OF SHARI’AH COMPLIANT FIRMS

(1)

IMPACTS OF DERIVATIVES AND MANAGERIAL OWNERSHIP ON THE FINANCIAL PERFORMANCE

BY

ZAMINOR BINTI ZAMZAMIR@ZAMZAMIN

A thesis submitted in fulfilment of the requirement for the degree of Doctor of Philosophy in Islamic Banking and

Finance

IIUM Institute of Islamic Banking and Finance International Islamic University Malaysia

JUNE 2021

(2)

ii

ABSTRACT

Most of the firms in the U.S, U.K, Australia and other developed countries have been using derivatives as an effective risk management instruments. Despite that, in Malaysia, many firms do not use derivatives as a risk management tool where the financial derivatives trading is low as compared to the neighboring countries as the use of derivatives by Malaysian is not comprehensive, derivatives are deemed to be complex and costly. Due to that, managers in Malaysia do not realise the advantages of taking positions in the derivatives market. Further, the firms are recognised as Shari’ah compliant firms, the risk management is still in the preliminary stage and the use of hedging instrument is found to be limited. This study covers 177 Shari’ah compliant firms that listed on Bursa Malaysia from 2000 to 2017, which 59 firms are the user of derivatives and the rest of 118 firms are non-users of derivatives. This study employs Logit Regression analysis to identify the users and non-users of derivatives. This study also employs the two-stage system GMM estimator for the total derivatives and foreign currency derivatives. While 2SLS GMM employs specifically for interest rate derivatives and commodity derivatives. This study finds Shari’ah compliant firms that are engaged in derivatives users seem to have performed better than non-users. Further, the results show that firm size, firms access to financial market, industry effect, and investment growth are the factors that influencing the decision to Shari’ah compliant firm to use derivatives. While managerial ownership and industrial diversification indicate negatively significant related to the probability of using derivatives. In the second part of analysis, it was extended to the performance context and impact on firms’ performance after the implementation of IFRS disclosure requirement. Using a two-step system GMM, the finding shows that derivatives has positive significant relationship with firm performance. Further, the third part of analysis, it was extended to non-linear relationship and interaction between derivatives use and managerial ownership. The analysis proved that a non-linear relationship exists between derivatives and firms performance of Shari’ah compliant firms. However, there is no non-linear relationship occurred for both interest rate derivatives and commodity derivatives on firms’ performance. Meanwhile, managerial ownership plays important role to engage in derivatives and eventually increase firm performance. This is based on the significant positive interaction between derivatives and managerial ownership. The results are also robust to different performance indicator of ROA, ROE and Probit regression. Overall, this study has important implications. The first is on the policymaker. The finding from this study has highlighted the importance of quality reporting on derivatives usage by firms and information symmetry in line with the required accounting standard on derivatives.

The second is on Shari’ah compliant firms which highlight on the use of derivatives/hedging practices by Shari’ah compliant firms to reduce risk exposure, act as an effective tool for managing risk and to increase firm performance. Lastly, on the manager and shareholder where they will be able to design and strategize their derivatives activities to match the specific needs of the firms and also to reduce the risk exposures faced by the firms.

(3)

iii

ثحبلا ةصلاخ

نادلبلا نم اهريغو ايلارتسأو ةدحتملا ةكلمملاو ةدحتملا تايلاولا يف تاكرشلا نم ديدعلا مدختست يف ،كلذ نم مغرلا ىلع .رطاخملا ةرادإ تاودأ نم ةلاعف ةادأ اهرابتعاب تاقتشملا ةمدقتملا لوادت نوكي ثيح رطاخملا ةرادلإ ةادأك تاقتشملا تاكرشلا نم ديدعلا مدختست لا ،ايزيلام سيل نييزيلاملا لبق نم تاقتشملا مادختسا نلأ ةرواجملا لودلاب ةنراقم اًضفخنم ةيلاملا تاقتشملا

يلوت ايازم ايزيلام يف ءاردملا كردي لا ،كلذل ةجيتن .ةفلكمو ةدقعم تاقتشملا ربتعتو ،ًلاماش تاكرش اهنأ اهنع فورعملا تاكرشلا ىتح ،كلذ ىلع ةولاع .تاقتشملا قوس يف بصانم مادختسا نأ امك ،ةيلولأا اهتلحرم يف اهيف رطاخملا ةرادإ لازت لا ،ةيملاسلإا ةعيرشلا عم ةقفاوتم أ دودحم طوحتلا ةاد .

