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Testing the pecking order theory of capital structure in an Islamic legal system: the case of Saudi Arabia

Moncef Guizani (Department of Accounting and Finance, High Institute of Computer Science and Management in Kairouan, University of Kairouan, Kairouan, Tunisia)
Ahdi Noomen Ajmi (Department of Business Administration, College of Science and Humanity Studies in Sulyel, Prince Sattam Bin Abdulaziz University, Al Kharj, Saudi Arabia)

International Journal of Islamic and Middle Eastern Finance and Management

ISSN: 1753-8394

Article publication date: 17 February 2021

Issue publication date: 27 July 2021




The purpose of this paper is to examine whether the basic premises according to the pecking order theory (POT) provide an explanation for the capital structure mix of firms operating under Islamic principles.


Pooled ordinary least squares, fixed and random effects regressions were performed to test the POT applying data from a sample of 66 Islamic-compliant firms listed on Saudi Stock Market over the period 2006–2016.


The results show that sale-based instruments (Murabahah, Ijara) track the financial deficit quite closely followed by equity financing and as a last alternative to finance deficit, Islamic-compliant firms issue Sukuk. In the crisis period, these firms seem more reliant on equity, then on sale-based instruments and on Sukuk as last option. The study findings also indicate that the cumulative financing deficit does not wipe out the effects of conventional variables, although it is empirically significant. This provides no support for the POT attempts by Saudi Islamic-compliant firms

Research limitations/implications

This research contributes to the theory of capital structure in re-validating the findings of a previous theoretical and empirical study. It helps understand the capital structure of Islamic-compliant firms in comparison with conventional firms. It highlights some areas where further research on topics related to capital structure of Islamic-compliant firms is needed. The failure of the POT to explain Saudi firms’ financing choices strongly pushed researchers to test the market timing theory for the Saudi Stock Market. Further research studies could re-examine the trade-off theory in the absence of interest tax shield as in an Islamic economy.

Practical implications

From a managerial perspective, this research can serve firm executive managers in their financing decisions to add value to the companies. Furthermore, policymakers, bankers and standard-setting organizations should undertake more collective work to simplify the process of issuing Islamic financial instruments including Sukuk. Moreover, the Saudi Government has to encourage the private sector to be more innovative in developing products and services that are in line with Sharia principles. Finally, to attract investors, the Capital Market Authority has to encourage transaction, efficiency and liquidity of Islamic financial instruments.


The proposed study presents several originalities. First, it explores the implications of relevant Islamic principles on financing preferences of Saudi firms. Second, the present study enables us to investigate what the sudden abundance of liquidity, generated by the record levels of oil prices, implied for the firms’ financing behavior. Finally, it provides further evidence on the impact of financial crisis on the firms’ capital structure choice in a period of considerable slowdown in the world.



Guizani, M. and Ajmi, A.N. (2021), "Testing the pecking order theory of capital structure in an Islamic legal system: the case of Saudi Arabia", International Journal of Islamic and Middle Eastern Finance and Management, Vol. 14 No. 4, pp. 732-752.



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