Islamic banking and corporate investment efficiency: empirical evidence from Malaysia

Purpose The purpose of this paper is to examine whether and how Islamic banks' financing affects corporate investment efficiency. Design/methodology/approach To achieve the research purpose, an empirical model was constructed to describe the relationship between Islamic banks' financing and corporate investment efficiency. The empirical model was tested through generalized method of moments (GMM) estimation technique using a panel data of 163 Malaysian listed firms for the period 2007-2017. Findings This study provides evidence that Islamic banks' financing plays an important role in enhancing investment efficiency and that this positive effect comes mainly from non-PLS contracts. Moreover, the results show that the effect of Islamic banks' financing in preventing suboptimal investments is stronger in the financial crisis period. The results also reveal that the contribution of Islamic banks' financing in reducing suboptimal investments is more prominent when firms face over-investment problems. Research limitations/implications This research contributes to the debate on the financial implications of Islamic banks' financing modes by exploring their effect on corporate investment efficiency. Practical implications From a managerial perspective, the research findings are beneficial to Islamic bank managers to the extent that they highlight the role of Islamic financial contracts in improving corporate investment efficiency. In addition, the lower effect of PLS contracts on investment efficiency implies that policymakers in Malaysia should multiply their efforts to further expand the PLS financing. Originality/value This paper offers some insights on the role of Islamic banks' financing in mitigating agency conflicts and reducing asymmetric information problems. It is the first attempt focusing on the role of Islamic financing in fostering corporate investment decisions.