Islamic Finance and the Theory of Capital Structure
Mamoru Nagano†
ABSTRACTThis paper empirically investigates firms using Islamic finance in Malaysia andMiddle East countries. The comparative analysis of Islamic finance and non-Islamic financeusers resulted in three major implications. First, Islamic bond issuers preferentially choose theIslamic bond issuance prior to bank borrowing and other external financing tools. Second,
Islamic bond issuance is not related to the issuer’s internal funds, while Islamic bank borrowing
is significantly influenced by the magnitude of a firm’s internal funds. These results suggestthat Islamic bond issuers do not always choose to issue bonds based on information cost, but
Islamic bank borrowers always do. Third, the Islamic bond issuance contributes to an increasein the issuer’s stock returns and total factor productivity. This empirical result suggests that
Islamic bond issuance is preferred because of this unique benefit which standard externalfinancing does not have.
JEL Classification: G20, G21, G32
Keywords: Capital Structure, Bond Issuance, Islamic FinanceI.

Introduction

Islamic financing scheme has recently emerged as the new international fund source
even for many firms from non-Islamic countries as shown in the following examples. For
instance, total funding volume by Islamic bond issuance (hearafter referred as “Sukuk”) asrecorded in the London market was as large as that in the Middle East countries. In East Asia,
the largest Japanese automobile manufacturer, Toyota Motors, also employed Sukuk as afunding scheme in July 2008. Realier, in 2007, the world total Sukuk issuance and Islamic bankborrowing were USD 47 billion and USD 29 billion, respectively. One important factor forthis increasing trend is the progress achieved towards market oriented economy by the Islamic
world. Reflecting the recent soaring natural resources prices, incoming cross-border securities
investments to the Islamic countries dramatically increased which promoted the financial
market development in these areas. In addition, multi-national firms from non-Islamic
countries are expecting future large returns from the 1.1 billion population of the Islamic† Corresponding author, Professor, Nagoya City University, Yamanohata 1, Mizuho, Nagoya 467-8501 Japan,

Tel/Fax：+81-52-872-5736, Email: mnagano@econ.nagoya-cu.ac.jp
The author thanks David Brown, Takashi Kondo and the anonymous reviewers for their helpful comments andsuggestions. This research is financially supported by Nihon Hosei Gakkai.

1society. Apparently, these firms employ Islamic finance as a funding scheme as a way tolocalize their business operations.
It is well known that Islamic finance has the characteristics of both debt and equity
issuances. Originally, prohibition of interest receipts or payment has made this financial
scheme a quasi profit sharing type of finance. Investors and lenders receive some form of
dividends from fund raisers, instead of interest receipts. The dividends vary depending onfund raisers’ future profitability. Since Islamic finance has intermediate characteristics of debt
and equity finance, our overall hypothesis that the determination of this financing choice is also
an intermediate determinant between debt and equity issuance. There are many literatures on
corporate capital structure based on pecking order and trade off theory. However, few
literatures examine Islamic finance using the theory of capital structure. Our major aim in thispaper is to determine if Islamic finance imposes larger agency costs to investors or if it brings anadditional unique benefit to users. Hence, our analysis will attempt to identify thedeterminants of Islamic finance use from the theory of capital structure. We believe it
contributes to explain the recent development of Islamic finance market.
This study first presents the recent developments of the Sukuk issuance and theIslamic borrowing markets by showing our empirical data. In the following two sections, we
introduce our hypotheses, how it interacts with existing literature and empirical methodology.
Sections III-V, show the empirical models and the results. Based on the three empirical results,
we derive implications and provide conclusions of this study in a final section.
II.

Backgrounds

The size of Sukuk market was USD 400 million by end December 1995, but it
dramatically expanded since 2001. Volume of the primary market in 2007 was recorded USD
47 billion, 60 times as large as that of 2001. Such recent dramatic increase could be attributed to
the Kuala Lumpur market development promotion by the Malaysian government. This
government’s promotional policy triggered an increase in several new types of bond issuancesuch as Ijara Sukuk, Musharakah Sukuk as the government provided preferential tax
treatments for them. The increase in the number of Sukuk schemes also encouraged theparticipation of fund raisers to choose the most appropriate schemes among them.
The recent remarkable trend of the Sukuk market development is longer bondmaturity and high credit rating. Sukuk with over five year maturities accounts for more than 69
percent of the total Sukuk issued in 2001-2008 with more than 29 percent of the total accounted
for by the over ten-year maturity bonds. Furthermore, the Malaysian credit rating agency,
MARC, provided “AAA”, “AA” and “A” to eighteen percent, twenty percent and sixty one
percent of the total Sukuk issued in Malaysia, respectively. Total ninety nine percent of the
Sukuk issued in Malaysia has at least more than “A” rating in the primary market. Remarkably,
no default deal has been announced since 2001.
Development of the Islamic banking market was not remarkable until 2004, reflectingsome development delays of a few years after the Sukuk growth. While the Sukuk market
development is led by Malaysia, that of the Islamic banking is pulled by Middle East countries.
Saudi Arabia has the largest Islamic banking market recording USD 17 billion from January
to June 2008. The second largest market is the United Arab Emirates with USD 9 billion in theabove period. Gulf Cooperation Countries (GCC) countries, meanwhile, deregulated the new2

entry of foreign banks since 2005, contributing to the dramatic expansion of Islamic banking
market since then.
Table.1 Total Funding Volume of Islamic Finance by Region ( in USD million)
Sukuk Issuance
Total
2005
2006
2007

Islamic Bank Borrowing

Malaysia

12,034(100.0%)27,167(100.0%)46,950(100.0%)8,747(72.7%)
15,048(55.4%)
26,529(56.5%)GCC 6

Others2,341(19.5%)
11,191(41.2%)
18,710(39.9%)

Total

946(7.9%)
928(3.4%)
1,711(3.6%)

Malaysia

8,528(70.9%)
19,273(70.9%)
29,312(62.4%)

102(0.8%)
230(0.8%)
70(0.2%)GCC 6

Others7,848(65.2%)
18,443(67.9%)
22,230(47.3%)

578(4.8%)
600(2.2%)
7,011(14.9%)

Source: Author’s calculation based on ISI Emerging Markets.
Note: GCC 6 countries consist of United Arab Emirates, Oman, Kuwait, Qatar, Saudi Arabia and Bahrain.

Table 2.

