According to the substitution hypothesis and recent evidence, firms that are better governed carry less debt and experience fewer agency problems. This may also imply that firms with lower debt are better governed and experience lower agency costs. We test this hypothesis by comparing the agency costs of Shariah compliant (SC, and therefore low debt) and Shariah noncompliant (SNC) firms, using a proprietary dataset comprising constituents of the Dow Jones Islamic index for the period 2006-2015. The findings support the hypothesis but are contingent on the firm’s idiosyncratic risk; SC firms with low idiosyncratic risk have higher agency costs.
Agency costs, Shariah compliant equities, Corporate governance, Capital structure
Naeem Azmi, Choudhari Wajahat and Anwer, Zaher and Ramadili Mohd, Shamsher Mohamad and Mohd Rasid, Mohamed Eskandar Shah. (2019). The substitution hypothesis of agency conflicts: evidence on Shariah compliant equities. Global Finance Journal, 41, pp. 90-103.