key: cord-0809714-v3iyesuq
authors: shear, Falik; Ashraf, Badar Nadeem
title: The performance of Islamic versus conventional stocks during the COVID-19 shock: evidence from firm-level data
date: 2022-02-08
journal: Res Int Bus Finance
DOI: 10.1016/j.ribaf.2022.101622
sha: 2a35f0d198ed5ad806fb14d8eed612d189ad5229
doc_id: 809714
cord_uid: v3iyesuq

In this study, we extend the recently heated debate that compares the performance of Shariah compliant equities with their non-Shariah compliant counterparts especially during the Covid-19 shock. Unlike the existing literature, which uses stock market index level data to reach controversial conclusions, we use firm-level stock returns data to find robust evidence that Shariah compliant stocks outperformed their conventional counterparts during the Covid-19 market meltdown. More specifically, we find that the prices of Shariah compliant stocks reacted to the increase in Coronavirus confirmed cases and government social distancing measures with lower negative returns than the prices of non-Shariah compliant stocks. Overall, our findings imply that Shariah compliant stocks fared better during the Covid-19 crisis episode.

The question whether the Shariah compliant stocks outperform their conventional counterparts especially during the crisis episodes has attracted substantial academic attention in recent years.

The extant literature in this regard is largely inconclusive with some finding the Shariah compliant stocks outperform, others arguing their performance is not any different from conventional stocks and some even reporting their underperformance (see, for example, the recent literature survey by Delle Foglie and Panetta (2020)). Exploiting the Covid-19 health and economic crisis as an exogenous shock, recent papers use stock market index-level data and, consistent with pre-Covid-19 literature, largely report mixed evidence. For instance, one stream of papers finds the Shariah compliant stock indexes experienced lower drop in valuation, lower volatility and faster recovery in response to the Covid-19 outbreak (Chowdhury et al. 2021; Hassan et al. 2021; Dharani et al. 2022) . Another stream, however, reaches the conclusion that the outbreak resulted in identical drop To qualify for Shariah-compliance, a stock has to fulfill Shariah based screening criteria which, first, excludes the interest-based and non-permissible businesses and, second, limits, for the underlying business, the level of leverage, the interest payments, the investments in non-Shariah compliant interest-based financial instruments and the income received from interest-based and speculative sources. The exclusion of interest-based businesses and limits on leverage, interest payments and speculative income suggests that Shariah compliant stocks would be relatively safer (Azad et al. 2018; Cheong 2021) .

Our empirical approach builds on the recent literature which shows that the stock markets responded negatively to the Covid-19 confirmed cases and related government social distancing policies (Al-Awadhi et al. 2020; Ashraf 2020b, a; Zhang et al. 2020; Ashraf 2021; Ashraf & Goodell 2021) and this negative stock market reaction varied depending on the risk of underlying assets (Albuquerque et al. 2020; Ramelli & Wagner 2020; Ding et al. 2021) . We hypothesize that if investors assessed the Shariah compliant stocks as less risky assets class as compared to the conventional stocks then the comparative decline in the prices of former assets class would be the milder.

Using the daily stock return data over the period January 1-June 30, 2020 for the Shariah compliant and non-compliant companies included in the KSE-100 index of the Pakistan Stock Exchange, we find the Shariah compliant stocks exhibited relatively milder negative reaction to the increase in Covid-19 confirmed cases, government social distancing interventions and feverish stock market situation. Overall, our results suggest the Shariah compliant stocks were more resilient to the crisis. Foglie and Panetta (2020) note that "Literature has not yet actually proven differences in performance and diversification benefits of Islamic Finance instruments". Second, our paper can also interest those interested in the general issues surrounding Shariah compliant assets during the Covid-19 outbreak, such as the hedging benefits or the performance of equity funds. In this regard, recent studies have found Islamic stock indexes acted as attractive hedging instrument against the US, Global and European stock market (Ashraf et al. 2020; Hasan et al. 2021a; Umar & Gubareva 2021) . Likewise, Shariah compliant equity funds outperformed the conventional ones during the Covid-19 (Mirza et al. 2022) .