Total Funding Volume of Sukuk Issuance in Malaysia by Type(in USD million)
Total

2003
2005
2007

4,072
(100.0%)8,747(100.0%)26,529(100.0%)Ijara Sukuk
350(8.6%)
2,028(23.2%)
4,105(15.5%)

Murabahah
Sukuk

Mudarabah
Sukuk

920
(22.6%)
3,737(42.7%)
8,516(32.1%)

939(23.1%)
26(0.3%)
2,743(10.3%)

MusharakahSukuk0(0.0%)
1,840(21.0%)
5,806(21.9%)

Others
1,863(45.7%)
1,116(12.8%)
5,359(20.2%)

Source: Author’s calculation based on ISI Emerging Markets.

III.

Existing Literatures and Testing Hypotheses

The number of literatures focusing on Islamic finance from the view point ofcorporate finance is not large. Other than that of Aggarwal and Yousef (2000), we cannot find
any focusing on capital structure. Their paper examined and compared the behavior of theIslamic banking activity with the non-Islamic banking sector, and confirmed that Islamicbanking has the characteristics of both debt financingg and equity issuance. In other words,
Islamic funding avoiding interest payment/receipt has very close characteristics withprofit-sharing type of financing. Benefits of money suppliers, i.e., investors and banks, forinstance, depends on future profitability of the issuers/borrowers in this case. Therefore,
investors and banks must monitor the performance of fund raisers, more carefully. This finding
intuitively points that the choice for Islamic finance depends on information costs between
corporate insiders and outsiders.
As shown by Myers and Majluf (1984), Harris and Raviv (1991) and Rajan andZingales (1995), many literatures focused on the funding order from the asymmetric
information in the corporate finance theory. This paper first examines if agency cost influences
the choice for Islamic finance by looking at funding order. Our hypothesis is that the Islamic
finance is chosen prior to equity finance, but subordinated to the normal bond issuance and3bank borrowings. Similar to profit sharing type of firms, the choice for a financing scheme isbased on information cost, i.e., size of the information cost of Islamic finance between debt
finance and equity issuance. Taking examples of fund raisers in Malaysia and Middle East
countries, this paper empirically verifies the order of the Islamic finance. Bolton and Freixas(2001) discussed the determinants of bond issuance of firms, i.e., the choice of bond issuanceand bank borrowing depends on flexibility of negotiation between fund raisers and money
suppliers. Our first analyses also considers comparison of the direct and indirect financing
tools.
Part two of this paper further analysed bond issuance based on trade-off theory. The
trade-off theory argues that firms balance the benefits of debt against the cost of debt and thecapital structure is then determined. Existing literature suggests that pecking order andtrade-off theories are mutually correlated. Jensen and Meckling (1976) regards information cost
as a kind of cost of debt. Ang et. al. (1982) also picked up bankruptcy cost as an example of costof debt. Thus, there can be a variety of definitions of benefit and cost of debt. Our hypothesis isthat Islamic finance markets attract potential participants when the financing brings in an
additional benefit which normal traditional external finance does not provide. We test thishypothesis by taking as an example the shareholder’s value and total factor productivity. In
addition to literatures based on pecking order and trade off theory, there exist other literatures
on Islamic finance. Dhumale and Sapcanin (1999), Errico and Farahbaksh (1998), Iqbal and
Mirakhor (1987) and Khan(1989) discussed the possibilities and perspectives of Islamic financeas a new development financing scheme and appropriate financial supervision called for1.
However, the studies did not focus on corporate financing aspect.
Since Modigliani and Miller (1958), many literatures suggest that firm’s capital
structure is not always neutral to the firm’s performance in the product market, but does
influence it from the view point of asymmetric information and trade off theory. This paper
also examines and determines if the choice for Islamic financing influences the corporate
performance in the post funding period.
IV.

Data

Our study uses the Islamic finance deal data from ISI Emerging Markets, Inc. andmatches them with the Thomson Reuters financial data. We first compared three Islamic
financing deal data, i.e., Bloomberg LP., Thomson Reuters and ISI Emerging Markets. We
employed ISI Emerging Markets because neither Bloomberg nor Thomson Reuters provide
information on the type of Islamic financing and we cannot accordingly distinguish types ofdeals, i.e., Ijara, Musharakah and Mudarabah. In addition, these data sources do not provide
Islamic banking data, either. The above qualitative information on the type of and other Islamicbanking data are absolutely necessary for our study. Since ISI provides such qualitative
information and banking data, but does not have financial data of the fund raisers. Therefore,
we matched the financial data of the Thomson Reuters with the ISI’s deal data. As for the firm’s

1 Dr. Kuran of South California University wrote a series prominent literature on Islamic finance by verifying how

Islamic finance had contributed to economic development in the Islamic society since the 1980s. Recent studies by
Kuran (2005) (2004) (2003) also focused on this matter from corporate financing view.

4

financial data, Thomson Reuters financial data, originally known as “Worldscope”, is more
useful than Bloomberg since it includes delisted and newly listed firms.
The ISI Emerging Market provides the 2001-2007 sample deal data for Sukuk and2004-2007 data for Islamic banking, but not for subsbscribers. Although sample period of the
Sukuk and Islamic banking data are different, we consider the bias, if any, as insignificant since
the number of issuers and borrowers is quite small during 2001-2003. The matched data
between ISI’s deal and Thomson Reuters financial data resulted in the following results. In
Malaysia, 417 firms issued a total USD61 billion of Sukuk in 2001-2007. Of these firms, 76 arelisted. The annual average number of Malaysian listed firms is 990 firms, hence, there are 76
issuers and 914 non-issuers. As for Islamic bank borrowing, a total of USD50 billion wereborrowed by GCC firms in 2004-2007. There were 86 firms that borrowed, of which 29 firms
are listed.
As Malaysian issuers are not concentrated on a limited number of industrial sectors,
the number of manufacturing issuers is as large as those of banks and real estate business firms.
DRB-Hicom, Tracoma Holdings are issuers from automobiles and parts industries and Forms
Resources, Symphony House are those from electronics industries. No particular industry
accounts for more than 30 percent of the market. On the other hand, one remarkable difference
between issuers and non-issuers is the firm size and profitability. Averages of these indicatorsof issuers statistically exceed those of non-issuers.
Different from Sukuk sample data, GCC Islamic banking borrowers mainly belong tocommercial banks or real estate business sector. Emirates Islamic Bank, Qatar Islamic Bank andSaudi British Bank are frequent borrowers of the Islamic banking market. In addition,
non-bank business borrowers such as National Leasing Inc. and Kuwait Finance House arealso participants of the market. Since interbank market is undeveloped in the region, Islamicbanking market seems to be used as a short-term funding tool by banks. Other thancommercial banks and non-banks, real estate business participants are main borrowers in themarket. These firms generally have large firm size since they have their own real estate orcommercial/residential buildings as their assets. Therefore, the firm size of the Islamic bankborrowers is larger than other listed firms in the region. Averages of firm’s profitability of theIslamic banking borrowers are also statistically larger than that of non-borrowers due to therecent real estate boom in the region.
Table 3. Overview of Sample Data (in USD million)(a) Sukuk Issures in Malaysia
AmountIssued(b) Islamic Banking Borrowers in GCC

