unsecured debt (S&P Ratings Services, 2015). However, our model suggests that more care
should be taken to rate the cashflows of an individual project rather than the rating the firm
itself. Additionally, our empirical findings suggest that investors realize the possibility of 785
wealth creation for capital-constrained firms. While we study the largest set of sukuk
issuances, additional research should seek to include a more diverse collection of countries.

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 MF Appendix
44,6

Year Amount Sector Amount Country Amount

2001 5,030 Communications 8,580 Bahrain 16,700

786 2002 7,540 Consumer discretionary 22,000 Bangladesh 59.40
2003 6,490 Consumer staples 7,140 Bermuda 794
2004 14,100 Energy 20,000 Britain 345
2005 20,800 Financials 308,000 British Virgin 2,880
2006 38,300 Government 339,000 Brunei 6,230
2007 56,900 Health care 2,050 Cayman Islands 64,300
2008 42,100 Industrials 66,000 France 0.62
2009 52,300 Materials 19,200 Gambia 92.10
2010 60,100 Technology 9,350 Germany 109
2011 104,000 Utilities 55,500 Guernsey 60
2012 148,000 Hong Kong 3,000
2013 132,000 Indonesia 48,800
2014 110,000 Jersey 19,700
2015 59,800 Kazakhstan 77.10
Kuwait 703
Luxembourg 13,000
Malaysia 573,000
The Netherlands 124
Nigeria 70.90
Oman 130
Pakistan 9,720
Qatar 22,300
Saudi Arabia 37,300
Senegal 205
Singapore 1,770
SNAT 200
South Africa 1,000
Switzerland 24.70
Turkey 17,100
Table AI.
Sukuk issuance UAE 16,400
during the Yemen 713
period January, Notes: The total issuance of $857 billion is divided between subcategories. Years, sectors, and countries are
2001-October, 2015 selected to represent subcategories (amounts in $millions)

About the authors

Hasib Ahmed is a PhD Candidate at the University of New Orleans, New Orleans, Louisiana, USA.
M. Kabir Hassan is a Professor of Finance and Hibernia Professor of Economics and Finance and
Bank One Professor in THE Business Department of Economics and Finance at the University of
New Orleans, New Orleans, Louisiana, USA. M. Kabir Hassan is the corresponding author and can be
contacted at: [email protected]
Blake Rayfield is a PhD Candidate at the University of New Orleans, New Orleans, Louisiana, USA.

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