Alternative Financial Decision Principles: Theoretical Foundations of Islamic Banks’ Capital Structure

Abstract

Purpose – The aim of this chapter is to analyse consequences of the consideration of ethical principles in the financial decisions process of banks. More specifically, we study how the consideration of shariah principles could affect the capital structure of Islamic banks (IBs).Design/methodology/approach – First, we apply the classical concepts and theories of capital structure (trade-off theory, pecking order theory, agency theory) in the specific context of IBs. Then, through a literature review, we propose some expected determinants of the capital structure of IBs.Findings – Our theoretical analysis reveals that the trade-off theory is more suitable for IBs. Moreover, in Islamic institutions, information asymmetry and agency conflicts should be less important than in their conventional counterparts. However, our analysis does not allow us to conclude on the optimal combination of equity and non-equity financing.Research limitations – In this study, we have not constructed a new capital structure theory specific to IBs but we apply the classical concepts and theories (information asymmetry, agency theory, trade-off theory, pecking order theory) to the Islamic context.Originality/value – The study contributes to both the capital structure and the Islamic finance literature. There are few studies comparing IBs to conventional banks’ capital structure. Our chapter is the first, to our knowledge, which propose to theoretically explain the observed difference between these two categories of banks.