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Article

Siti Raihana Hamzah, Norizarina Ishak and Ahmad Fadly Nurullah Rasedee

The purpose of this paper is to examine incentives for risk shifting in debt- and equity-based contracts based on the critiques of the similarities between sukuk and bonds.

Abstract

Purpose

The purpose of this paper is to examine incentives for risk shifting in debt- and equity-based contracts based on the critiques of the similarities between sukuk and bonds.

Design/methodology/approach

This paper uses a theoretical and mathematical model to investigate whether incentives for risk taking exist in: debt contracts; and equity contracts.

Findings

Based on this theoretical model, it argues that risk shifting behaviour exists in debt contracts only because debt naturally gives rise to risk shifting behaviour when the transaction takes place. In contrast, equity contracts, by their very nature, involve sharing transactional risk and returns and are thus thought to make risk shifting behaviour undesirable. Nonetheless, previous researchers have found that equity-based financing also might carry risk shifting incentives. Even so, this paper argues that the amount of capital provided and the underlying assets must be considered, especially in the event of default. Through mathematical modelling, this element of equity financing can make risk shifting unattractive, thus making equity financing more distinct than debt financing.

Research limitations/implications

Global awareness of the dangers of debt should be increased as a means of reducing the amount of debt outstanding globally. Although some regulators suggest that sukuk replaces debt, they must also be aware that imitative sukuk poses the same threat to efforts to avoid debt. In short, efforts to ensure future financial stability cannot address only debts or bonds but must also address those types of sukuk that mirrors bonds in their operation. In the wake of the global financial crisis, amid the frantic search for ways of protecting against future financial shocks, this analysis aims to help create future stability by encouraging market players to avoid debt-based activities and promoting equity-based instruments.

Practical implications

This paper’s findings are relevant for countries that feature more than one type of financial market (e.g. Islamic and conventional) because risk shifting behaviour can degrade economic and financial stability.

Originality/value

This paper differs from the previous literature in two important ways, viewing risk shifting behaviour not only in relation to debt or bonds but also when set against debt-based sukuk, which has been subjected to similar criticism. Indeed, to the extent that debts and bonds encourage risk shifting behaviour and threaten the entire financial system, so, too, can imitation sukuk or debt-based sukuk. Second, this paper is unique in exploring the ability of equity features to curb equityholders’ incentive to engage in risk shifting behaviour. Such an examination is necessary for the wake of the global financial crisis, for researchers and economists now agree that risk shifting must be controlled.

Details

Managerial Finance, vol. 44 no. 10
Type: Research Article
ISSN: 0307-4358

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Article

Marius Popescu and Zhaojin Xu

The purpose of this paper is to explore the motivation behind mutual funds’ risk shifting behavior by examining its impact on fund performance, while jointly considering…

Abstract

Purpose

The purpose of this paper is to explore the motivation behind mutual funds’ risk shifting behavior by examining its impact on fund performance, while jointly considering fund managers’ compensation incentives and career concerns.

Design/methodology/approach

The study uses a sample of US actively managed equity funds over the period 1980-2010. A fund’s risk shifting is estimated as the difference between the fund’s intended portfolio risk in the second half of the year and the realized portfolio risk in the first half of the year. Using the state of the market to identify the dominating type of incentive that fund managers face, we examine the relationship between performance and risk shifting in a cross-sectional regression setting, using the Fama and MacBeth (1973) methodology.

Findings

The authors find that poorly performing (well performing) funds are likely to increase (decrease) their risk level in bull markets, while reducing (increasing) it during bear markets. Furthermore, we find that funds that increase risk underperform, while those that decrease their portfolio risk do not. In addition, we find that poorly performing funds that increase (or decrease) their risk underperform across bull and bear markets, while well performing funds that reduce risk during bull markets subsequently outperform.

Originality/value

The paper contributes to the literature on mutual fund risk shifting by providing evidence that the performance consequence of such behavior is dependent on the state of the market and on the funds’ past performance. The results suggest that loser funds tend to be agency prone or be managed by managers with inferior investment skill, and that winner funds exhibit superior investment ability during bull markets. The authors argue that both the agency and investment ability hypotheses are driving fund managers’ risk shifting behavior.