The remainder of the paper is organized as follows: Next section reviews the relevant literature. A parallel literature however also showed that the stock market drop was not uniform and largely depended on the risks of underlying assets. For instance, Ramelli and Wagner (2020) explore that stock prices of US companies with higher exposure to China dropped more initially with the Covid-19 outbreak in China, however later investors favored those stocks when epicenters of the outbreak shifted to Europe and the US. They also observe stocks of firms with lower leverage and higher liquid assets were less severely affected by the outbreak. Albuquerque et al. (2020) show that stocks with higher environmental and social ratings observed significantly higher returns and lower return volatility during the first quarter. Ding et al. (2021) employ data of 6700 companies from 61 countries and find that the negative stock prices reaction to the Covid-19 confirmed cases was milder for firms with less leverage, higher profits, and more liquid assets. Likewise, Heyden and Heyden (2020) also find that stock price reaction to the Covid-19 depended on firm-specific characteristics such as the assets tangibility, liquidity, and institutional holdings. Building on these studies, we expect, if Shariah compliant companies were considered safer by investors, then the decline in stock prices of such companies in response to Covid-19 confirmed cases and government social distancing measures would be milder.

Pakistan is a Muslim majority country with significant demand of Shariah compliant financial assets. Pakistan Stock Exchange (PSX from hereafter), which is the only stock market in Pakistan, classifies listed companies into either Shariah compliant or non-compliant.

To be Shariah compliant, a stock has to fulfill two types of screening criteria: the qualitative and the quantitative. The qualitative criterion assesses whether the business of the applicant company is permissible in Islam. Businesses involving interest based transactions, such as conventional J o u r n a l P r e -p r o o f banks and leasing and insurance companies, making or selling liquor, pork or haram meat, and gambling activities such as derivatives, are not permissible.

The quantitative criterion sets the requirements for company financials such as the level of interest bearing debt, interest bearing investments, interest income, liquid assets and market price. For example, a company has to fulfil following quantitative criteria to be designated as Shariah compliant. The interest bearing debt that includes debt raised through conventional bank loans, bonds, commercial papers, hire purchase, finance lease, or by issuing preference shares should be less than 37% of total assets. The non-Shariah compliant investments, which include investments in conventional bank deposits, money market instruments, mutual funds, bonds, treasury bills, commercial paper, Bonds, or derivatives etc., should be less than 33% of total assets of the business. The non-Shariah compliant income that includes the income from interest based transactions, gambling, derivatives, casinos, addictive drugs, alcohol, penalty charged on late payment in credit sale and insurance claim reimbursement from a conventional insurance company) should be less than 5% of total revenue. Illiquid assets, which include all fixed assets such as property, plant & equipment, and inventories of raw materials, work-in-process and finished goods, should be at least 25% of total assets. Finally, the market price per share should be at least equal to or greater than net liquid assets per share.

The listed companies are reviewed semiannually, on the first day of January and July each year, for Shariah compliance criteria. Usually, the composition of companies changes after each review; some existing companies that fail to comply the Shariah screening criteria are excluded while others that start complying are included.

In response to the Covid-19 outbreak in the first quarter of 2020, stock markets around the world reacted with substantial negative returns. The Pakistan Stock Exchange (PSX) was no exception 

Motivating from the recent studies of Ashraf (2020b), Ashraf (2020a) and Ashraf (2021), we use following pooled panel data regression model: Daily market capitalization is added as a control variable. ∈ are heteroscedastic robust standard errors cluster at company-level. Appendix A briefly summarizes the variables definitions.

To assess whether Shariah compliant stocks reacted differently to the outbreak of Covid-19 and related government measures, we include following interaction terms.

J o u r n a l P r e -p r o o f

We expect significant interaction terms if Shariah compliant companies reacted differently to the Covid-19 cases, government response measures and feverish stock market trend.

Summary statistics J o u r n a l P r e -p r o o f (Insert Table 3 here) In Model 2, we add fever period dummy variable, which also enters negatively significant capturing the effect of contagious stock market declines during the months of February and March of 2020. Results of cases and government response variables still hold, showing that stock prices' reaction to these variables was over and above the contagious market fall of first quarter of 2020.

We add interaction terms in Models 3 to 5. The interaction term between cases and Shariah instance, the industries such as Tourism and energy were hit hard adversely while pharmaceutical and IT gained substantially during the pandemic. To account for the concern that Shariah compliant companies of some specific industries do not drive our results, we include industry fixed-effect dummy variables in the regression. As shown in Model 6, after including industry fixed effects, the interaction term between Shariah compliant firms and coronavirus cases remains significant eliminating the concern that results are because of some specific industry.

Overall, our results suggest that Shariah compliant stocks have demonstrated higher resilience to the Covid-19 shock.