ةساردلا هذه يطغت 177

ةيملاسلإا ةعيرشلا ماكحأ عم ةقفاوتم ةكرش

نم ةرتفلا يف ايزيلام ةصروب يف ةجردم 2000

ىلإ 2017 اهنم ، 59 تاقتشملا مدختست ةكرش

ةيقبو 118

تيجول رادحنلاا ليلحت ةساردلا هذه مدختست .تاقتشملل ةمدختسم ريغ ةكرش

Logit Regression Analysis ( لا ديدحتل )

مدختست .تاقتشملل نيمدختسملا ريغو نيمدختسم

ريدقت ماظن اًضيأ ةساردلا هذه GMM

تلامعلا تاقتشمو تاقتشملا عومجمل نيتلحرملا يذ

لمعتست امنيب .ةيبنجلأا SLS2 GMM

.علسلا تاقتشمو ةدئافلا راعسأ تاقتشمل اًصيصخ

لاسلإا ةعيرشلا عم ةقفاوتملا تاكرشلا نأ ىلإ ةساردلا هذه تلصوت تاقتشملا يف لمعت يتلاو ةيم

،ةكرشلا مجح نأ جئاتنلا رهظت ،كلذ ىلع ةولاع .نيمدختسملا ريغ نم لضفأ ًءادأ تققح رثؤت يتلا لماوعلا يه رامثتسلاا ومنو ،ةعانصلا ريثأتو ،ةيلاملا قوسلا ىلإ تاكرشلا لوصوو ريشت امنيب .تاقتشملا مادختسلا ةعيرشلا عم ةقفاوتملا ةكرشلا رارق ىلع عيونتلاو ةيرادلإا ةيكلملا

نم يناثلا ءزجلا عيسوت مت .تاقتشملا مادختسا ةيلامتحاب ةطبترم ةيبلس ةقلاع ىلإ يعانصلا ريياعملا نع حاصفلإا تابلطتم ذيفنت دعب تاكرشلا ءادأ ىلع ريثأتلاو ءادلأا قايس لمشيل ليلحتلا يتوطخ نم ماظن مادختساب .ةيلاملا ريراقتلا دادعلإ ةيلودلا GMM ن

تاقتشملا نأ ةجيتنلا رهظت ،

ليلحتلا نم ثلاثلا ءزجلا عيسوت مت ،كلذ ىلع ةولاع .ةكرشلا ءادأ عم ةمهم ةيباجيإ ةقلاع اهل ليلحتلا تبثأ .ةيرادلإا ةيكلملاو تاقتشملا مادختسا نيب لعافتلاو ةيطخلا ريغ ةقلاعلا لمشيل شلل تاكرشلا ءادأو تاقتشملا نيب ةيطخ ريغ ةقلاع دوجو ةعيرشلا عم ةقفاوتملا تاكر

علسلا تاقتشمو ةدئافلا راعسأ تاقتشم نم لكل ةيطخ ريغ ةقلاع دجوت لا ،كلذ عمو .ةيملاسلإا تاقتشملا يف طارخنلال اًمهم ا ًرود ةيرادلإا ةيكلملا بعلت ،هسفن تقولا يفو .تاكرشلا ءادأ ىلع عافتلا ىلع اذه دمتعي .فاطملا ةياهن يف ةكرشلا ءادأ ةدايزو تاقتشملا نيب ريبكلا يباجيلإا ل

دئاعلل ةفلتخم ءادأ تارشؤم مادختسا دنع اًضيأ ةيوق جئاتن ةساردلا ترهظأ .ةيرادلإا ةيكلملاو ( لوصلأا ىلع ( مهسلأا ىلع دئاعلاو ،) ROA

( يلامتحلاا رادحنلااو ،) ROE Probit

regression بأ .ةسايسلا عناص ىلع اهلوأ ةمهم راثآ اهل ةساردلا هذه .)

جئاتنلا تزر

تاكرشلا لبق نم تاقتشملا مادختسا ةدوج نع غلابلإا ةيمهأ ةساردلا هذه نم ةصلختسملا قلعتي يناثلاو .تاقتشملاب قلعتملا بولطملا يبساحملا رايعملا عم ىشامتي امب تامولعملا لثامتو اقتشملا مادختسا ىلع ءوضلا طلست يتلاو ةيملاسلإا ةعيرشلا عم ةقفاوتملا تاكرشلاب / ت

لمعتو ،رطاخملل ضرعتلا ليلقتل ةعيرشلا عم ةقفاوتملا تاكرشلا لبق نم طوحتلا تاسرامم

نونوكيس ثيح مهاسملاو ريدملل ةبسنلاب ،ا ًريخأ .ةكرشلا ءادأ ةدايزو رطاخملا ةرادلإ ةلاعف ةادأك

عم بسانتتل اهل تايجيتارتسا عضوو مهب ةصاخلا تاقتشملا ةطشنأ ميمصت ىلع نيرداق

يتحلاا

.تاكرشلا اههجاوت يتلا رطاخملل ضرعتلا ليلقتل اًضيأو تاكرشلل ةددحملا تاجا

(4)

iv

APPROVAL PAGE

The thesis of Zaminor Zamzamir @ Zamzamin has been approved by the following:

_____________________________

Razali Haron Supervisor

_____________________________

Zatul Karamah Ahmad Baharul Ulum Co-Supervisor

_____________________________

Anwar Hassan Abdullah Othman Co-Supervisor

_____________________________

Romzie Rosman Internal Examiner

_____________________________

Rosylin Mohd Yusof External Examiner

_____________________________

Nitty Hirawaty Kamarulzaman External Examiner

_____________________________

Adibah Abdul Rahim Chairman

(5)

v

DECLARATION

I hereby declare that this thesis is the result of my own investigations, except

where otherwise stated. I also declare that it has not been previously or concurrently submitted as a whole for any other degrees at IIUM or other institutions.

