The impact of leverage on the cost of capital and market value: Evidence from Sharīʿah-compliant firms

Abstract

Purpose

This paper aims to investigate the impact of leverage on the cost of capital and market value in the Indonesia Stock Exchange (IDX), where there are Sharīʿah and non-Sharīʿah compliant firms.

Design/methodology/approach

This study uses a mixed methods sequential exploratory design and is based on an empirical analysis undertaken with a sample of firms listed on the IDX. In particular, a qualitative analysis was conducted to identify the Sharīʿah-compliant firms and the qualitative study was designed to compare some financial elements in Sharīʿah and non-Sharīʿah compliant listed companies. The correlations among the main elements observed are considered and a principal component analysis describes the framework.

Findings

First, the results of the analysis show that for the Sharīʿah-compliant companies, identified as those that apply Islamic principles, the lower level of leverage that it is typical of these type of firms implies a higher cost of capital [cost of equity and weighted average cost of capital (WACC)] than non-Sharīʿah ones. Secondly, for the Sharīʿah-compliant companies, the lower level of leverage entails a higher market value measured by the multiples method (price/earning and enterprise value/operating profit) than for non-Sharīʿah ones.

Originality/value

This paper sheds new light on how leverage can affect the cost of capital and market value in the case of Sharīʿah and non-Sharīʿah compliant listed companies in the IDX. In particular, this research highlights the fact that Sharīʿah-compliant firms, despite having a higher WACC, create more market value compared to non-Sharīʿah compliant ones.

Citation

Battisti, E., Bollani, L., Miglietta, N. and Salvi, A. (2020), "The impact of leverage on the cost of capital and market value: Evidence from Sharīʿah-compliant firms", Management Research Review, Vol. 43 No. 9, pp. 1081-1096. https://doi.org/10.1108/MRR-01-2019-0007