Number ofIssuers

Listed Firms

AmountIssuedNumber ofIssuers

Listed Firms

2001
2002
2003
2004
2005
2006
2007

680
761
4,072
4,949
8,747
15,04826,529

3
4
25
48
71
150
116

0
0
10
14
18
18
16

1,178
7,848
18,443
22,230

4
16
28
38

2
4
10
13

Total
Year Average

60,786
8,684

417
60

76
11

49,69912,425

86
22

29
7

Source: Author’s estimates based on ISI Emerging Markets.

5

Table 4. Average Size, Profitability and Growth of Sukuk Issuers in Malaysia (in USD million)
Total Assets
Sukuk Issuers （N=48)
Non-Sukuk Issuers（N=941)
t-test Results for Difference between
Issuers and Non-issuers Averages

Issuers >NonIssuers

Return on Assets (%) Market to Book Ratio

4,499

3.361

1.061

389

1.200

1.197

***

Issuers >NonIssuers***

Issuers <NonIssuers***

Source: ISI Emerging Markets.
Notes:
1: The t-test for difference of averages between issuers and non-issuers are indicated as ***, ** and * for 1 percent, 5
percent and 10 percent levels of significance, respectively.
2: “Market to Book Ratio” is used as a proxy for a firm’s future growth opportunity .

Table 5. Average Size, Profitability and Growth of Islamic Bank Borrowers in GCC (in USD
million)Total Assets

Return on Assets (%) Market to Book Ratio

Islamic Bank Borrowers（N=25)

19,818

6.989

1.376

Non-Islamic Bank Borrowers (N=440)

4,294

5.876

3.224

t-test Results for Difference between
Issuers and Non-issuers Averages

Issuers >NonIssuers***

Issuers >NonIssuers*

Insignificant

Source: ISI Emerging Markets
Notes:
1: The t-test for difference of averages between issuers and non-issuers are indicated as ***, ** and * for 1 percent, 5
percent and 10 percent levels of significance, respectively.
2: “Market to Book Ratio” is used as a proxy for firm’s future growth opportunity.
3: GCC 6 countries are United Arab Emirates, Oman, Kuwait, Qatar, Saudi Arabia and Bahrain.

III.

Empirical Analysis 1: Common Characteristics of Islamic Finance Users

1.

Determinants of Sukuk Issuance

The first empirical analysis of this paper focuses on the determinants of Sukukissuance and examines the information cost of financing. As noted in the previous section,
Sukuk is categorized as an intermediate corporate financing tool between fixed interest
securities and equity issuance. Sukuk is originally structured to avoid interest payment/receipt
in a financial market and investors accordingly receive dividends from the issuer’s future profit,
instead. Thus, this profit sharing type of financial tool depends on internal information of theissuers when investors would like to receive the maximum dividends. In this paper, ourhypothesis of this is information cost of Sukuk issuance is between normal debt finance andequity issuance; the choice of this financing tool is accordingly subordinated to normal debt
finance, but prior to equity issuance according to pecking order theory. Another hypothesis
which is based on trade-off theory is that Sukuk is chosen prior to the above external financing
6when the financial scheme provides managerial merits to the issuer. We analyze this financial
order by examining the following empirical equations:（A) SUKUK it  const   1 ROAit 1   2 CFlowit 1   3 SIZE it 1   4 MBRit 1
  5 BANK it 1   5 Islam _ Pit 1   6 N _ BONDit 1   7 DERit 1  v it（B） N _ BONDit  const   1 ROAit 1   2 SIZE it 1   3 Islam _ Pit 1   4 DERit 1   it（C） BANK it  const  1 ROAit 1   2 SIZE it 1   3 Islam _ Pit 1   4 DERit 1   it

SUKUK : Sukuk Issued divided by book value of total liability, ROA : EBITDA divided by book value of total assets,
CFlow : cashflow divided by total sales, SIZE : natural logarithm of book value of total assets, MBR : book value of
liability plus market value of capital divided by book value of total assets, BANK : Bank borrowing plus inter-firmborrowing plus other debt increase divided by book value of total liability, Islam _ P : accumulated Sukuk issued byprevious year divided by book value of liability, N _ BOND : accumulated normal bond issued by this year divided
book value of liability, DER : book value of liability divided by market value of capital, Year01 -Year05: year dummy
variables, DUM1: =1 when the firm is real estate, building materials, engineering and construction, others=0, DUM2:=1 when the firm is coal, gas, mining, oil and the suppliers of energy, others =0, DUM3: =1 when the firm is acommercial bank, insurance firm, venture capital, investment fund and other financial firm, others =0, DUM4: =1
when the firm is electronics, internet provider, semiconductor manufacture, software and telecommunications,others=0

Variables of the empirical model (A) are employed to examine the determinants of
Sukuk issuance. In this model, we assume that internal funding ability and bank borrowing
influences the issuance of Sukuk. In our hypothesis, the parameter of the proxy of internal fund,i.e., ROA, Cash Flow and bank borrowing are negative as those are chosen prior to the Sukuk.
Model (A) also includes the issuer’s growth opportunity, i.e., market to book ratio, debt toequity ratio, and the past issuance experience of Sukuk and the normal bond issuance aspossible determinants that might influence Sukuk issuance. Since we estimate model (A) toverify financial order of Sukuk issuance based on information cost, parameter of accumulated
normal bond issued by previous year is negative as this is prior to Sukuk issuance. Model (B)tries to find out if the Sukuk issuance crowd outs the use of the normal bond issuance. Our
hypothesis is that the parameter of past Sukuk issuance experience is negative. In other words,
the Sukuk is chosen prior to the normal bond issuance based on Trade-off theory. The
empirical model (C) verifies if the past Sukuk issuance experience influences the bankborrowing as well. Our hypothesis is that the parameter of the Sukuk issuance experience isalso negative based on trade-off theory.
The empirical results are summarized as follows. Under model (A), six equations are
estimated to avoid possible correlations among the independent variables and confirm therobustness of the equations. The empirical results (a) to (f) suggest that natural logarithm oftotal asset, i.e., proxy of firm size, is positively related to the Sukuk issuance. These positive
parameters imply that large firms can access the Sukuk funding market more easily. In
addition, what the empirical results of (e) and (f) suggest is that Sukuk is chosen by firms thathave past issuance experiences. Firms without any previous experience of Sukuk issuance7