Zaminor binti Zamzamir @ Zamzamin

Signature ... Date ...

(6)

vi

COPYRIGHT PAGE

INTERNATIONAL ISLAMIC UNIVERSITY MALAYSIA

DECLARATION OF COPYRIGHT AND AFFIRMATION OF FAIR USE OF UNPUBLISHED RESEARCH

IMPACTS OF DERIVATIVES AND MANAGERIAL OWNERSHIP ON THE FINANCIAL PERFORMANCE OF SHARI’AH COMPLIANT

FIRMS

I declare that the copyright holders of this thesis are jointly owned by the student and IIUM.

No part of this unpublished research may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without prior written permission of the copyright holder except as provided below

1. Any material contained in or derived from this unpublished research may be used by others in their writing with due acknowledgement.

2. IIUM or its library will have the right to make and transmit copies (print or electronic) for institutional and academic purposes.

3. The IIUM library will have the right to make, store in a retrieved system and supply copies of this unpublished research if requested by other universities and research libraries.

By signing this form, I acknowledged that I have read and understand the IIUM Intellectual Property Right and Commercialization policy.

Affirmed by Zaminor binti Zamzamir@Zamzamin

……..……….. ………..

Signature Date

(7)

vii

To my beloved late father and my mother for their dua’ and support:- Zamzamir @ Zamzamin Husin

and

Umi Kelsom Shariff

“ My lord, enable me to be grateful for Your favour which You have upon me and upon my parents and to do righteousness of which You approve. And admit me by

Your mercy into (the rank of) Your righteous servant.”

(Qur’an, an-Naml:19)

Thank you to my lovely husband and my sweety childrens:- Izzuddin Mohamed @ Ismail

Zuyyin Zulaikha Izzuddin Zehra Zafeera Izzuddin Zairah Zakyrah Izzuddin

(8)

viii

ACKNOWLEDGEMENTS

In the name of Allah, the most Gracious, the merciful. All praises and glories are for Allah s.w.t, the Almighty, the Guide. Peace and blessing be upon Prophet Muhammad s.a.w. Alhamdulillah, my pray and truthful thank to Allah s.w.t who grant me strength and patience to complete this journey. The journey of searching of knowledge.

My utmost and sincere gratitude to my supervisor, Assoc. Prof. Dr. Razali Haron for always being generous with his time and patience to share his knowledge in research method, publication and his word of encouragement; Assoc. Prof. Dr. Zatul Karamah Ahmad Baharul Ulum for always giving me words of encouragement, du’a, guidance and support throughout my PhD journey; Dr Anwar Hassan Abdullah Othman for kindness and support to improve my thesis. I am indebted to their continuous du’a, guidance and encouragement throughout my PhD journey. May Allah protect them and bless them with good health and livelihood.

My special appreciation and dedication to my late beloved father Haji Zamzamir @ Zamzamin Husin and my lovely mother Hajah Umi Kelsom Shariff for their endless du’a and support. May Allah grant both of you the highest Jannah. To my dearest husband Izzuddin Mohamed @ Ismail and my sweety daughters Zuyyin Zulaikha, Zehra Zafeera and Zairah Zakyrah, who granted me the gift of their unwavering belief in my ability to accomplish this goal: thank you and forgive me for everything, love, support, sacrifice and patience in completing my study journey. To my dearest brothers Muhammad and Muammar, thanks for always assist and support me. Not to forget to my supportive siblings who always there and be with me. Special appreciation to my father and mother in law Haji Mohamed @ Ismail and Hajah Siti Kamauriah for du’a and support.

Great thanks to my PhD buddy- Sis. Nur ‘Iffah, Dr. Syarah Syahira, Dr. Nur Hasnida, Dr. Nur Fariza, Dr. Nurshamimitul Ezza, Sis. Nur Lina, Sis. Atirah, Sis. Zeti, Sis. Nadia and the rest whom I am not able to mention here. Thank you, my dear friends, you guys definitely spiced up my PhD journey and always being there for me.

Not to forget my best friends Dr. Nor Hafiza, Dr. Asma and Sis. Nazeeha, who also always shares and keep asking my study progress and always be a good listener.

Thank you for the friendship and may Allah bless all of you.

My gratitude also goes to Dr Elya Nabila, who has tirelessly educated me on quantitative methods, all the IIiBF staff especially Sis. Nur Fadila, the Ministry of Higher Education and my employer Universiti Malaysia Kelantan (UMK) for granting me a scholarship and also provides study leave to pursue my PhD.

Last but not least, thank you to those who have been involved directly and indirectly in my PhD journey. Your kind assistance has tremendously helped me in completing this study. Alhamdulillah and Thank You Allah.

