Sustainability Performance and Corporate Financial Stability of Shariah-Compliant Companies in Malaysia: The Moderating Effects of Ownership Concentration

Sustainability Performance and Corporate Financial Stability of Shariah-Compliant Companies in Malaysia: The Moderating Effects of Ownership Concentration

Mohamad Azwan Md Isa¹, Norashikin Ismail² & Mohd Halim Kadri³

^1,2Faculty of Business and Management, Universiti Teknologi MARA, Johor Branch, Segamat Campus, Malaysia.

³Faculty of Accountancy, Universiti Teknologi MARA, Johor Branch, Segamat Campus, Malaysia.

DOI: https://dx.doi.org/10.47772/IJRISS.2024.814MG004

Received: 18 October 2024; Accepted: 24 October 2024; Published: 13 November 2024

ABSTRACT

To date, sustainability performance (SUSP) has become a pivotal component that influences the corporate sectors viability, resilience and financial success in the long term. The SUSP, which portrays the corporate sectors’ engagement with the environment and community, has increasingly gained attention among the market regulators and business stakeholders especially since the launching of the UN’s SDGs Agenda in 2015. Strong SUSP contributes towards achievement of triple bottom lines (planet, people and profit) that ultimately leads to the realization of the UN’s 17 SDGs. However, there are conflicting conclusions on the relationship between SUSP and corporate financial stability (CFS) as evidenced by the previous studies. Therefore, this study attempts to examine the association between the SUSP (ESG scores) and the CFS (Altman’s z-score) using the samples of 77 Shariah-compliant public listed companies at Bursa Malaysia. In addition, this study looks into the moderating effects of ownership structure (ownership concentration) on the SUSP-CFS association. The study uses annual unbalanced panel data from 2018 to 2023 and uses the static panel analysis (fixed and random effects) to account for differences within and between companies. Although the results were not statistically significant, the finding reveals that the SUSP (ESG) is positively associated with the CFS. However, the positive association between the SUSP and CFS has weakened when there are ownership concentrations in the companies. The results imply that the corporate sectors’ commitment towards the issues related to the environment, society and governance pay off in terms of enhanced legitimacy and improved reputation, which consequently brings about the CFS.  Nevertheless, the SUSP-CFS connection is deteriorated if the substantial shareholders do not approve or support the commitment towards the SUSP. The rational might be that the concentered ownerships have the belief the SUSP comes at the expense of decreased financial performance. This study has policy and managerial implications.  The policy makers and regulators need to improve the ESG framework, which is still unclear and not standardized to be implemented by the corporate sectors. In addition, the government has to come up with robust ESG-related incentives to encourage the corporate sectors to undertake the SUSP. Meanwhile, the corporate sectors have to ensure clear sustainability plan and strategy besides convincing the shareholders to render strong support in committing towards SUSP.

Keywords: corporate financial stability, ESG, ownership concentration, sustainability performance

INTRODUCTION

Financial stability is an essential element for the long-term success of a corporate entity. CFS is defined as the ability of corporate sector in facilitating and enhancing the economic pursuits, managing the risks and absorbing the financial upsets (Schinasi, 2004). The CFS is a blend of strong and consistent financial position, financial performance and cash flows (Stobierski, 2020).  Maverick (2022) noted that the CFS is varying over time as it is the outcome of concoction of multiple financial metrics including liquidity, operating efficiency, profitability, and solvency. Apparently, the CFS does not solely depend on the profitability, but it requires the persistence from the companies in overcoming the business problems such as decline in sales, lack of financing, and losing key workers or consumers (Nosiru, 2023).

A report by the Bank of Thailand (n.d.) stating the corporate sectors, which are financially stable and healthy, are more resilient towards unforeseen disturbance, thus reducing the intense impacts from the financial crises. In addition, operational efficiency (Osazefua, 2019), investment performance (Chen & Wong, 2004), and efficient control of resources and cost (Sayidah et al., 2019) are the main drivers towards the CFS. Apart from that, the internal management characteristics such as leadership effectiveness, management confidence, and corporate governance strength and investor protection also contribute to the CFS (Hasan et al., 2018; Friedman et al., 2002).

Moreover, the CFS is influenced by the changes in the macroeconomic fundamentals (Dafermos et al., 2018) and development in the markets (Tsoukas, 2011). For instance, the rising inflation and interest rate have contributed to skyrocketing operating and financing costs, which have worsened the CFS, thus increasing the probability of bankruptcy (IMF, 2022). On top of that, the current global geopolitical instability such as Russia-Ukraine conflict and the US-China trade war has also interrupted the business operation and disturbed the supply chain, which has led to higher production cost and contributed to financial instability.