hardly employ this financing tool. In summary, it can be stated that two common
characteristics of Sukuk issuers are large firm size and past Sukuk issuance experience .
The empirical results for models (B) and (C) are indicated as empirical results (f) and(g) in Table 5. Empirical result (g) suggests that past Sukuk issuance experience negatively
influences the issuance of normal bonds for the current financial year. Empirical result (f) ofmodel (A) indicates that normal bond issuance of the previous financial year does not influence
the current year Sukuk Issuance. Therefore, issuance of Sukuk is considered to be chosen prior
to the normal bond issuance. In addition, empirical result (h) of model (C) indicates that Sukukissuance negatively influences the bank borrowing, while the parameter of Sukuk isinsignificant in empirical result (d). These empirical results imply that Sukuk issuanceinfluences both the normal bond issuance and bank borrowing, but neither the normal bondissuance and bank borrowing influences the Sukuk issuance.
Table 5A.

Empirical Results 1 : Determinants of Sukuk Issuance8Model (A)(a) Dep. Var.= Sukuk(b) Dep. Var.= Sukuk

ROA
CFlow
SIZE
MBR
BANK
Islam_P
N_BOND
DER
Dum1
Dum2
Dum3
Dum4
Year01
Year02Year03Year04
Year05Const

4.1E-05(0.010)0.001 *

(1.840)-1.2E-04
0.001 *(-0.040)(1.790)-0.001 ***-0.0010.011 ***
-0.004-0.001
0.003
0.002
0.005 **
0.005 **
0.002
-0.002(-2.560)(-0.570)(2.860)(-1.300)(-0.610)(1.350)(1.170)(2.440)(2.210)(1.030)(1.040)-3.7E-04 ***-0.0010.011 ***
-0.004-0.001
0.003
0.002
0.005 **
0.005 **
0.002
-0.004(-2.560)(-0.560)(2.870)(-1.270)(1.180)(1.350)(1.180)(2.430)(2.210)(1.030)(-1.480)

Wald chi2rho
Likelihood Ratio of sigma_u
Observations
Firms

22.060 **0.005
11.130 ***
4,620
955

21.960 **0.007
10.220 ***
4,602
954

(c) Dep. Var.= Sukuk

0.001 *
1.6E-04(1.880)(0.260)-0.001 ***-0.0010.011 ***
-0.004-0.001
0.003
0.002
0.005 **
0.005 **
0.002
-0.005(-2.580)(-0.550)(2.820)(-1.300)(-0.640)(1.340)(1.170)(2.430)(2.200)(1.040)(-1.520)

22.130 **0.005
10.120 ***
4,620
955

Model (A)(d) Dep. Var.= Sukuk
ROA
CFlow
SIZE
MBR
BANK
Islam_P
N_BOND
DER
Dum1
Dum2
Dum3
Dum4
Year01
Year02Year03Year04
Year05Const

0.001 *
-2.2E-07-0.0010.011 ***
0.000
-0.001
0.003
0.002
0.005 **
0.005 **
0.002
-0.004

Wald chi2rho
Likelihood Ratio of sigma_u
Observations
Firms(1.850)(-0.010)(-0.560)(2.910)(-1.360)(-0.600)(1.340)(1.140)(2.500)(2.230)(1.030)(-1.520)

22.550 **0.005
21.160 ***
4,708
951

(e) Dep. Var.= Sukuk(f) Dep. Var.= Sukuk

0.001 **

(2.000)0.001 **

(2.140)0.004 *

(1.710)6.7E-05(0.690)-0.0010.009 ***
-0.004-0.001
0.002
0.002
0.005 **
0.004 **
0.002
-0.004(-0.620)(2.740)(-1.480)(-0.560)(1.310)(1.110)(2.410)(2.170)(1.260)(-1.720)-0.0010.009 ***
-0.004-0.001
0.002
0.002
0.005 **
0.004 **
0.002
-0.004(-0.620)(2.760)(-1.480)(-0.550)(1.310)(1.100)(2.400)(2.160)(1.260)(-1.710)22.330 **0.003
17.040 ***
5,064
973

22.490 **0.001
15.010 ***
5,059
973

Notes: *** indicates the coefficient is significantly different from zero at the 1 percent level of confidence or less;** indicates the coefficient is significantly different from zero at 5 percent level of confidence* indicates the coefficient is significantly different from zero at 10 percent level of confidence

Table 5B.

Empirical Results 2 : Determinants of Sukuk Issuance9Model (B)Model (C)(g) Dep. Var.= N_BOND(h) Dep. Var.= BANK

ROA
CFlow
SIZE
MBR
Islam_P
DER
Dum1
Dum2
Dum3
Year01
Year02Year03Year04
Year05Const-1.2E+00 ***(-15.610)-5.241 ***(-3.740)-0.005(-0.460)

2.019 ***

(4.140)-0.570 *-0.004 **-0.0060.110
0.151 **
0.064
0.036
0.103
0.303
0.032
0.043

(-1.910)(-2.170)(-0.110)(1.160)(2.050)(1.230)(0.680)(1.940)(0.580)(0.570)(0.590)-0.335 *-3.3E-01 ***-0.989-0.010-6.636
0.537
0.305
0.924
1.225
0.386
-12.614 ***(-1.750)(-2.782)(-0.320)(-0.180)(-1.550)(0.670)(0.380)(1.140)(1.500)(0.470)(-4.560)

Wald chi2rho
Likelihod Ratio of sigma_u
Observations
Firms

262.610 ***0.007
37.210 ***
4,617
955

32.560 ***0.747
27.560 ***
4,483
942

Notes:*** indicates the coefficient is significantly different from zero at the 1 percent level of confidence or less** indicates the coefficient is significantly different from zero at the 5 percent level of confidence* indicates the coefficient is significantly different from zero at the 10 percent level of confidence

2.