(9)

ix

CHAPTER TWO: OVERVIEW OF DERIVATIVES MARKET IN MALAYSIA ... 21

2.1 Introduction... 21

2.2 Development of Derivatives Market ... 24

2.3 Accounting and Reporting for Derivatives in Malaysia ... 25

2.4 Overview of Shari’ah Compliant Firms Listed on Bursa Malaysia ... 27

2.5 The Screening Process of Shari’ah Compliant Firms Listed in Bursa Malaysia ... 29

CHAPTER THREE: LITERATURE REVIEW ... 37

3.2 Derivatives Users and Non-Users ... 37

3.3 Factors Influencing the Decisions of Shari’ah Compliant Firms to Use Derivatives ... 40

3.4 Derivatives Use and Firm Value... 42

3.5 Derivatives Use and Firm Performance ... 46

3.6 Managerial Ownership and Firm Performance... 48

3.7 Effect of IFRS Requirement on Firm Performance ... 50

3.8 Derivatives Use and Managerial Ownership ... 53

3.9 Non-Linear Relationship and Hedging Optimality... 57

(10)

x

CHAPTER FOUR: THEORETICAL FRAMEWORK AND

DEVELOPMENT OF RESEARCH HYPOTHESIS ... 65

4.1 Risk Management Theory ... 65

4.1.1 Hedging Theory ... 65

4.1.2 Managerial Risk Aversion Theory ... 67

4.1.3 Agency Cost Theory ... 70

4.2 Hedging Theory from Islamic Perspective ... 72

4.3 Empirical Model Development... 76

4.4 Development of Research Hypotheses ... 77

4.4.1 Users and Non-Users Of Derivatives ... 77

4.4.2 The Influence of Shari’ah Compliant Firm Decision to Use Derivatives ... 78

4.4.3 Linear Approach ... 82

4.4.3.1 Derivatives, Managerial Ownership and Firm Performance ... 82

4.4.3.2 Interaction Between Derivatives and Managerial Ownership ... 83

4.4.4 IFRS Disclosure Requirement and Firm Performance ... 84

4.4.5 Non-Linear Approach ... 86

4.4.5.1 Derivatives, Managerial Ownership and Firm Performance ... 86

4.4.5.2 Interaction Between Derivatives and Managerial Ownership ... 87

CHAPTER FIVE: RESEARCH METHODOLOGY ... 89

5.2 Sampling and Data Description ... 89

5.2.1 Research Population and Sample Size ... 89

5.2.2 Sources of Data ... 96

5.2.3 Period of Study... 97

5.3 Variables Definitions and Measurements ... 99

5.3.1 Dependent Variables ... 99

5.3.1.1 Tobin’s Q ... 99

5.3.1.2 Return on Asset ... 100

5.3.1.3 Return on Equity ... 100

5.3.2 Explanatory Variables ... 101

5.3.2.1 Derivatives ... 101

5.3.2.2 Managerial Ownership ... 103

5.3.3 Control Variables ... 104

5.3.3.1 Firm Size... 105

5.3.3.2 Access to Financial Market ... 105

5.3.3.3 Leverage ... 105

5.3.3.4 Industrial Diversification ... 106

5.3.3.5 Investment Growth (Opportunities) ... 106

5.3.3.6 Industry Effect ... 106

5.3.3.7 Firm Risk ... 107

5.3.3.8 Time Effects ... 108

5.3.3.9 Year Crisis ... 108

(11)

xi

5.4 Methods of Analyses ... 109

5.4.1 Binary Logit Regression Analysis ... 109

5.4.2 Panel Data Analysis ... 111

5.4.2.1 Static Panel Data Analysis ... 113

5.4.2.2 Dynamic Panel Model Analysis ... 115

5.4.2.3 2SLS Panel Data ... 119

5.5 Data Screening Procedure... 126

5.5.1 Treatment for Outliers ... 126

5.6 Research Model ... 127

5.6.1 Empirical Model for User and Non-User of Derivatives ... 127

5.6.1.1 Logit Regression ... 128

5.6.1.2 Probit Regression ... 129

5.6.2.1 Empirical Model for Linear Relationship between Derivatives and Firm Performance ... 130

5.6.2.2 Empirical Model for Linear Interaction between Derivatives and Managerial Ownership ... 133

5.6.3 Empirical Model for IFRS Requirement and Firm Performance ... 135

5.6.3.1 Two-Step System GMM ... 135

5.6.3.2 Two-Stages Least Squared (2SLS) ... 136

5.6.4.1 Empirical Model for Non-Linear Relationship between Derivatives and Firm Performance ... 138

5.6.4.2 Empirical Model for Non-Linear Interaction between Derivatives and Managerial Ownership ... 141

5.6.5 Sasabuchi-Lind-Mehlum of U-Test ... 143

CHAPTER SIX: ANALYSIS AND DISCUSSION OF RESULT ... 145

6.2 Presentation of Findings ... 145

6.2.1 Descriptive Statistics ... 145

6.2.2 Static Panel Data and Diagnostic Test ... 153

6.3 Result of Panel Data Regression Model ... 154

6.3.1 Derivatives Users and Non-Users (Empirical Model 1) ... 155

6.3.1.1 Derivatives Users and Non-Users... 158

6.3.2 Factors Influencing Decisions of Shari’ah Compliant Firms to Use Derivatives (Empirical Model 1 and Model 2) ... 159