Aside from the financial and economic factors, the CFS is also influenced by non-financial factors. The corporate governance attributes pose mixed impacts on the CFS (Nguyen et al., 2022). In the European context, the sustainability performance enhances the CFS of the financial sector during the financial turmoil but the effects differ notably across companies’ characteristics and operating environments (Chiaramonte et al., 2022; Li et al., 2023; Orazalin et al., 2023). Further, the CFS is contributed by the strength of intellectual capital of the corporate sector (Festa et al., 2021).

The companies that are not stable financially will be exposed to probability of defaults (Badayi et al., 2021; Shih et al., 2021; Li et al., 2022; Citterio & King, 20223). The studies by Cooper and Uzun (2019), Shih et al. (2021), Lisin et al. (2022), Brooks and McGuire (2023),  Habermann and Fischer (2023) associate the corporate financial instability with the likelihood of bankruptcy. Therefore, the CFS is crucial to ensure the creditworthiness, solvency, and long term survival of companies (Aslan et al., 2021; Lisin et al., 2022). Cohen (2023) suggested that the companies must be willing to invest certain portion of funds and resources to achieve the financial stability. In addition, the companies must be efficient in fund allocation and monitoring system, thus minimizing the costs related to potential bankruptcy.

Meanwhile, Hsiao et al. (2022) relate the financial instability to the financial difficulties that vary from one company to another due to different reasons. The study notes that huge capital or non-operating expenditure allocated by companies to improve the relationship with their stakeholders had caused financial instability, particularly during the crisis period. Furthermore, Castenholz (2021) claims the corporate financial instability can negatively influence the capability of companies to obtain funds in the capital market, thus raising the cost of fund. The study also associates the financial instability with financial failure, which leads to the companies’ inability to meet their financial obligations (Aslan et al., 2021).

On another note, the sustainability performance (SUSP) has gained interest among the business communities particularly since the introduction of the UN’s SDGs Agenda in 2015. The issues related to sustainability such as renewable energy, carbon emission, diversity, and consumer data privacy and security have become increasingly concerning. The SUSP is currently linked to environmental, social and governance (ESG) performance. The environmental pillar comprises resource reduction, emission reduction and product innovation. The social pillar encompasses workforce, community, and human right and product responsibility whereas; the governance pillar consists of corporate management, shareholders’ right, and CSR strategy (Fiandrino et al., 2019; Lisin et al., 2022).

In the previous studies, the SUSP (ESG) is interchangeably referred to the ethical investing (Lisin et al., 2022), socially responsible investment (Castenholz, 2021; Domanovic, 2022; Jia & Li, 2022), green investment (Hsiao et al., 2022), sustainability initiatives (Fiandrino et al., 2019; Qureshi et al., 2021; Abdi et al., 2022; Saidane & Abdallah, 2021; Harymawan et al., 2021; Li et al., 2022; Brooks & McGuire, 2023), and green income (Shih et al., 2021). The ESG-related investment by the companies is also associated with the sustainable finance as highlighted by the IMF (2022) towards promoting the sustainability of this world.

The SUSP brings about a new standard of corporate endeavor in the value creation (Castenholz, 2021; Sandberg et al., 2023). Moreover, the SUSP potentially improves the corporate reputation, image, competitive advantage, and creditworthiness (Sadiq et al., 2020; Castenholz, 2021; Aslan et al., 2021; Harymawan et al., 2021; Citterio & King, 2023; Cohen, 2023). The SUSP also enhances the corporate visibility, legitimacy, approval from various stakeholders (Duque-Grisales & Aguilera-Caracuel, 2021; Jia & Li, 2022), and minimizes the exposure of the companies to the market risk besides establishing the goodwill in the long-term (Badayi et al., 2021).

In addition, the SUSP is able to influence the investors’ decision on the companies (Chen et al., 2023). The companies that perform well in the sustainability will be able to attract public sympathy (Cohen, 2023), and more secured and trusted by the stakeholders (Atkins, 2020; Chen et al., 2023). Besides, the SUSP contributes to the financial efficiency (Iazzolino et al., 2023), creates greater business value (Hagen, 2021) and establishes pragmatic corporate culture (Bukhari, 2023).

On the other hand, the SUSP (ESG) requires strong corporate commitment operationally and financially (Efthymiou et al., 2023). The report by NAVEX Inc. (2021) stated that the corporate sectors’ expenditure on the sustainability practices has increased year by year, which imposed extra financial burden as more cost and resources need to be allocated for  SUSP (Ang et al., 2022; Pérez et al., 2022). This creates new challenges to the corporate sectors in the integration of SUSP as the relevant costs are exorbitant and instant (Papageorgiou & Suntheim, 2019). The PwC (2022) found 75 percent of the global companies had to commit to the sustainability initiatives despite its negative impact on their profitability. The debate is still ongoing whether the SUSP is an effective business strategy in improving the corporate efficiency and profitability in the future (Andrey, 2023). With the above arguments, it is noteworthy to study the relationship between SUSP and CFS, particularly in the context of Malaysian corporate sector.