Determinants of Islamic Bank Borrowing

This section examines the determinants of another Islamic financing tool, i.e., Islamicbank borrowing. While Malaysia is the world largest Sukuk market, firms rarely choose Islamicbanking as a financing scheme. GCC countries Bahrain, Kuwait, Oman, Qatar, Saudi Arabia
and United Abab Emirates hold the world’s largest Islamic banking market. We empiricallyverify the characteristics of the firms that promote and determine the use of Islamic borrowing
and the funding order of the borrowing. To examine the above propositions, we employedthese equations:(D)

IslamBit  const   1 ROABit 1   2 SIZEBit 1   3 DERBit 1
  4 BANKBit 1   5 IslamB _ Pit 1   it

IslamB : amount borrowed as Islamic bank borrowing divided by book value of total liability, ROAB : EBITDA
divided by book value of book value of total assets, SIZEB : natural logarithm of book value of total assets,
BANKB : Bank borrowing plus inter-firm borrowing plus other debt increase divided by book value of total liability,
IslamB _ P : accumulated Islamic bank borrowing by previous year divided by book value of liability, DERB : bookvalue of liability divided by market value of capital, Year01 -Year05: year dummy variables, DUM1: =1 when the firm
is real estate, building materials, engineering and construction, others=0, DUM2: =1 when the firm is coal, gas, mining,
oil and the suppliers of energy, others =0, DUM3: =1 when the firm is a commercial bank, insurance firm, venture
capital, investment fund and other financial firm, others =0, CDUM1-CDUM5: country dummy variables, i.e.,
CDUM1: =1 when the firm headquarters is in United Arab Emirates, CDUM2:=1 when the firm headquarters is in
Kuwait, CDUM3: =1 when the firm headquarters is in Bahrain, CDUM4: =1 when the firm headquarters is in Oman,
CDUM5: =1 when the firm headquarters is in Qatar.

10Equation (D) above employs the variables based on the following hypotheses. First,
ROAB is chosen as a proxy of the firm’s internal funding ability. We argue that firms with large
internal funds do not have to participate in Islamic banking market as borrowers. SIZEB is anatural logarithm of book value of firm’s total assets. Our hypothesis is that large firms aremostly those have long been established and have a channel to this funding market. BANKB isused as a proxy of firm’s dependency on non-Islamic bank borrowing or inter-firm credit. Our
hypothesis is that high BANKB firms avoid participating in the Islamic borrowing market.
Here, we assume the normal bank borrowing or inter-firm credit is preferentially chosen to
Islamic bank borrowing. IslamB_P is a variable that represents the past experience of Islamicbank borrowing. Our hypothesis, in this regard, is that firms that have past Islamic borrowing
experience can easily access this market. We employed Panel Tobit and GMM estimation andmade three types of estimations to avoid possible correlation among the independent variables
and confirm the robustness of the results.
Table 6 suggests that the parameters of ROAB are significantly negative as shown inempirical results (i) – (k), This is the major difference with the empirical result of Sukukissuance. Firms with huge internal funds avoid Islamic bank borrowing, while Malaysian firms
issues Sukuk regardless of the magnitude of their internal funding abilities. Islamic bankborrowing is chosen by large firms which is also true for Sukuk issuance. The empiricalresults (i) to (k) suggest that industrial concentration of Islamic bank borrowing users isremarkable in this case. Especially, firms in industrial sectors of real estate and urban
development business are frequent Islamic banking borrowers.
Table 6. Determinants of Islamic Bank Borrowers: Empirical Results
Model (D)(i) Dep. Var.= IslamB
IslamB(-1)
ROAB
SIZEB
DERB
BANKB
IslamB_P
Dum1
Dum2
Dum3
cdum1
cdum2
cdum3
cdum4
cdum5
Year01
Year02Year03Const
Wald chi2rho
Likelihood Ratio of sigma_u
Observations
Firms
Number of Instruments-8.9E-03 ***0.009 **
0.002 *
-0.002(-3.060)(2.430)(1.768)(-0.690)0.258 **
0.007
-0.0030.011-0.003-0.079 ***0.097
0.004 ***
0.053
-0.004-0.006-0.008(2.190)(0.260)(-0.300)(0.590)(-0.210)(-3.410)(0.530)(3.180)(0.750)(-0.270)(-0.330)(-0.200)(j) Dep. Var.= IslamB22.340 **0.094
27.200 ***
1,502
481

-0.002 *0.003 *
0.006(-1.660)(1.750)(1.490)0.181 ***
0.367 **
0.238
-0.0050.265-0.001-0.009 ***0.153
0.003 ***
0.051
0.256
0.997 ***
-1.873 **(4.430)(2.120)(0.620)(-0.340)(1.030)(-0.000)(-4.030)(0.590)(2.840)(0.500)(1.040)(3.800)(-1.860)

32.480 **0.139
3.910 *
1,502
481

Notes:

11(k) Dep. Var.= IslamB
0.036-0.009 *0.005 *
0.182
0.181 **

(0.673)(1.900)(1.880)(1.540)(2.540)0.219 ***
0.301
-0.0080.327-0.002-0.016 **0.188
0.037 **
0.116
0.362

(3.560)(0.570)(-0.400)(0.930)(-0.500)(-2.370)(0.530)(2.080)(1.460)(1.060)-3.166 **(-2.060)

13.490 *18.000653
365
18

1 : ***, **, * indicate significance at 1 percent, 5 percent and 10 percent levels of confidence, respectively.
2 : Equations (i) and (j) are estimated by panel tobit estimation and (k) is by GMM estimation.

IV.