6.3.2.1 The Influence of Shari’ah Compliant Firm’s Decision to Use Derivatives... 162

6.3.3.1 Derivatives, Managerial Ownership and Firm Performance (Empirical Model 3 and Model 4) ... 167

6.3.3.2 Interaction between Derivatives and Managerial Ownership (Empirical Model 5) ... 177

6.3.4 The Effects of IFRS Requirement on Firm Performance (Empirical Model 6 and Model 7) ... 181

(12)

xii

6.3.4.1 The Effect of Firm Performance on the Pre-and Post-

Implementation Phase of IFRS Disclosure. ... 187

6.3.5.1 Non-Linear Relationship between Derivatives, Managerial Ownership and Firm Performance (Empirical Model 8, Model 9 and Model 11) ... 190

6.3.5.2 Non-Linear Interaction between Derivatives and Managerial Ownership (Empirical Model 10 and Model 11) ... 205

6.3.6 Robustness Check ... 218

CHAPTER SEVEN: CONCLUSION, RECOMMENDATIONS AND SUGGESTIONS FOR FUTURE RESEARCH ... 221

7.2 Summary of Result ... 221

7.2.1 Users and Non-Users of Derivatives and Factors that Influence Shari’ah Compliant Firms to Engage in Derivatives (Objective One and Objective Two) ... 221

7.2.2 Linear Approach and the Effect of IFRS Disclosure Requirement and (Objective Three and Objective Four) ... 225

7.2.3 Non-Linear and Interaction (Objective Five and Objective Six)... 227

7.3 Contribution of the Study ... 231

7.3.1 Theoretical Contribution to the Body of Knowledge... 231

7.3.2 Contribution to the Literature ... 232

7.3.3 Methodology Contribution ... 233

7.4 Research Implications ... 233

7.4.1 Implication for Policymaker ... 234

7.4.2 Implication for the Shari’ah Compliant Firms ... 235

7.4.3 Implication for Managers and Shareholders ... 235

7.5 Limitations of the Study ... 236

7.6 Suggestions for Future Research ... 237

REFERENCES ... 239

APPENDIX 1 :LIST OF DERIVATIVES USER AMONG THE SHARI’AH COMPLIANT FIRMS (2000-2017) ... 255

APPENDIX II :LIST OF NON-USER OF DERIVATIVES AMONG THE SHARI'AH COMPLIANT FIRMS (2000-2017) ... 257

APPENDIX III :STATIC PANEL DATA AND DIAGNOSTIC TEST ... 260

APPENDIX IV:COMMAND STATA FOR PANEL DATA ANALYSIS PROCEDURE ... 266

APPENDIX V :LIST OF PUBLICATIONS AND CONFERENCE ... 278

(13)

xiii

LIST OF TABLES

Table 2.1 Four Level of Activity Benchmark 31

Table 2.2 Financial Ratio Benchmark 33

Table 2.3 Revised Shari’ah Screening Methodology vs. Current Shari’ah

Screening Methodology 34

Table 2.4 Debt Ratio Benchmark of Shari’ah Global Equity Index 35

Table 5.1 Industry Definition 93

Table 5.2 List of Selected Listed Shari’ah Compliant Firms (2000-2017) 95 Table 5.3 The Segregation of the Selected Shari’ah Compliant Firms by

Industry 96

Table 5.4 Dependent Variable Measurements and Source of Information 101

Table 5.5 Summary of Explanatory Variables 104

Table 5.6 Summary of Control Variables and their Proxies 108

Table 6.1 Summary of Descriptive Statistic 148

Table 6.2 Correlation Coefficients among Independent Variables 150 Table 6.3 Variance Inflation Factor and Tolerance 151 Table 6.4 Descriptive Statistics and Univariate Test of Variables 157 Table 6.5 Dynamic Panel Regression Result of Derivatives User to Firm

Performance 157

Table 6.6 Logistic and Probit Regression Result on Factors Influencing

Decisions of Shari’ah Compliant Firms 161

Table 6.7 Dynamic Panel Regression Results of Total Derivatives and

Firm Performance 168

Table 6.8 Dynamic Panel Regression Results of Foreign Currency

Derivatives and Firm Performance 170

Table 6.9 2SLS Regression Results of Interest Rate Derivatives and Firm

Performance 171

Table 6.10 2SLS Regression Result of Commodity Derivatives and Firm

Performance 172

(14)

xiv

Table 6.11 Interaction between Total Derivatives and Managerial

Ownership 178

Table 6.12 Interaction between Foreign Currency Derivatives and

Managerial Ownership 179

Table 6.13 Dynamic Panel Regression Results of the IFRS Requirement

on Firm Performance for Total Derivatives 183

Table 6.14 Dynamic Panel Regression Results of the IFRS Requirement

on Firm Performance for Foreign Currency Derivatives 184 Table 6.15 2SLS Results of the IFRS Requirement on Firm Performance

for Interest Rate Derivatives 185

Table 6.16 2SLS Results of the IFRS Requirement on Firm Performance

for Commodity Derivatives 186

Table 6.17 The Non-linear Relationship between Total Derivatives and

Firm Performance: Two-step system-GMM 191

Table 6.18 Sasabuchi-Lind-Mehlum (SLM) test for U-shaped Model 192 Table 6.19 The Non-linear Relationship between Foreign Currency