In the meantime, the ownership structure also plays crucial role in maintaining the CFS. The OWNS represents the percentage of ownership in a corporation by several parties and shows how those owners are interrelated contractually in affecting the corporate managerial decisions (Baba & Baba, 2021). The ownership structure comprises several forms, namely institutional, concentrated, managerial or insider, state or government, foreign and family ownerships (Raimo et al., 2020; Ahmad et al., 2023; Souguir et al., 2024). In this study, the concentrated ownership (CONC) is used to proxy the ownership structure. CONC is also referred to block ownership, where small number of shareholders with substantial percentage of share ownership in the companies. Recent studies (Sarpong-Danquah et al., 2022; Alhmood et al., 2023; Al Lawati & Sanad, 2023) measure the CONC as the 5% or more shareholding over total shares outstanding in the companies.

Previous studies highlight that there are positive impacts of CONC such as better protection of the shareholders’ interest, effective monitoring on the management and quality of corporate disclosures and reporting (Raimo et al., 2020; Batra et al., 2023) besides boosting the innovation in the companies (Lee, 2023). The companies with large CONC will be actively monitored, thus reducing the agency problem or conflict of interest and agency costs that might arise (Nashier & Gupta, 2023). In addition, ideal CONC contributes towards better financial performance (Shahrier et al., 2020; Sarpong-Danquah et al., 2022; Nashier & Gupta, 2023), helps in elevating the companies’ efficiency and reducing the cost of capital (Faysal et al., 2020; Habib et al., 2022).

However, Maniruzzaman et al. (2024) claim that the larger CONC increased the agency problem and has no significant influence on the companies’ financial performance. Meanwhile, Karim et al. (2023a) concluded the CONC had significant negative influence on the operating-based financial performance whereas; Mohamad et al. (2020) proved that the CONC had no significant relationship with both operating and market performances. In this regard, it is contentious to what extent the CONC can influence the CFS and moderate the relationship between the SUSP and CFS in Malaysia.

Empirically, studies related to the relationship between the SUSP and CFS is still inadequate and inconclusive specifically for the non-financial sectors in the developing countries. The studies by Lisin et al., (2022), Saïdane and Abdallah (2021), and Chiaramonte (2022) indicate that overall SUSP (combined ESG) has contributed to the CFS with the governance had the greatest positive impact. Meanwhile, Maquieira et al. (2024) claim the overall SUSP has significant relationship with CFS specifically the environmental and social performances whereas; Jia and Li (2022), and Shih et al. (2021) reveal only environmental performance significantly relates with or has positive influence on CFS. The results are in accordance with the Stakeholder theory (Freeman, 1984) as tested by Cooper & Uzun (2019), who stated the more concerned the companies are in the environmental issues, the more support the companies will gain from the stakeholders.

Meanwhile, the combined SUSP (ESG) played pivotal role in predicting CFS (Citterio & King, 2023). Their result suggested that the appropriate measures and actions taken by the companies pertaining to the ESG-related risks will bring about the financial stability, thus preventing the companies from going into bankruptcy. In addition, the investment in the sustainability activities should be treated as a long-term strategy by the companies despite the SUSP negative influence on the profitability in the short term (Hsiao et al., 2022). Their study further iterated that the investment for the social sake (SOCP) has deferred positive significant impact on the overall CFS. Castenholz (2021) emphasized that good relationship with various stakeholders will reduce the companies’ financial instability. The notion implied that the companies will be financially stable if they are taking good care of the stakeholders’ well-beings.

Cooper and Uzun (2019) claimed highly levered companies are more risky and financially unstable. Meanwhile, Shih et al. (2021) suggested the extent of SUSP influence on companies’ financial stability is more pronounced for the companies with high systematic risk, fragile business foundation, serious pollution and high energy consumption. Moreover, the companies that are highly exposed to the credit, market and environmental risks will experience lower financial stability. Their study further encouraged the companies to embrace the environmental performance in the risk management strategies and called for the policy makers to have strategic alliance with the companies in advancing the sustainable development.

In contrast, the overall SUSP (combined ESG) was found to reduce the CFS according to Magnússon (2023). The result was supported by Cohen (2023), who concluded the higher cost incurred on mitigating the environmental and social risks reduces the CFS. In addition, too much focuses on the environmental and social issues will distract the companies’ management from their core business operation that can lead to lower revenue and profitability. Meanwhile, Antunes et al. (2023) noted that only governance performance has significant negative influence on the CFS. According to Kanoujiya et al. (2023), they argued the SUSP alone does not influence the CFS. Their result is in support of Habermann and Fischer (202), who notes that high SUSP (ESG) had no significant impact on the CFS particularly during the times of economic upswing.

