General Discussion

The purpose of this study, with its various ramifications, was to explore the relationship between capital structure and capital performance from an Islamic perspective within the Saudi Arabian context. It attempted to explore some gaps in Saudi Arabian firms’ financial analysis, in addition to providing empirical evidence that could be the basis for further research and improved understanding in this field.

Debt is considered a good tool to reduce agency costs and FCF costs, according to the agency and FCF theories. With more debt, managers are unable to use cash flow in risky projects, which may lead to the risk of bankruptcy if the firm is unable to pay its debt. One of the motivations for undertaking this research was the GFC that occurred in 2008, which was mainly caused by overdue debts that banks were unable to collect, and thus went bankrupt. This lowered firms’ trust in bank loans as a source of funds. Since 2003, the Saudi Arabian stock market has been reregulated and improved to become a trustworthy source of funds for business. However, the stock market had its own disaster, which was clearly exposed by its collapse in 2006. This study has proven that there could be a balance between debt and equity that could help improve businesses’ financial performance by lowering the risk of bankruptcy through lowering debt in the capital structure.

This research indicates that Saudi Arabian firms have the potential to increase their profitability when managing borrowing behaviour with liability and zakat. One of this study’s findings was that before and after the economic downturn at the end of the decade, there was a potentially significant effect of zakat on firms’ financial performance. This relationship was generally positive. The average financial performance increased significantly with respect to an increase in zakat every year from 2001 to 2010, with the exception of 2008. One could argue that it is logical that when financial performance increases, zakat should increase, and vice versa. However, the definition of zakat suggests that this finding supports the meaning of zakat. In Chapter 3, zakat was defined as meaning ‘purification’ and an increase in wealth. Samad and Glenn (2010) defined

zakat (according to its Islamic meaning) as ‘the fertility or growth’. One scenario of this

relationship between zakat and corporate financial performance is demonstrated in Figure 6.1. By contributing zakat, firms are involved in raising the standard of living of the whole community, which subsequently increases the ability of society to be involved in the economic cycle. A future investigation of the movement and spending of zakat might help prove this assumption.

Figure 6.1 The Economic Cycle of Corporate Zakat The Community Social Security Small Project Finances The Corporation Giving Za kat

Department of Zakat and Income Tax

Use

Za

kat

The Ministry of Social Affairs

Another finding of this study was that higher leverage levels are associated with a higher level of zakat. The threshold level, above which zakat tended to increase, was approximately 0.3 to 0.4. According to the trade-off theory, it seems that no tax savings appear from increasing debt in capital structure for Saudi Arabian companies. Consequently, lowering debt will increase firms’ financial performance. Hence, issuing more shares to raise funds seems to be better than attaining more debt. The healthy balance of leverage of Saudi Arabia firms is that lower than 0.4.

Zakat has many benefits compared to tax. First, zakat is generally taken as a stable

percentage of income (2.5 per cent of net wealth) that is not subject to be changed in any circumstances—this makes it a permanent and regular system. Moreover, zakat is only required if wealth reaches a specific limit. Any wealth under that limit is not subject to

zakat. For taxes, there are tax exemptions, but these are specified and prescribed by the

government and tax authorities. This means that people can be required to pay tax even if they are unable to do so, unless the government determines that they are exempt from tax. Thus, these characteristics of the Saudi Arabian economy might help promote financial performance for both individuals and companies.

The pecking order theory states that firms’ managers prefer to finance new investments first internally with retained earnings, second with debt, and last by issuing new equity. According to the findings of this study, the order of preferred finance methods for Saudi Arabian firms could first be internal funds, second issuing equity, and last by using debt.

The no-interest based loan of Saudi Arabia is called ‘Al Gard Alhasan’, as reported in Chapter 3. This type of loan is provided by the government and by specialised lending institutions in order to promote growth and encourage development. The loans provided by banks using some Islamic instruments, as discussed in Section 3.6, are more close to being partnerships and trade activities that involve profit and loss bearing, rather than being debt processes. However, the practice of these Islamic instruments inside Saudi Arabian commercials banks mostly reflects the fixed interest on loans more than partnership and trade activities. Hence, most companies in Saudi Arabia rely more on the no-interest based Al Gard Alhasan loans that are provided by the government and specialised lending institutions, as these lower the cost of debt for companies.