Derivatives and Firm Performance: Two-step system-GMM 196 Table 6.20 Sasabuchi-Lind-Mehlum (SLM) Test for U-shaped Model 196 Table 6.21 The Non-linear Relationship between Interest Rate Derivatives

and Firm Performance: Two-step system-GMM 200

Table 6.22 The Non-linear Relationship between Commodity Derivatives

and Firm Performance: Two-step system-GMM 201

Table 6.23 The Non-linear Interaction between Total Derivatives and

Managerial Ownership: Two-step system-GMM 207

Table 6.24 Sasabuchi-Lind-Mehlum (SLM) Test for U-shaped Model 208 Table 6.25 The Non-linear Interaction between Foreign Currency

Derivatives and Managerial Ownership: Two-step system-

GMM 211

Table 6.26 Sasabuchi-Lind-Mehlum (SLM) Test for U-shaped Model 212

Table 7.1 Results Matrix 230

Table 7.2 Panel Regression Result of Total Derivatives 260 Table 7.3 Panel Regression Result of Foreign currency derivatives 261 Table 7.4 Panel Regression Result of Interest Rate Derivatives 262

(15)

xv

Table 7.5 Panel Regression Result of Commodity Derivatives 264 Table 7.6 Command Stata for Data Analysis Procedure 266

(16)

xvi

LIST OF FIGURES

Figure 1.1 The Notional Outstanding Amounts from 2006 to 2019 in Trillion of

USD 2

Figure 1.2 Growth Prospects for Malaysia's Capital Market (2000 -2020) 4 Figure 2.1 Regulatory Structure of Capital Market in Malaysia 28 Figure 4.1 Empirical Model for Derivatives and Firm Performance (Firm Value) 76

Figure 5.1 Data Analysis Procedure 125

Figure 6.1 Non-linear Relationship between Total Derivatives and Firm

Performannce (Tobin’s Q, ROA and ROE) 194

Figure 6.2 Non-linear Relationship between Foreign Currency Derivatives

and Firm Performance (Tobin’s Q, ROA and ROE) 199

Figure 6.3 The Effect of Managerial Ownership on Total Derivatives to

Firm Performance 210

Figure 6.4 The Effect of Managerial Ownership on Foreign Currency

Derivatives to Firm Performance 214

(17)

xvii

LIST OF ABBREVIATIONS

2SLS Two Stage Least Square BMB Bursa Malaysia Berhad

BMDB Bursa Malaysia Derivatives Berhad CMP2 Capital Market Master Plan 2 FEM Fixed Effect Model

FRA Financial Reporting Act

GMM Generalized Method of Moments

IASB International Accounting Standard Board ICM Islamic Capital Market

IFRS International Financial Reporting Standard IFIs Islamic Financial Institutions

KLSE Kuala Lumpur Stock Exchange MASB Malaysia Accounting Standard Board MDEX Malaysian Derivatives Exchange MFRS Malaysia Financial Reporting Standard OTC Over-The-Counter

POLS Pooled Ordinary Least Square

Q Tobin's Q

REM Random Effect Model ROA Return on Asset ROE Return on Equity

SAC Shari'ah Advising Council

SC Securities Commission

(18)

1

CHAPTER ONE INTRODUCTION

1.1 BACKGROUND OF THE STUDY

Risk management can be described as the activities designed to minimize the negative effect of the risk due to the potential losses (Schmit & Roth,1990; Shao et al., 2019).

Besides, risk management is essential to firms’ operation because without it, firms’

performance will be affected since it is closely related to the effectiveness of handling and managing firms in a proper way. Due to the importance of risk management practices, it has become shareholder's priority. Bouwman (2014) states that firms use derivatives as an effective tool for managing risk. In line with this argument, Antônio, Lima, dos Santos and Rathke (2019) confirm that firms use derivatives mainly for protection purpose. In addition, Barton (2001) states that firm manager use derivatives to minimize the impacts of earnings volatility and interest rate risk on the assumption that managers want to mitigate high degree of earnings volatility. This argument is also supported by Dewally and Shao (2013) where it was noted that derivatives are used to reduce risk exposure as well as for trading purposes to generate profit for financial firms. Hence, derivative is an instrument for risk management that is used for hedging position during the crisis; at the same time, it can be used to manage risk and ultimately increases firms’ performance.

Recently, most of the non-financial firms have been using derivatives as risk management tools and as such, derivatives have become the most effective and efficient tool for corporate hedging (Bartram, 2019). Based on the available data about the international settlements by banks, the markets for Over-The-Counter (OTC) instruments and exchange-traded derivative financial instruments on foreign exchange

(19)

2

rates and interest rates have exhibited exponential growth over the past 14 years as seen in Figure 1.1. The Figure 1.1 shows the notional amounts outstanding (in trillions of USD) by year for exchange rates and interest rate derivatives, separated for OTC and exchange-traded derivatives from year 2006 to 2019. As seen in the Figure 1.1, notional amounts outstanding of foreign currency derivatives shows an upward trend starting in 2010 and keep increasing over the years, reaching $99 trillion in 2019.