Empirical Analysis 2: Islamic Bond Issuers and Shareholder’s Value

A major finding of the previous section is that Sukuk issuance is resorted to prior tonormal external finance, but the relationship with a firm’s internal funds is insignificant. On theother hand, as for Islamic bank borrowing, significant negative relationship exists between
internal funds and the Islamic bank borrowing. The first result does not support the pecking
order theory while the second is subordinated to the internal funds when information cost is
the smallest. These results support the observation that firms choose Islamic banking
depending on the information costs, but Sukuk issuance does not consider the magnitude of
the information cost. Therefore, we need to explore further evidence of Sukuk issuance, andwhy this financing scheme is chosen regardless of the internal funds.
Insignificant relationship between Sukuk issuance and the internal funds suggeststhat issuers were even cash affluent in some cases. This suggests that firms issue Sukuk toobtain other benefit no matter how large the information cost is. Our first hypothesis on this isthat firms obtain an increase in the corporate value by issuing Sukuk. To examine thishypothesis, we employed event-study methodology of Brown and Warner (1985) andcompared shareholder’s values between Sukuk issuers and normal bond issuers. We first
adopt a standard event study methodology to calculate abnormal returns originally developed
by Brown and Warner (1985). The abnormal returns over three-day event window (-1, 1),eleven days event window (-5, 5), twenty one days event window (-10, 10) and forty one days
event window (-20,20) around the issuance date using market model benchmark returns were
estimated and market benchmark indexes were respectively extracted from the Kuala Lumpur
market. By calculating abnormal returns of the above short-term and long-term event windows,
we discussed the sources and origins of this abnormal return differences. The parameters forthe market model were estimated over the (-250,-21) interval.
Table 7 shows the cumulative abnormal returns classified by Islamic and non Islamic
issuers. In table 7, cumulative abnormal returns of Sukuk issuers are significantly positive nomatter what the length of the event windows are. However, in case of normal bond issuers, thereturns are insignificant, commonly. As for the difference in the cumulative abnormal returns
between Sukuk issuers and normal bond issuers, difference of the return is significantly
positive. To summarize, these empirical results suggest that Sukuk issuance obviously
influences the stock price of the issuers, while the normal bond issuance does not as intuitively
perceived.
Table 7. Shareholder’s Value of Bond Issuers: Empirical Results

12(i) Sukuk Issuers(1)(j) Normal Bond Issuers(2)(k) Difference(2)-(3)(-1, 1)

Mean
Median

3.11% ***
1.85% ***

[5.71][5.53]-0.14%-0.06%[-0.37][-0.47]

3.25% ***
1.91% ***

[5.08][4.58](-5, 5)

Mean
Median12.43% ***8.36% ***

[6.03][6.30]

0.51%-0.17%[0.38][-0.02]

11.92% ***8.53% ***

[5.04][3.93](-10, 10) MeanMedian20.39% ***15.26% ***[6.71][6.45]

1.15%
0.30%

[0.52][0.33]

19.24% ***14.96% ***[5.26][5.09](-20, 20) MeanMedian31.88% ***23.76% ***[6.77][6.07]

2.65%
0.47%

[0.59][0.01]

29.23% ***23.29% ***[4.40][5.28]

Observations

72

91

Notes:
1. Cumulative abnormal returns for acquirers are calculated for the three-day (-1, 1), eleven days (-5, 5), twenty onedays (-10, 10) and forty one-day (-20, 20) events around the announcement of a takeover. Abnormal returns are
estimated using market index returns of mother country market of each acquirer. The parameters for the market
model are estimated over the (-250,-21) interval. All issuers are publicly traded listed on the domestic/foreign stock
exchange.
2. *** denotes significance at 1 percent level of confidence, ** denotes significance at 5 percent level of confidence and *denotes significance at 10 percent level of confidence.

V.

Empirical Analysis 3: Islamic Finance and the Firm’s Productivity

Sukuk issuance is preferentially chosen as a funding scheme as it brings higher stock
returns as examined in the previous section. This section provides further verification of thisresult. Our hypothesis of this increasing shareholder’s value origin is where the issuer enhances
the competitiveness in the product market through an improvement of the consumer’s
credibility and their organizational reputation. Final consumers support firms funded byIslamic finance if the quality of the products is as competitive as other firms in the Islamic
society. Since it is difficult to estimate these qualitative values of credibility and reputation
directly, we employed the following empirical equations to assess the issuer’s post issuance
performance.
(E) GTFPi  const  1 SUKKAi   2 SHARE i   3 ( SUKKAi * SHARE i )  4 ( SUKKAi ) 2   5 ( SHARE i ) 2   6 Ijara i   7 Musharakah i   8 Mudharabah i   i(F) GTFPi  SALES i   * LABORi   * MATERIALi  (1     ) * CAPITALi

GTFP : average total factor productivity (2002-2006), SUKKA : Sukuk issued divided by total liability (2002-2006
average), SHARE : total sales divided by aggregated sales of same SIC code of listed firms, IJARA : =1 when thetype of Sukuk is Ijara Sukuk others are =0, Musharaka : =1 when the type of Sukuk is Musharakah Sukuk others are=0, Mudharabah : =1 when the type of Sukuk is Mudharabah Sukuk, others are =0, DUM1: =1 when the firm is real13

estate, building materials, engineering and construction, others=0, DUM2: =1 when the firm is coal, gas, mining, oiland the suppliers of energy, others =0, DUM3: =1 when the firm is a commercial bank, insurance firm, venture capital,
investment fund and other financial firm, others =0, DUM4: =1 when the firm is electronics, internet provider,semiconductor manufacture, software and telecommunications, others=0, SALES : average sales growth(2002-2006),
LABOR : average number of employee growth (2002-2006), MATERIAL : average cost of raw materials growth(2002-2006), CAPITAL : average capital stock growth (2002-2006),  ,  are respectively share of personnel expenses
and cost of raw materials to the total sales. Total sales and cost of raw materials are deflated by GDP deflator.

Re

Empirical model of (E)-(F) did not use panel data, but cross-sectional data of the listed
firms since the methodology of total factor productivity estimation could not be done withoutobtaining time series data by each firm. Hence, GTFP is calculated from the 2002-2006 data foreach listed firms. We accordingly employed the independent variable of the five year average
2002-2006. Our empirical results are as follows. The parameter of Sukuk issued divided by total
liability is significantly positive. The parameter of the firm’s market share is insignificant, but
the intersected variables between market share and the Sukuk issued divided by total liability
is significantly positive. To examine the robustness of the above equations, this section also
shows the result of additional test of (F) in addition to the equation (E). The above results arealso found in this additional model.
Table 8.

Sukuk Issuance and Total Factor Productivity: Empirical Results(l) Dep. Var.= GTFP(m) Dep. Var.= GTFP

SUKKA
Share
SUKKA*Share
SK^2
SH^2
ROAA
SIZEA
DERA
Ijara
Musharakah
Mudharabah
Dum1
Dum2
Dum3
Dum4
Const

1.4E+00 ***-0.1100.565 ***
-0.2530.094(2.790)(-1.070)(2.940)(-0.080)(0.760)

0.032
0.064
0.001
-0.0090.034-0.003-0.0040.011(0.320)(0.490)(0.322)(-0.460)(1.020)(-0.120)(-0.200)(1.530)Adj R-squared
Observations

0.005
970

1.576 **
-1.2E-01
0.587 *
9.1E-02
0.123-5.3E-05-0.011
0.001
0.053
0.030
0.017
-0.005
0.052
0.016
0.013
0.059

(2.000)(-0.740)(1.810)(0.380)(0.510)(-2.782)(-1.290)(0.310)(0.460)(0.150)(0.300)(-0.180)(0.880)(0.410)(0.340)(1.590)0.004
616

Notes:
1 : ***, **, * indicate significance at 1 percent, 5 percent and 10 percent levels of confidence, respectively.
2 : Equations (l) and (m) are estimated by ordinary least squares.

