Shariah Compliance and Corporate Cash Holdings

Abstract

This study investigates the influence of shariah compliance status on firms’ cash holding levels and speed of adjustment in non-financial firms listed in six Gulf Cooperation Council (GCC countries) from 2005 to 2016. It shows that shariah compliance status has a significant effect on firms’ cash holding decisions. Shariah-compliant firms have significantly higher cash holding levels than non-shariah-compliant firms. Further, shariah-compliant firms adjust more quickly to their target cash holdings than do their conventional counterparts. In our view, shariah-compliant firms are subject to multiple restrictions that limit their external financing channels; therefore, holding larger cash reserves is important as such firms are financially constrained and gain from the transaction cost motive of holding cash. The findings of the study have important implications for regulators, investors and managers. To the best of our knowledge, this study is the first to compare the effect of shariah compliance on firms’ cash holdings and speed of adjustment towards the trade-off theory’s optimal cash holding target.

Keywords: Cash holding, Speed of adjustment, Shariah compliance, Islamic finance, Gulf Cooperation Council

JEL Classification: G30, F61, G32, G39