Whereas, interest rate derivatives rose significantly between 2017 and 2019 and the OTC notional amounts outstanding at the end of 2019 stood around $60 trillion. This situation is similar to the derivatives Malaysian market. In 2003 the total notional amounts of total outstanding of OTC derivatives, comprising foreign currency derivatives and interest rate derivatives, grew by more than twofold to RM171 billion in four years from 1999 to 2003. Meanwhile, derivatives trading that includes both OTC and exchange traded derivatives are expected to account for the major of this growth, with the notional amounts traded projected to increase from $171 billion to

$1.4 trillion by 2020. This trend analysis shows that the use of derivatives has grown over the years, indicating the importance of derivatives as risk management instruments.

Figure 1.1 The Notional Outstanding Amounts from 2006 to 2019 in trillion of USD

Source: Bank for International Settlements (2017)

(20)

3

The global financial crisis of 2007 and 2008 has shaped the scope of derivative instruments in most of the countries. The collapse of some established and prominent U.S banks and other institutions, such as the Lehman Brothers, Merrill Lynch and National City Bank have raised many questions about the effectiveness of risk management; and questions about applying derivatives in financial institutions have also been brought forward. Moreover, failure of proper financial management has led to the collapse of the firm as demonstrated during the financial crisis in 2007 and 2008. For instance, firms in Brazil collapsed due to the failure of risk management (Zeidan & Rodrigues, 2013). Also a study by Dodd (2009) documents that, 12 countries incurred losses in derivatives due to poor risk management. In addition, the huge losses correlated with derivatives have encouraged the demands for increased reporting of derivatives activities (Blankley, Lamb, & Schroeder, 2002). Due to this, derivatives have become hugely popular as a hedging instrument among firms as they have been using these instruments to manage risk (Ayturk, Gurbuz, & Yanik, 2016;

Seng & Thaker, 2018), since the use of hedging during the financial crisis is value enhancing (Alam & Gupta, 2018).

However, Chong, Chang and Tan (2014) report that the volume of financial derivatives trading in Malaysia is low as compared to the neighboring countries, such as Singapore, Hong Kong, and South Korea. As such, market players need to be educated on how to use derivative instruments to minimize risk. They also maintain that financial firms and non-financial firms are pressured when operating in a more diverse market where they have to reduce risk and improve profitability. This is consistent with a survey conducted by the Future Industry Association, where it was reported that Malaysia is one of the developing market economies with comparatively

(21)

4

low derivatives trading as it was ranked 40, in the use of top 30 Derivatives in 2012.

Therefore, a vibrant and comprehensive derivatives market is required to improve dynamism in other segments of the Malaysian capital market. According to the Capital Market Master Plan 2 (CMP2) from 2000-2020, Malaysia is expected to expand and grow to a more diversified and innovative environment supported by a governance strategy to enhance the soundness and confidence of its capital market.

Figure 1.2 shows the growth prospect for Malaysia’s Capital Market from 2000 until 2020. From Figure 1.2, the growth prospect for derivatives is the highest (RM4169.5 million), followed by the Islamic capital market (RM2882.6 million), then equity (RM2430.2 million), investment management (RM1610 million), and the last growth prospect is bond with RM53.5 million. This discussion, therefore, indicates the importance of derivatives strategy in enhancing the capital market confidence.

Figure 1.2 Growth Prospects for Malaysia's Capital Market (2000 -2020) Source: Securities Commission (2011)

In relation to the growth prospects for Malaysia’s Capital Market, the foreign exchange market in Malaysia has been growing over the years. Bank Negara (the Central Bank) states that the net export on foreign exchange recorded a cumulative

444 273.1

55.2 293.7

175.3 84

758.6

377.4

1050.1

512.1 2430.2

53.5

1610

2882.6

4169.5

Equity Bond Investment

Management Islamic Capital

Market Derivatives 2000 (RM billion) 2010 (RM billion) 2020 (RM billion)

(22)

5

amount of US$8.8billion as at December 2016. The central bank also noted that the foreign currency market in 2017 sustained a daily average volume of US$9.9billion compared to US$8.8billion in 2016. This demonstrates the essence of derivatives engagement in firms to manage risk due to the increased exposure to the exchange rate risk. In 2017, the total turnover of the foreign currency market for forward and swap transactions recorded an average of US$3.8billion higher than the forex spot and options. Thus, forward and swap instruments are the most used by firms in their transactions. Hong, Chu and Song (2018) state that 23.6% of Malaysian listed firms faced significant foreign exchange exposure from 2014 to 2016. The financial derivatives are now widely traded around the world on many exchanges’ platform.

Bhagawan and Lukose (2017) report that firms that are exposed to higher foreign exchange risk tend to engage in more derivatives positions for hedging purposes.