VI.

Discussion

A subsidiary of the Japanese supermarket, AEON Credit Service, issued USD56
million of Musharakah Sukuk in January, May and October in 2007. During our interview
survey with them in 2006, financial officers of AEON Credit Service mentioned that their ROA
and Capital Adequacy Ratio of the firm are high enough and they would not have originally14depended on external funding market for their corporate finance. This preliminary interview
survey is a background of our hypothesis and suggests that the Sukuk issuance is notdetermined depending on information cost, but other managerial merits as shown in ourempirical results.
Our empirical results also suggest that Islamic bank borrowing is, on the other hand,
positioned as one of the corporate financing tools in GCC countries. Here, explanatory powerof pecking order theory is high. However, this funding scheme is used by firms in a limited
number of industrial categories and not many firms have access to this funding market. Realestate and the urban development business are among these industrial categories and thesefirms usually have large assets for their commercial activities. This is one of the reasons why
common characteristics of Islamic banking users are firms which are large. Our empiricalresults of Sukuk and Islamic bank borrowing pointed out that determinants of these financing
choices are different. Therefore, we must recognize that participants in the Malaysian market
and those in GCC Islamic banking market have a different purpose for their market entry.
One of the remarkable points of our empirical results is that the relationship between
the firms’ internal funds and Sukuk issuances are insignificant. This suggests that even firms
with huge internal funds might even issue Sukuk. We hypothesize that the issuer’s purpose isto enhance competitiveness in the product market through an improvement in final
consumer’s credibility. Although it is difficult to estimate the competitiveness and thecredibility, directly, we examined this by looking at shareholder’s value and total factor
productivity before and after the issuance and found these two indicators support the
hypothesis. This evidence suggests that direct financing tool of Sukuk issuance is moreconvenient for firms that would like to make a new entry in the local Islamic product market.
Therefore, this could be an important factor in the dramatic expansion of the Sukuk market in
the recent years.
Friedman (1970) defined a firm as “That responsibility is to conduct the business inaccordance with their desires, which generally will be to make as much money as possible
while conforming to the basic rules of the society, both those embodied in law and thoseembodied in ethical custom.” In this regard, it is understandable that Shariah qualified Islamic
finance is ethically preferred because of the latter reason. However, there are recent discussionsof this matter focusing on socially responsible ethical custom that may reduce shareholder’svalue. Since Jensen and Meckling (1976) and Easterbrook and Fishel (1991) regard corporate
activities as the “nexus of contracts” between the suppliers of various factors of productions
and shareholders have no contractual guarantee of a fixed payment from the activities, pursuitof the social contribution is not appropriate for the firm. These literatures suggest that Islamic
finance consequently reduce the corporate value and it must not be used if this financedeteriorates the managerial performance. On the other hand, Sheehy (2005) and Gabaldon(2006) suggested that sacrificing profits in the public interest is entirely allowed since corporate
directors have fiduciary responsibilities that extend to a wide variety of potential stakeholders.
In addition, Lyon and Maxwell (2004) and Vogel(2006) pointed out that firms with highcorporate performance frequently combined profit maximizing project and social responsible
activities. These also suggest that social responsible activities do not always reduce corporate
value, it sometimes accelerates it. Our empirical results regarding shareholder’s value and totalfactor productivity show that this idea can be a possible explanation why Sukuk issuers are
increasing in the Islamic bond market. Sukuk issuance is used not only as a corporate funding15

tool, but also used because it financially and ethically brings high benefit. Jensen et al. (2002),
Heinkel et al. (2001) and Graff Zivin and Small (2005) pointed out that these social responsible
activities not only improves the consumer’s credibility, but also increase corporate value
through an increase in additional equity investment from the emphatizing external investors.
The main conclusion of this paper is that Sukuk issuance and the Islamic bankborrowings are used by firms with different characteristics, sdifferent purpose and different
funding orders. Therefore, benefits that users receive from the funding tool are different
between Sukuk and Islamic bank borrowings. This paper does not employ the direct
qualitative survey to examine the above corporate purpose, etc., but we regard our empiricalresults of stock price effect and post issuance productivity support our hypotheses that Sukukissuance is used to enhance the competitiveness in the product market. This is also the reason
why non-Islamic multinational firms made new entry in the Sukuk market.
VII.

Concluding Remarks

Empirical evidences from this paper suggest that users of Sukuk and Islamic bankborrowing are different and the purpose of the use is also different. Accordingly, funding orderof these financial schemes is also different. Both financial schemes are used by large firms thathave past experiences of this type of funding, but the Islamic bank borrowing has an industrial
sectoral bias, i.e. borrowers are mainly real estate business or urban development business
firms. More than anything, Sukuk issuance is not possibly regarded as a primary funding tool.
In this regard, although a firm’s social responsible ethical custom may in general reduce theshareholder’s value in many industrial countries, this ethically desirable Islamic financeincreases the shareholder’s value and improve the issuer’s productivity. This is what we would
like to emphasize in our discussion based on the empirical results. The above finding is thereason why foreign investors increase the investment in Sukuk and the equity of the issuers
and improve their corporate performance in the product market in the post-issuance period.
These are our study’s main conclusions, but some of them are not directly derived from thesurvey. In particular, this paper did not directly examine the possible relationship between
corporate ethical custom and the Sukuk issuance. In addition, we employed total factor
productivity as a proxy of market competiveness in a product market. Future studies can verify
the relationship between final consumer’s credibility and firm’s productivity in a post issuance
period.

Reference
Aggarwal, R. K., and T. Yousef (2000), “Islamic Banks and Investment Financing,” Journal of Money,
Credit and Banking 32 (1) pp.93-120.
Ang, J., J. Chua, and J. McConnell (1982), “The Administrative Costs of Corporate Bankruptcy: A
Note,” Journal of Finance 37, pp. 219-226.
Butler, H., and F. S. McChesney (1999), “Why They Give at the Office: Shareholder Welfare andCorporate Philanthropy in the Contractual Theory of the Corporation, Cornell Law Review 84(July):
1195.