In regard concentrated ownership (CONC), Donker et al. (2009), Ramly (2013), and Al-Absy (2020) suggested the CONC significantly increases the CFS. The positive impact of the CONC was supported by Peljhan et al. (2020) and Fernando et al. (2020). The rationale was that CONC is considered as an ideal organizational characteristic to prevent or mitigate the principal-agent problem (agency conflict), thus better protecting the principals or owners’ interest (Jensen & Meckling, 2019). The larger CONC means huge incentives and capabilities to control, direct monitoring and supervision on the board of management (Nurim et al., 2017; Faisal et al., 2020), thus urging the agents to act in the best way to enhance firms’ value and ensure financial stability of the companies.

On the contrary, the CONC was proven to diminish the CFS according to Rubio-Misas (2020), Olga et al. (2022) and Gerged et al. (2022). The reason was that CONC led to increase in conflict or misaligned the interests and vision between the owners and managers (agents), which contributed to the agency problem, thus raising the agency cost. Another rationale was that block or substantial shareholders might have strictly monitored the companies’ management, which has affected their efficiency and performance, thus diminishing the CFS.

Meanwhile, Lim and Yen (2011) claimed that the external CONC had no influence on remuneration of the executive directors among the Malaysian public listed companies. However, CONC among the executive directors (insiders) leads to the act of expropriation at the expense of the minority shareholders’ interest, thus contributing to the owner-owner conflict and financial instability. Similar finding was revealed by Faisal et al. (2020) and Nurim et al. (2017) in the case of Indonesian companies, where CONC had negative impact that brings about the agency conflict between the majority and minority shareholders. The top shareholders with larger control can misuse the power through earnings manipulation and expropriation of minority shareholders’ interest, thus negatively affecting the firms’ value and ultimately diminishing CFS.

With respect to the moderating effects of CONC, it mitigates the positive impact of the CSR performance on the information asymmetry (Rehman et al., 2022). The CONC was also found to have significantly weakened the positive influence of the CEO power on the stock price crash risk (Shahab et al., 2020). However, Buertey (2021) noted that the CONC reduced the positive relationship between board gender diversity and the CSR reporting assurance. Similarly, the CONC weakened the positive impacts of the CSR practices on the financial performance of the heavily polluting companies (Ang et al., 2022). Meanwhile, there was no significant moderating effect of the CONC on the positive nexus between the ESG performance and firms’ value s as disclosed by Wu et al. (2022).

Looking at the inconclusive debates on the relationship between the SUSP and CFS, this study aims to investigate the relationship between the SUSP and CFS in Malaysian corporate setting. In addition, this study attempts to examine the extent of moderating effects of CONC on the SUSP-CFS nexus. This study is crucial as this will enrich the scarce literature on this area of study in the developing countries. Further, the study will shed light at what level of the SUSP among the Malaysian companies, particularly the Shariah-compliant companies that are supposed to have more awareness towards the sustainability agenda. The Shariah companies are also expected to be more committed towards the SUSP as it is in line with the Shariah principles. In Malaysia, the Shariah compliance status is strictly monitored by the Securities Commission Malaysia, where every six months the status will be revised and updated. The study will benefit the regulators on how to further enhance the ESG framework for the corporate implementation. Besides, the policy makers can encourage the corporate sector to commit to the SUSP by introducing effective incentives and allowances. The companies can prioritize on the ESG pillars that can improve their financial stability besides restructuring the ideal ownership. Lastly, the investors will benefit by considering the SUSP in their decision making to better manage their portfolio in the future.

DATA AND METHOD

The initial sample of this study comprised the F4GBM Index’s 109 constituents, which come from the list of the Top 200 Malaysian stocks in the FBM EMAS Index as of December 2023. We used convenience sampling and selected 84 Shariah-compliant companies by excluding 10 non-Shariah non-financial companies and 15 financial companies. The reason we excluded the financial sector’s companies are that they have unique capital structure and different nature and treatment of assets, liabilities, revenue and expenditure besides different reporting requirements (Kim et al., 2014; Habermann & Fischer, 2023; Ahmad et al., 2023).

Our final sample was only 77 Shariah companies as 7 companies had no ESG score data available in Refinitiv Eikon. As additional information, the F4GBM Index was launched in December 2014 mainly to enhance the profiles and exposures of the listed companies at Bursa Malaysia with leading sustainability (ESG) practices and stimulate the companies to disclose their best practices. The sample represents various sectors, where the consumer products and services and technology sectors make up the majority, followed by industrial products and services, property, energy, telecommunications and media, transportation, health care, utilities, and plantation.