Moreover, Belghitar, Clark and Mefteh (2013) find that derivative instruments are effective in decreasing foreign currency risk exposures. This is in line with the finding of Wahab, Rahim and Janor (2019) that foreign currency derivatives exposure have roles to play in determining the hedging practices in Malaysian firms.

Risk management is practiced by the firms to reduce various kinds of risk such as currency risk, interest rates risk and commodity risk. Understanding the most important risks facing the firms will enable the stakeholders, especially the managers and the regulatory authorities, to undertake necessary measures to minimize the adverse impacts of these risks on the performance of the institutions. Adam, Fernando, and Salas (2017) in their study on hedging explains that, firms hedge by varying the size and the timing of their derivatives transactions based on managers’ market views, a practice known as “selective hedging”. In this type of hedge, managers will only be taking a hedging position subject to market timing where managers incorporate their

(23)

6

market views into firms’ hedging programs. This practice according to them is widely spread in the U.S. and other countries. Stulz (1996) argued that selective hedging could enhance the value of firms that possess an information advantage relative to the market and have the financial strength to withstand the additional risk from market timing. Adam et al. (2017) also found that the selective hedging is most prevalent among firms that are most likely to have private information about future prices; as in the current study, the future movement of foreign currencies.

With regard to that, Arif, Muda, Alam and Mohamad (2019) report the attitude of managers in relying on the current structure of conventional instruments is one of the key concerns that could threaten Islamic risk management tools in the financial market. Besides, hedging practices between its Shari’ah compliant firms are still not well explored and very much lag behind against firms in the developed countries (Wahab, Abdul Rahim, & Janor, 2020). Abdul Rahim, Wahab and Yusoff (2019) also document that Shari’ah compliant firms are found twice as likely as conventional firms to adopt hedging instruments and the Shari’ah compliant status does not hinder the respecting firms from using the contractual hedging instrument to mitigate risk exposure. However, the growing of Islamic risk management instruments increasing based on the average volume of foreign exchange forward transaction (BNM, 2017) and Malaysia is the leading country in Islamic finance and having the most advanced Islamic capital market (Ledhem & Mekidiche, 2020). Therefore, the managers of Shari’ah compliant firms will only participate in selective hedging if they deemed appropriate to take such positions subject to market timing. Besides, the development of the Islamic financial industry is essential for the global financial system and as such, the Shari’ah compliant firms have to be accustomed with the latest risk management instruments and skills to sustain the challenges of the present financial

(24)

7

environment. In other word, Shari’ah compliant firms need to engage in derivatives in order to mitigate risk exposure.

Besides, Mitchell (2010) reports that one of the factors that contribute to the global financial crisis is the failure of risk management. This is in line with Ahmed (2009) findings where it was noted that failure of risk management at different levels may lead to financial crisis. Thus, due to the weaknesses of the conventional financial system, Islamic finance has become an alternative (Baber, 2018; Nafis & Mohammad Shadique, 2016). Furthermore, researchers have documented that Islamic financial institution are better equipped to cope with the economic downturn during the financial crisis compared to conventional financial institution (Baber, 2018; Nafis &

Mohammad Shadique, 2016). Consequently, financial crisis has exposed the weaknesses of the conventional financial system, triggering the proponents of Islamic financial system to suggest that Islamic financial system is an alternative. The complexity of financial instrument in Islamic financial system has led to a similar increase in the risk posed on the asset. The Shari’ah compliant firms also experience the same risks as its conventional counterparts, such as currency risk, interest rates risk, commodity risk, and operational risk. Moreover, Islamic financial institutions were developed four decades ago as an alternative to conventional financial institutions primarily to provide Shari’ah compliant investment, transactions, and financing. The Islamic financial industry has grown rapidly and occupied important landscape in the global financial system. Thus, the future of the institution’s sustainability is dependent on its capacity to deal with the rapidly changing financial landscape. The Shari’ah compliant firms need to be well positioned to overcome the challenges posed by the current financial landscape in terms of the latest risk management capabilities and operational system. Identifying how these firms handle

OF SHARI’AH COMPLIANT FIRMS

IMPACTS OF DERIVATIVES AND MANAGERIAL OWNERSHIP ON THE FINANCIAL PERFORMANCE

Logit Regression Analysis ( لا ديدحتل )

DECLARATION

COPYRIGHT PAGE

ACKNOWLEDGEMENTS

TABLE OF CONTENTS

CHAPTER TWO: OVERVIEW OF DERIVATIVES MARKET IN MALAYSIA ... 21

CHAPTER FOUR: THEORETICAL FRAMEWORK AND

CHAPTER FIVE: RESEARCH METHODOLOGY ... 89

CHAPTER SIX: ANALYSIS AND DISCUSSION OF RESULT ... 145

CHAPTER SEVEN: CONCLUSION, RECOMMENDATIONS AND SUGGESTIONS FOR FUTURE RESEARCH ... 221

REFERENCES ... 239

APPENDIX 1 :LIST OF DERIVATIVES USER AMONG THE SHARI’AH COMPLIANT FIRMS (2000-2017) ... 255

LIST OF TABLES

LIST OF FIGURES

LIST OF ABBREVIATIONS

CHAPTER ONE INTRODUCTION