Details

Managerial Finance, vol. 43 no. 7
Type: Research Article
ISSN: 0307-4358

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Article

Siti Raihana Hamzah, Obiyathulla Ismath Bacha, Abbas Mirakhor and Nurhafiza Abdul Kader Malim

The purpose of this paper is to examine the extent of risk shifting behavior in bonds and sukuk. The examination is significant, as economists and scholars identify risk

Abstract

Purpose

The purpose of this paper is to examine the extent of risk shifting behavior in bonds and sukuk. The examination is significant, as economists and scholars identify risk shifting as the primary cause of the global financial crisis. Yet, the dangers of this debt-financing feature are largely ignored – one needs to only witness the record growth of global debt even after the global financial crisis.

Design/methodology/approach

To identify the signs of risk shifting existence in the corporations, this paper compares each corporation’s operating risk before and after issuing debt. Operating risk or risk of a firm’s activities is measured using the volatility of the operating earnings or coefficient variation of earning before interest, tax, depreciation and amortization (EBITDA). Using EBITDA as the variable offers one distinct advantage to using asset volatility as previous research has – EBITDA can be extracted directly from firms’ accounting data and is not model-specific.

Findings

Risk shifting can be found in not only the bond system but also the debt-based sukuk system – a noteworthy finding because sukuk, supposedly in a different class from bonds, have been criticized in some quarters for their apparent similarity to bonds. On the other hand, this study thus shows that equity feature, when it is embedded in bonds (as in convertible bonds) or when a financial instrument is based purely on equity (as in equity-based sukuk), the incentive to shift the risk can be mitigated.

Research limitations/implications

Global awareness of the dangers of debt should be increased as a means of reducing the amount of debt outstanding globally. Although some regulators suggest that sukuk replace debt, they must also be aware that imitative sukuk pose the same threat to efforts to avoid debt. In short, efforts to ensure future financial stability cannot address only debts or bonds but must also address those types of sukuk that mirror bonds in their operation. In the wake of the global financial crisis, amid the frantic search for ways of protecting against future financial shocks, this analysis aims to help create future stability by encouraging market players to avoid debt-based activities.

Originality/value

This paper differs from the previous literature in two important ways, viewing risk shifting behavior not only in relation to debt or bonds but also when set against debt-based sukuk, which has been subjected to similar criticism. Indeed, to the extent that debts and bonds encourage risk shifting behavior and threaten the entire financial system, so, too, can imitation sukuk or debt-based sukuk. Second, this paper is unique in exploring the ability of equity features to curb equity holders’ incentive to engage in risk shifting behavior. Such an examination is necessary for the wake of the global financial crisis, for researchers and economists now agree that risk shifting must be a controlled behavior – and that one way of controlling risk shifting is by implementing the risk sharing feature of equity-based financing into the financial system.

Details

Journal of Islamic Accounting and Business Research, vol. 9 no. 5
Type: Research Article
ISSN: 1759-0817

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Article

Mohd Yaziz Mohd Isa and Md. Zabid Hj Abdul Rashid

This paper aims to investigate the adequacy of regulatory capital funds through loss provisioning policies because of worsening credit quality associated with distressed…

Abstract

Purpose

This paper aims to investigate the adequacy of regulatory capital funds through loss provisioning policies because of worsening credit quality associated with distressed financial conditions. A financial distress occurs when banks have difficulty in honoring financial commitments. This paper is expected to unveil how the provisioning mechanisms can address concerns associated with pro cyclicality of regulatory capital funds requirements, and how the banks behave in distressed financial conditions to share risks. The pro cyclicality of regulatory capital funds is the effect of various components of the financial system that aggravates the economic cycle such as during the expansion of the economy when banks are able to provide more loans and meet regulatory capital requirements with ease, while during the contraction of the economic cycle, can lead to deterioration of asset quality, and the resultant need to make loss provisions and recognize impairment. In turn, the situation puts further pressures on the capital requirements held by banks and their risk-sharing behavior. The paper analyzes a sample of Islamic banks in Malaysia.

Design/methodology/approach

By estimating credit risk-related information through loss provisioning policies, the paper uses an unbalanced panel data on all Islamic banks in the Association of Islamic Banking Institutions Malaysia from 2003 to 2014. The association consists of full-fledged Islamic banks and several foreign-owned entities.

Findings

The paper findings support that Islamic banks during observed period of distressed financial conditions were less discouraged to increase their regulatory capital funds to share risks. Intuitively, they were more encouraged to engage in risk-shifting behavior. Also, the risk-shifting behavior was found to have a significantly high potential in foreign-owned Islamic banks than in domestic Islamic banks.

Research limitations/implications

Although the study is based on a sample of Islamic banks in Malaysia, the findings suggest targeted interventions aimed at discouraging risk shifting or transfer of risks in an interest-free Islamic financing.