The dependent variable is the CFS using the proxy of adjusted Z-score (Emerging Market Score or EMS) as tested by Shahwan and Habib (2020), and Habib and Kayani (2022). The EMS was manually calculated using the EMS model (Altman, 2005) as follows:

EMS = 3.25 + 6.56X1 + 3.26X2 + 6.72X3 + 1.05X4

Where;

EMS = Z-score for the emerging markets’ companies

X1 = working capital / total assets

X2 = retained earnings / total assets

X3 = earnings before interest and taxes / total assets

X4 = book value of equity / total liabilities

Precisely, X1 measures the liquidity of companies in meeting short term needs and financial obligations, X2 captures companies’ sustainable profitability and reinvestment opportunity for future growth using the internal financing, X3 represents companies’ operating efficiency in generating income from the assets utilized after considering the operating expenses, and X4 indicates companies’ level of leverage or solvency.

The raw financial data for the EMS was collected from the respective companies’ financial statements. As for the independent variables, the ESG combined and individual (E, S, G) scores were used to measure the SUSP (Saidane & Abdallah, 2021; Habermann & Fischer, 2023). The scores we collected from the Refinitiv Eikon database. The moderating variable (CONC) was measured based on the substantial percentage of shareholdings, namely 5% or more following Alhmood et al. (2023) and Al Lawati and Sanad (2023). The CONC was manually calculated using the annual reports of companies at the section of shareholding analysis. The control variables consist of size, age of companies, and leverage. The size used log of total assets (Ismail et al., 2022; Hsiao et al., 2022), the age was based on the number of year’s incorporation (Abdi et al., 2022; Harymawan et al., 2021; Diantini et al., 2023), and the leverage used the proxy of debt ratio measured by total debt over total assets (Lee & Isa, 2022; Habermann & Fischer, 202). The raw data for the control variables were sourced from the Refinitiv Eikon. This study used secondary annual data covering the period from 2018 to 2023. The unbalanced panel with 253 observations was tested by employing the static panel data techniques of analysis, namely POLS, Fixed and Random effects (Saygili et al., 2022; Duque-Grisales & Aguilera-Caracuel, 2021) besides the descriptive, correlation and unit root analyses. We determined the appropriate model based on the likelihood ratio (Chow) test between POLS and FE; and Hausman (1978) test between RE and FE. We tested the hypotheses as outlined in the following models:

Baseline model:

Where; CFS, SUSP, CONC, SIZE, AGE, LEV are as explained above. The ∝ represents the constant term, β indicates the beta coefficients of the respective variables, ∈ is the error term, i represents the unit of analysis (individual company), and t indicates the respective year of observation (2018-2023).

RESULTS AND DISCUSSION

Descriptive Analysis

Table 1 shows the results of descriptive statistics. On average, the sample companies indicated a mean EMS of 7.47, which is above 5.85. According to Altman (2005), the companies are considered as financially stable if the EMS above 5.85. Nevertheless, there is a large disparity between the lowest and highest EMS values, which imply that some companies are highly financially stable with the EMS as high as 20.63 whilst some companies are financially unstable with the EMS as low as 1.62. Generally, the companies with high EMS come from the technology, health care, and consumer products and services sectors. Meanwhile, the companies under the telecommunications and media, energy, utilities and property indicate the lowest EMS.

Table 1 Descriptive Statistics

For the combined score (ESGP), the companies scored 52.74 on averages, which is categorized as good performance and above average. Specifically, some companies in the property, construction and industrial products and services sectors had excellent performance with the score as high as 87.5 whilst other companies in the consumer products and services, plantation, energy, technology, and transportation sectors indicated poor performance with the score as low as 14.86.

With respect to the individual scores, governance (GOVP) indicated excellent performance with the highest score at 95.24, followed by environmental (ENVP) with 88.62 whilst social (SOCP) with slightly lower 88.2. However, on average, the corporate sector only indicated the mean score at 58.85 for SOCP, followed by GOVP at 53.53 whilst ENVP at 43.81. Surprisingly, some companies had performed poorly on ENVP with the lowest score 0.29, GOVP with 8.75, and SOCP with 13.89. Specifically, the companies that had poorest performance fall under the technology sector.

Obviously, the Malaysian companies still emphasized highly on GOVP such as the board member’s best practices and protection of shareholders’ interest. The selected companies also committed well to SOCP such as taking care of customers and community, and treating well of workforce. Nevertheless, the companies in Malaysia are still much lacking on the ENVP such as lack of concerns on the impacts of companies’ operation on the environment and ecosystem, and low mitigation on the environmental risks.

