Impact of Investment Efficiency on Cost of Equity: An Empirical Study on Shariah and Non Shariah Compliance Firms Listed on Pakistan Stock Exchange

Abstract

The primary purpose of the study is to investigate the impact of investment efficiency on cost of the equity of firm. This study further explores whether the relationship of investment efficiency and cost of equity is different for the shariah and non shariah compliance firms. Using sample of 235 non financial firms listed at Pakistan stock exchange (PSX) for the period of 2005-2015, the results revealed that there is a negative significant influence of investment efficiency on the cost of equity. This signifies that investors required rate of return increases with the increase in the level of investment inefficiency. We also found out that the negative association of investment efficiency and cost of equity is weaker for the shariah compliance firms than for non shariah compliance firms. The results of our study also provided evidences that overinvestment is positively associated with the cost of equity. But we are unable to find significant impact of under investment on the cost of equity, this pointed that over investment is considered more serious problem for investors as compared to the underinvestment. The results furnished empirical support to our argument that shariah acts as a mechanism to lower bankruptcy and leverage cost hence reduce the cost of equity. The findings are helpful for academicians, regulators, investors and Shariah board. Further research may be conducted in different economies in order to generalize the findings.