(Insert Table 4 here)

We draw Figure 1 

We confirm the main results with a number of robustness checks. First, we add daily time fixed-effect dummy variables in the main model to further control for global trends during the Coronavirus pandemic. As shown in Table 5 , the results are like the ones in Table 4 .

(Insert Table 5 here)

Second, we add VIX and MSCI world indexes one-by-one as additional controls for global uncertainty and financial markets trend during the pandemic. VIX is considered as a strong predictor of global stock market volatility especially during the pandemic (Berger et al. 2020).

MSCI world index have been widely used as the international equity market benchmark (e.g.

(Shear et al. 2020)). As Shown in Table 6 , our main results still hold after controlling for VIX and MSCI world index. Further consistent with expectation, VIX has a negative impact on stock returns while MSCI has a positive impact.

(Insert Table 6 here)

Third, we estimate cross-sectional regression only for fever period. For doing so, we calculate stock returns for each company from February 25 to March 25, 2020. Using these returns as the dependent variable in Table 7 , the Shariah compliant dummy variable enters positive, significant suggesting the decline in Shariah compliant stocks during the fever period was relatively milder.

(Insert Table 7 here)

We consider the two firm-level characteristics 1 , the leverage and tangibility, to further investigate the channels through which Shariah-compliance firms act to be more resilient. Shariah screening criteria requires firms to have lower leverage and higher tangible assets. We interact both the Coronavirus cases and Govt. response with these two firm-level variables. Significant interaction terms would show that the adverse effect of Pandemic related variables on stock returns depends on firm leverage and tangibility.

As shown in Table 8 , the interactions terms of the leverage variable with cases and govt.

response enter negative and significant suggesting that the negative effect of both cases and govt.

response on stock returns strengthens for the firms with higher leverage. Likewise, the interaction terms between cases and tangibility enter positive and significant pointing out that the negative effect of cases weakens for the firms with higher amount of tangible assets. Figure 2 graphically displays the results of interaction terms. As shown in Panel A, stock price reduction in response to the increase in Coronavirus cases is milder if leverage is lower. Likewise, Panel 2 shows the stock price reduction is milder if the level of tangible assets held is higher. As Shariah-compliance screening criteria limits the maximum leverage and the minimum amount of tangible assets to be held, together above results imply that Shariah compliance criteria are helpful in ensuring the complying firms stand resilient to the crisis episodes.

(Insert Table 8 Dependent variable is Return, measured as the daily returns of a stock, in all models. Cases represents the extent of Coronavirus outbreak, measured as the natural logarithm of daily change in confirmed cases. Govt. response is represented with daily change in stringency index of the Oxford Covid-19 Government Response Tracker (OxCGRT). Shariah compliant is a dummy variable, equals 1 if a company is Shariah compliant and 0 otherwise. Fever period dummy equals 1 for the period January 17-March 15, 2020, and 0 otherwise. Market capitalization is daily total market value of all outstanding shares of a company. Shariah compliant × Cases, Shariah compliant × Govt. response, Shariah compliant × Fever period are interaction terms, capturing the joint effect of Shariah compliance and Pandemic on stock returns. Two firm level characteristics include, Tangibility (the ratio of tangible assets to total assets) and Leverage (the ratio of total asset to total equity). Interaction terms of Tangibility and Leverage with Cases and Govt. response variables capture the joint effect of the Pandemic and firm-level characteristics. Results are estimated with pooled ordinary least squares regression model, with robust standard errors clustered at company-level. *, ** and *** shows significance at 10%, 5% and 1% levels, respectively.

(1) J o u r n a l P r e -p r o o f 

Death and contagious infectious diseases: Impact of the COVID-19 virus on stock market returns

Do Islamic stock indexes outperform conventional stock indexes? A stochastic dominance approach

Do Islamic stocks outperform conventional stock sectors during normal and crisis periods? Extreme co-movements and portfolio management analysis

Resiliency of Environmental and Social Stocks: An Analysis of the Exogenous COVID-19 Market Crash. The Review of Corporate Finance Studies

Hidden cointegration reveals hidden values in Islamic investments

Economic impact of government interventions during the COVID-19 pandemic: International evidence from financial markets

Stock markets' reaction to COVID-19: cases or fatalities?

Stock Markets' Reaction to COVID-19: Moderating Role of National Culture

COVID-19 social distancing measures and economic growth: Distinguishing short-and long-term effects