The moderating variable (CONC) has a mean of 54.85 percent, which shows, on average, the ownership of companies is highly concentrated. The disparity between the lowest and highest score is substantial, which indicates some companies’ ownerships are extremely concentrated whilst others are slightly concentrated. The majority of CONC are by the institutions or companies except a few by individual owners or companies’ directors.

As for the control variables, the size shows the mean of 22.29. The smallest size is RM182 million whilst the largest size is RM206 billion. The disparity in size of companies is substantial. For the age, on average, the companies are approximately 30 years of incorporation. The youngest company is 2 years whilst the oldest is 102 years, showing the age gap of companies is extensive. The leverage (DR) shows an average of 43.5 percent with the highest 92.6 percent whilst the lowest is 7.7 percent. That implies some companies are highly levered and some are lowly levered in financing their assets.

For data distribution, EMS and size indicate the slightest dispersion from the means, respectively. Meanwhile, for other variables, the standard deviation values range approximately between 15.0 and 20.0, respectively. In term of skewness, all variables show the values near to zero, respectively. In addition, the kurtosis indicates the values close to 3, respectively, which implies that the data is normally distributed.

Correlation Analysis

Table 2 presents the correlation matrix between the variables. The correlation analysis is crucial to determine the extent of association or multi-collinearity between the variables.

Table 2 Correlation Matrix

All the independent and control variables have negative correlations with the dependent variable. The results imply that when other variables increase, EMS will decrease or vice versa. The rationale for the negative correlations of the sustainability variables with EMS might be that the more the companies commit to the sustainability performance, the more the financial and physical resources, and management focus are required, thus lowering the assets, profits, and management focus, which ultimately diminishing their financial stability.

In respect to CONC, the higher the percentage of ownership concentration the lower EMS. This indicates the disadvantage of CONC because when it is too extreme, it will create disturbance to the management especially in managing the companies and making the decisions.  Moreover, the management might not be as efficient as they are supposed to be if there is over control or strict supervision by concentrated owners. Consequently, their performance might be adversely affected, thus reducing the financial stability of companies. Nevertheless, the correlations are weak or very weak, respectively.

Meanwhile, the correlations between the respective independent and control variables are found to be weak and positive except between GOVP and DR with AGE, respectively. However, there are moderate to strong positive correlations between the combined ESGP and the individual scores (ENVP, SOCP, GOVP). These results are expected as the combined score are weighted from the three individual pillars. Therefore, in this study, we ran separate regression models for the combined performance and individual performances to avoid the multi-collinearity issue. In sum, there is no strong correlation between the other variables and that permitted us to continue with the regression analysis.

Unit Root Analysis

Table 3 presents the results of unit root test using the common unit root type, LLC (Levin, Lin & Chu, 2002). The LLC is able to control the heterogeneity in the panel data. With the automatic lag length selection based on the SIC criterion and automatic bandwidth selection of Newey-West and Bartlett kernel, the unit root test indicates the following results.

Table 3 Unit Root Results

*p<0.05

All variables are stationary at Level except for the AGE based on the p-value less than 0.05. Therefore, we conclude that all the variables included in the regression models do not have unit root problem and are integrated at the same order, namely order zero, I(0). To further confirm, we tested the unit root using the Fisher-PP (Choi, 2001). This test is based on the individual unit root type and can be applied to the unbalanced panel data. The test results evidenced that all variables are stationary at the same order as the p-values are less than 0.05 except for the ESGP, ENVP, and GOVP. Nevertheless, in sum, all the variables passed at least one of the tests. Therefore, we conclude that the variables have no unit root issue, thus the data are reliable for regressions.

Selection of Appropriate Models for Estimation

We split the models into four (Model 1, Model 2, Model 3, Model 4) based on the number of independent variables. First, we ran the POLS model that ignore the panel data structure and the heterogeneity or individual effect of each entity in the cross-sectional data, thus assuming the intercepts are the same for all entities. Next, we ran the FE model that assumes every entity has its own intercept due to the heterogeneity or individuality of the respective entities. To determine the appropriate model between POLS and FE, we tested using the likelihood ratio test. The hypotheses are as follows:

H0: POLS is appropriate

Ha: FE is appropriate

The results indicate that the FE is the appropriate model for estimation based on the p-values less than 0.05. Then, we ran the RE model, which assumes all entities have a common mean value for the intercept due to randomness of the sample selected. To determine the best model for estimation between the RE and FE, we used the Hausman test, which is able to control the unobserved heterogeneity in the data. The hypotheses are as follows:

H₀: Random effect (RE) is appropriate

H_a: Fixed effect (FE) is appropriate

We had mixed results based on the p-value of 0.05, where for Models 1 and 2 we concluded to use the FE model for analysis whilst for Models 3 and 4 we estimated the models using the RE. Table 4 below summarizes the test results.