16

Dhumale, R., and A. Sapcanin (1999), “An Application of Islamic Banking Principles and MicroFinance: Technical Note,” World Bank Working Paper 23073.
Easterbrook, F., and D. Fischel (1991), The Economic Structure of Corporate Law.
Errico, L., and M. Farahbaksh (1998), “Islamic banking: Issues in Prudential Regulations andSupervision,” IMF Working Paper 98/30. International Monetary Fund, Washington, D.C.
Friedman, M., (1970), “The Social Responsibility of Business is to Increase its Profits,” The New YorkTimes Magazine, September 13.
Gabaldon, T. A., (2006), “Like a Fish Needs a Bicycle: Public Corporations and Their Shareholders,”
Maryland Law Review 65: 538.
GraffZivin, J. and A. Small, (2005), “A Modigliani-Miller Theory of Altruistic Corporate Social
Responsibility,” B. E. Journals in economic Analysis and Policy: Topics in Economic Analysis andPolicy 5(1): pp. 1-19.
Heinkel, R., A. Kraus and J. Zechner (2001), “The Effect of Green Investment on Corporate Behavior,”
Journal of Financial and Quantitative Analysis 36(4): p.431-449.
Iqbal, Z., and A. Mirakhor (1987), “Islamic Banking,” IMF Occasional Paper 49. International
Monetary Fund, Washington, D.C.
Jensen, M., and W. Mechling (1976), “Theory of the Firm: Managerial Behavior, Agency Costs andOwnership Structure,” Journal of Financial Economics 3(4): pp.305-360.
Jensen, K., P. Jakus, B. English and J. Menard, (2002), “Willingness to Pay for Environmentally
Certified Hardwood Products by Tennessee Consumers,” University of Tennessee, Department ofAgricultural Economics, Study Series No. 01-02.
Khan, M., (1989), “Islamic Banking; Experiences in the Islamic Republic of Iran and Pakistan,” IMF
Working Paper 89/12, International Monetary Fund, Washington, D.C.
Kuran. A., (2005), "The Logic of Financial Westernization in the Middle East." Journal of Economic
Behavior and Organization, 56 (April 2005): pp. 593-615.
Kuran. A., (2004),"Why the Middle East Is Economically Underdeveloped: Historical Mechanisms of
Institutional Stagnation." Journal of Economic Perspectives, 18 (Summer 2004): 71-90.
Kuran. A., (2003), "The Islamic Commercial Crisis: Institutional Roots of Economic
Underdevelopment in the Middle East." Journal of Economic History, 63 (June 2003): 414-46
Lyon, T. and J. Maxwell (2004), Corporate Environmentalism and Public Policy, Cambridge
University Press: Cambridge.
Samad, A. and Kabir Hassan (1999), “Performance of Malaysian Islamic bank during 1984-1997: An
Exploratory Study,” International Journal of Islamic Services1(3).
Sheehy, B., (2005), “Scrooge The Reluctant Stakeholder: Theoretical Problems in the
Shareholder-Stakeholder Debate”, University of Miami Business Law Review 14(Fall/Winer): 193.
Vogel, D., (2006), The Market for Virtue. Washinton, D.C., Brookings Institution Press.

APPENDIX 1:

Explanation of Data Employed in Study

17

1.

Number of Sukuk Issuers and Non-Issuers(A) Sukuk Issuers(B) Normal Bond Issuers(C) Non-Sukuk(a) All(b) Listed Firms (a) All(b) Listed Firms
Issuers
2002
2003
2004
2005
2006
2007

Total

4
25
48
71
150
116

0
10
14
18
18
16

303
112
158
375
390
505

25
27
42
41
42
71

708
763
834
904
924
953

708
773
848
922
942
969

414

76

1,843

248

5,086

5,162

Note: Author’s estimates based on ISI Emerging Markets.

2.

Number of Sukuk Issuers and Non-Issuers by Type(a) Ijara Sukuk(b) Musharakah Sukuk(c) Mudarabah Sukuk(d) BBA(e) Others(A) Sukuk Issuers by
Type(f) Total(B) Listed Issuers by Type

(B)/(A)(a)～(e)/(B)

57
46
10
82
219

4
2
3
14
51

7.0%
4.3%
30.0%
17.1%
23.3%

5.4%
2.7%
4.1%
18.9%
68.9%

414

74

17.9%

100.0%

Note: Author’s estimates based on ISI Emerging Markets

3.

Number of Islamic Bank Borrowers(A) Islamic Borrowers(a) All(b) Listed Firms

16
28
39
86

4
9
11
12

437
485
511
465

441
494
522
477

169

36

1,898

1,934

2004
2005
2006
2007

(B) Non-Islamic Borrowers(C) Total

Note: Author’s estimates based on ISI Emerging Markets

4.

Number of Islamic Bank Borrowers by Country(A) Islamic Borrowers(B) Listed Borrowers(B)/(A)(a)～(e)/(B)(a) Saudi Arabia(b) United Arab Emirates(c）Kuwait(d) Qatar(e) Oman(f) Bahrain

62
63
15
20
3
38

8
11
7
6
1
3

12.9%
17.5%
46.7%
30.0%
33.3%
7.9%

22.2%
30.6%
19.4%
16.7%
2.8%
8.3%

Total

201

36

17.9%

100.0%

Note: Author’s estimates based on ISI Emerging Markets

18

APPENDIX 2:

Basic Concept and Scheme of Islamic Finance by TypeThe chart below presents the flow of funds of Islamic finance scheme by selected type.
Mudarabah and Ijara are indicated because these financial schemes represent and symbolize
Islamic finance. As noted in section II of this paper, these two schemes account for 26 percent of
Sukuk market in 2007. The remaining 74 percent are accounted for by Murabahah,
Musharakah and others. As interest payment/receipt is forbidden by shariah,
invstors/depositors receive benefit as dividend from the net profit of the project. In case of
Mudarabah, investor/depositors are separated from the project, but are considered project
participants in the case of Musharakah. Under Ijarah scheme, which recorded the mostdramatic development, fund raisers first establish a special purpose company (SPC), sell their
fixed assets and this SPC provides the leasing facility for the production. This SPC issues Sukuk
asset backed by the leased fixed assets.
(A) Mudarabah(a) Mudarabah Sukuk Issuance(b) Mudarabah Bank Facility

Investors
Dividend

Depositors
Investment

Deposit

Dividend

Firm
Operational Profit

Bank

Project Management

Operational Profit

Project

Project(B) Ijara Sukuk
Investors
4. BondIssuance

5. CashSPC
1. Establish new SPC and the
SPC purchase fixed asset fromthe firm

Investment/Loan

3. Lease
Payment

2. CashFirm

19