Practical implications

The outcome of this paper has practical implications for Islamic banks to build a buffer of capital funds to face downward pressures during heightened financial uncertainties while serving as protection to depositors. Moreover, this study has practical implications for shareholders to avail themselves the benefits of high investment accounts financing. The Islamic banks can continue to play their role in promoting inclusive growth, reducing inequality and accelerating poverty reduction.

Social implications

Although the current study is based on a sample of Islamic banks in Malaysia, the finding suggests that the extent of risk shifting was significantly more incentivized among the foreign-owned rather than the domestic Islamic banks. This information can be used to develop targeted interventions aimed at discouraging risk shifting or transfer of risks in an interest-free Islamic financing.

Originality/value

This paper is the first that investigates on adequacy of regulatory capital funds of Islamic banks through loss provisioning policies.

Details

Journal of Financial Reporting and Accounting, vol. 16 no. 1
Type: Research Article
ISSN: 1985-2517

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Article

Tomoki Kitamura and Kozo Omori

The purpose of this paper is to theoretically examine the risk-taking decision of corporate defined benefits (DB) plans. The equity holders’ investment problem that is…

Abstract

Purpose

The purpose of this paper is to theoretically examine the risk-taking decision of corporate defined benefits (DB) plans. The equity holders’ investment problem that is represented by the position of a vulnerable option is solved.

Design/methodology/approach

The simple traditional contingent claim approach is applied, which considers only the distributions of corporate cash flow, without the model expansions, such as market imperfections, needed to explain the firms’ behavior for DB plans in previous studies.

Findings

The authors find that the optimal solution to the equity holders’ DB investment problem is not an extreme corner solution such as 100 percent investment in equity funds as in the literature. Rather, the solution lies in the middle range, as is commonly observed in real-world economies.

Originality/value

The major value of this study is that it develops a clear mechanism for obtaining an internal solution for the equity holders’ DB investment problem and it provides the understanding that the base for corporate investment behavior for DB plans should incorporate the fact that in some cases the optimal solution is in the middle range. Therefore, the corporate risk-taking behavior of DB plans is harder to identify than the results of the empirical literature have predicted.

Details

Managerial Finance, vol. 45 no. 8
Type: Research Article
ISSN: 0307-4358

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Book part

C.W. Sealey

A major theme in the literature on bank regulation is that greater reliance on market forces can mitigate the moral hazard problem inherent in government sponsored deposit…

Abstract

A major theme in the literature on bank regulation is that greater reliance on market forces can mitigate the moral hazard problem inherent in government sponsored deposit insurance. Specific proposals to impose greater market discipline on banks include minimum requirements on (1) uninsured subordinated debt financing (either fixed-term or with option-type features), and (2) private coinsurance on deposits. Both proposals amount to delegating the responsibility for bank regulation to various private sector claimholders. The results suggest that such delegation (with or without claims that include option-type features) may be ineffective in lowering bank risk, at least within the present regulatory and institutional framework. Alternative mechanisms exist that can mitigate the moral hazard problem; however, it may be necessary for the regulator/deposit insurer to be an integral part of the solution.

Details

Research in Finance
Type: Book
ISBN: 978-1-84950-549-9

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Article

Bassam Mohammad Maali and Muhannad Ahmad Atmeh

The purpose of this paper is to examine the use of the social welfare concepts of Takaful and Tabarru’ (donations) as tools to guarantee deposits in the Islamic banking…

Abstract

Purpose

The purpose of this paper is to examine the use of the social welfare concepts of Takaful and Tabarru’ (donations) as tools to guarantee deposits in the Islamic banking industry, and the effect of such practice on the concept of risk sharing in Islamic finance.

Design/methodology/approach

The study critically analyzes the Mudaraba contract used by Islamic banks to mobilize funds, the use of Profit Equalization Reserves and Investment Risk Reserves, the use of other income smoothing techniques and the insurance of Islamic banks’ by regulatory agencies in some countries based on the Takaful and Tabarru’ concepts.

Findings

This paper shows that Islamic banks are increasingly using the concepts of Takaful and Tabarru’, which are intended originally for social welfare, as tools to justify the move to more guaranteed-in-substance type of deposits, and hence, more risk shifting rather than risk sharing in the Mudaraba contract. This use, is argued, moves Islamic banking towards more market-oriented, but less Shariaa-compliant in substance.

Research limitations/implications

This papers examined the behaviour of Islamic financial institutions and Islamic scholars based on the available literature. No empirical analysis was conducted.

Originality/value

This paper contributes to the ongoing debate about the substance of Islamic banking transactions and the risk shifting inherent in such transactions. Furthermore, it is the first study that examines the extent of utilizing different social welfare concepts to legalize – from Shariaa perspective – Islamic banking transactions.