Table 4 Chow and Hausman Tests Results

Regression Analysis  

Table 5 shows the results of regression for the baseline models. For Model 1, we used the combined score (ESGP) as the independent variable. The result indicates high ESG performance contributed to financial stability of the companies (β=0.0157). However, the relationship was not statistically significant (p>0.05). Similar results were revealed for the three individual scores (ENVP, SOCP, GOVP) as the independent variables in Models 2, 3 and 4, respectively. The achievements in the respective environmental, social and governance aspects led to better corporate financial stability. Nevertheless, the relationships were not statistically significant for the Shariah-compliant companies in Malaysia.

As for the control variables, size of companies had negative relationship with the EMS for all four models tested. This implies the larger the size, the more susceptible the companies to financial instability. However, the relationship was not statistically significant. The age shows mixed results. When tested along with the combined score and individual ENVP, the relationships were positive. Meanwhile, when tested together with the individual SOCP and GOVP, the age indicated negative relationships, which mean the longer they are in the business the more vulnerable the companies financially. Nonetheless, the relationships were not statistically significant. The leverage of companies had significant negative relationships with EMS. This means the more debts the companies employed to finance their assets the more unstable they are financially.

In sum, the four baseline models show significance with p-values of F-statistics less than 0.05, implying all the variables fit well in the models, respectively. The R² also indicated considerable percentage with more than 90 percent (Models 1 and 2) and 50 percent (Models 3 and 4) variability in the dependent variable (EMS) were explained by the independent variables.

Table 5 Regression Results (Baseline Models)

*p<0.05

Table 6 presents the results on the moderating effects of the CONC on the relationships between the combined and individual scores and the EMS. We found that the ESGP (combined) and ENVP, SOCP and GOVP (individually) still contributed positively to financial stability of the companies when tested along with the CONC. But, the relationships were statistically insignificant. Meanwhile, the CONC showed negative significant relationships with the EMS, which implied that the more concentrated the ownerships the more unstable the companies financially. The possible reason might be that the companies are directly and highly controlled by small number of owners, which inhibits the management to take the best investment decisions for the companies. The concentrated owners might also act in such a way to protect their wealth by hindering the funds from being channeled to the sustainability causes. As a result, the companies’ reputation and image in the eyes of stakeholders will be negatively affected, thus contributing to their financial instability.

With respect to the moderating effects of CONC, it was shown that the CONC had weakened the positive relationships between the ESGP, ENVP, SOCP, GOVP and EMS, respectively. This indicates that in presence of increased CONC, the positive effects of SUSP on CFS will be reduced. In other words, the CONC did not help in enhancing the sustainability performances, consequently contributing towards the corporate financial instability. As for the control variables, the size, age and leverage had shown similar results as the baseline models.

Table 6 Regression Results (Moderating Models)

*p<0.05

DISCUSSION

This study had examined the relationship between the SUSP and the CFS of the Shariah-compliant companies in Malaysia for the period from 2018 to 2023. In addition, this study had looked into the extent of moderating effects of the CONC on the relationships between the SUSP and CFS. The previous studies on Malaysian corporate setting had specifically focused on the relationship between the ESG (sustainability) scores or disclosure and firms’ financial performance, which used the ROA, ROE or Tobin’s Q as the proxies.  This study attempted to address the gaps by examining the relationship between SUSP and CFS using the proxy of Altman’s adjusted z-score (EMS). The EMS is an inclusive and robust measure, which not only looking at the companies’ profitability as the ROA and ROE do, but also combining the effects with other influencing financial metrics. As per our knowledge based on the literature search, this is the first attempt in Malaysian setting to study the relationship between the SUSP and EMS (CFS) with the moderating effects on CONC.

The empirical results indicated that the SUSP is positively associated with the CFS. Despite of its insignificance, the positive results implied that the companies that had committed to the environmental causes such as emission reduction, resource reduction and product innovation had enhanced their financial stability (Jia & Li, 2022; Shih et al., 2021; Castenholz, 2021). In addition, the companies that engaged and treated well their employees, customers and community had been financially stable compared to the companies that did not put great concern on the social issues (Hsiao et al., 2022). Moreover, the companies with best practices in the corporate governance such as effective board composition and leadership, board diversity and strong protection of shareholders have been performing financially well (Lisin et al., 2022; Habermann & Fischer, 2021; Saidane & Abdallah, 2021).