Details

International Journal of Islamic and Middle Eastern Finance and Management, vol. 8 no. 2
Type: Research Article
ISSN: 1753-8394

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Article

Georgios I. Zekos

Aim of the present monograph is the economic analysis of the role of MNEs regarding globalisation and digital economy and in parallel there is a reference and examination…

Abstract

Aim of the present monograph is the economic analysis of the role of MNEs regarding globalisation and digital economy and in parallel there is a reference and examination of some legal aspects concerning MNEs, cyberspace and e‐commerce as the means of expression of the digital economy. The whole effort of the author is focused on the examination of various aspects of MNEs and their impact upon globalisation and vice versa and how and if we are moving towards a global digital economy.

Details

Managerial Law, vol. 45 no. 1/2
Type: Research Article
ISSN: 0309-0558

Keywords

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Article

Karmila Hanim Kamil, Marliana Abdullah, Shahida Shahimi and Abdul Ghafar Ismail

The purpose of this paper is to provide an insight of Islamic securitization based on sukuk structures.

Abstract

Purpose

The purpose of this paper is to provide an insight of Islamic securitization based on sukuk structures.

Design/methodology/approach

Descriptive, analytical, and comparative analyses are used to discuss the risk‐sharing behaviour in Islamic securitization through different structures of mudharabah and musharakah sukuk derived from asset securitization.

Findings

The paper reveals that although sukuk are structured in a similar way to conventional asset‐backed securities, they can have significantly different underlying structures, provisions and shariah‐compliant. In particular, it prohibits the receipt and payment of interest and stipulates that income must be derived from an underlying real business risk rather than as a guaranteed return from interest. With regards to sukuk securitization, an asset is one of the vital elements that should exist as an evidence to support the process and make it permissible in Islam. In terms of Islamic securitization mechanism, it can be divided into two principles, namely, debt based and partnership. This paper further emphasizes that sukuk structures based on partnership principle is regarded as risk sharing rather than risk shifting, where it works by combining risk‐exposures in such a way that they offset one another to some degree. Accordingly, overall risk will be less than total risks on individual basis.

Practical implications

This paper has important implication for the understanding of risk management practices particularly in structuring sukuk. Banks as originators and special purpose vehicles (SPV) as issuers, might consider more sukuk on partnership principles since it directed towards risk‐sharing concept that could lead to increase mobilization of savings and investment. As for the investors or sukuk holders, the partnership principle could generate the wealth creation, which to be shared between both investors (fund providers) and issuers (fund users), while both bear the risks involved and the resulting loss.

Originality/value

The paper will fill the gap in the existing literature of Islamic finance by showing that Islamic securitization via sukuk is a viable source of funds that could help stabilize the securities market, and as solution to the current subprime mortgages financial crisis.

Details

International Journal of Islamic and Middle Eastern Finance and Management, vol. 3 no. 4
Type: Research Article
ISSN: 1753-8394

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Article

Peter Buell Hirsch

The purpose of this paper is to examine how changes in the global geopolitical climate have created new and more acute reputation risks for multinational corporations.

Abstract

Purpose

The purpose of this paper is to examine how changes in the global geopolitical climate have created new and more acute reputation risks for multinational corporations.

Design/methodology/approach

This viewpoint examines recent shifts in the global geopolitical claims covered in international media and analyzes variety of instances in which these shifts have created new and more intense reputation risks. From this analysis, the authors derive insights into how companies can prepare for and manage their operations to mitigate potential reputation risks.

Findings

The author finds that the increases in reputation risk created by shifting global geopolitical structures expose weaknesses in the infrastructure and skill sets by which companies manage their corporate reputation and makes recommendations about overcoming these weaknesses.

Research limitations/implications

The geopolitical issues analyzed and the reputation risks exposed are selective; therefore, this is not a comprehensive review of all the potential risks.

Practical/implications

Companies can do a great deal to protect themselves from new reputation risks created by the geopolitical shifts discussed by setting up a new infrastructure for managing and reporting on these risks and hiring communications professionals with the appropriate capabilities for analyzing and managing the risks.

Social/implications

If these new risks are well managed, the potential for significant business disruption and the safety and security of corporate employees could be significantly reduced.

Originality/value

To the best of the author's knowledge, this is the first discussion of geopolitical shifts and corporate reputation.

Details

Journal of Business Strategy, vol. 40 no. 6
Type: Research Article
ISSN: 0275-6668

Keywords

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