The results are in support of the Stakeholder theory, which stated the good values that the companies delivered to the stakeholders would have positive impacts on the stakeholders (Freeman, 1984). As a result, the companies received the approval from the stakeholders and attained the legitimacy among the stakeholders. Consequently, the companies with high SUSP would enhance their reputation and corporate image, thus gaining greater supports from the stakeholders (Cooper & Uzun, 2019; Alodat et al., 2023) such as increased demand from customers, higher commitment and productivity from employees, lower cost of funds from creditors, and increased incentives or allowances from the government.

On the degree of effect of individual performance, the environmental and social had more positive effects on financial stability compared to the governance. This result was in accordance with Castenholz (2021), who suggested the companies to put priority on the environmental pillar that constitutes 43 percent of the combined ESG score. Meanwhile, the considerable effect of social on the financial stability was in support of Habermann and Fischer (2023), who note that the social performance plays a key role in enhancing the overall financial stability.

However, this study contradicts the study by Duque-Grisales and Aguilera-Caracuel (2021), who concluded the combined and individual performances, had significant negative effects on the firms’ profitability, thus harming the financial stability of five Latin American countries. The positive findings on environmental and social contradict Cohen (2023), who claimed that the more the companies invest resources to overcome both environmental and social risks, the lower their financial performance, thus consequently reducing the financial stability in the US companies. This study was also in contrast to Saidane and Abdallah (2021) in the case of African companies. The result on social pillar was conflicting Pillai and Al-Malkawi (2018), who noted that the companies’ management did not believe by allocating funds for social causes would enhance their competitive advantage and that might also reduce the financial stability of companies in six GCC countries.

Further, this study examined the influence of ownership concentration and its moderating effects. We found that the CONC alone had significant negative influence on the companies’ financial stability. The result is in support of Olga et al. (2022) and Gerged et al. (2022), who argued strict monitoring and supervision by the large concentrated owners, in order to protect their interests, negatively influenced the management performance, motivation and efficiency and consequently the companies’ financial stability. This study is also in agreement with Faisal et al. (2020) and Nurim et al. (2017), who claimed large CONC contributed to conflict between majority and minority shareholders, thus leading to corporate financial instability of Indonesian companies.

Moreover, the presence of CONC would reduce the positive relationship between sustainability performance and financial stability in Malaysian Shariah-compliant companies. The results signified the drawbacks of companies with highly concentrated ownership. High CONC not only directly reduced the financial stability, but also hindered the sustainability practices by the companies that led to financial instability. The concentrated owners might not see the funds allocated on the sustainability sakes would enhance their wealth. The weakening moderating effects of CONC are consistent with Buertey (2021), who found the CONC lessened the positive relationship between board gender diversity (GOVP) and the CSR reporting assurance. The result is also in line with Ang et al. (2022), who claimed the CONC reduced the positive influences of the CSR practices (ESG) on the financial performance of companies.

CONCLUSION

Conclusively, the sustainability performances influence the corporate financial stability positively, even though insignificant. The results can be indicative that the management and owners in Malaysian Shariah-compliant companies still lack of concern on the sustainability performance particularly related to the environmental and social issues. The results also signify that they did not fully value the importance of sustainability performance in improving the financial stability. There might be various reasons, which among others include the ESG requirement on the companies is still not finalized by the regulators or authorities amid the unclear framework and regulations for their implementation. In addition, the cost concern on the companies’ side for the sustainability initiatives along with the conflicts between the shareholders and managers can also contribute to the insignificance of the sustainability performance. Therefore, the government must come up with a clear-cut ESG framework and policies in order to be implemented by the companies. The government also needs to find effective ways either through giving incentives or allowances to boost the sustainability practices among the corporate sector. The companies need to pay great attention to the sustainability issues by having effective ESG policies and plans integrated into their business strategies. The companies should also believe that by investing in the sustainability causes will improve their visibility, reputation, recognition and competitive advantage among the various groups of stakeholders. The owners or shareholders should also play their roles in encouraging the management to engage in the sustainability practices. This, in turn, will benefit the companies in terms of increase in sales, reduction in cost, improvement in financial performance, and sustainability in financial health. This study has several limitations. First, this study only focused on the Malaysian corporate sector specifically the Shariah-compliant companies. Second, this study covered the period from 2018 to 2023 with unbalanced panel data that subjected to complete data in the database. This study employed the static panel data analysis instead of the dynamic panel data analysis that might give different results.  Therefore, the future studies are proposed to extend the sample into non Shariah-compliant companies for comparison. The ESG variables also can be further disaggregated to have more detailed results of sub-pillars effects on the corporate financial stability. The moderating effects of other ownership forms such as managerial, government, family and foreign ownerships can also be tested in future studies. Last but not least, different methods of analysis and different proxies for the financial stability can be applied to generate robust results in the future studies.

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