DETERMINANT OF SUKUK RATINGS
II.3. Hypotheses and Theoretical Framework Hypothesis One about Total Asset (H1)
Hypothesis One about Total Asset (H1) Hypothesis One about Total Asset (H1) Hypothesis One about Total Asset (H1) Hypothesis One about Total Asset (H1)
Horrigan (1966), Kaplan and Urwitz (1979), Belkaoui (1980), Kamstra (2001), Cho et.al (2002), found total asset to be important element in determining rating. LeClere (2002), Hu and Hansel (2005), Chancharat et.al (2007), and Li (2009) also use this variable in their research for predicting the company financial distress and financial bankruptcy. Horrigan (1966) explained how relative size (expressed in total asset) should make a difference in the eyes of rater or analyst. His logic was that bigger firms are better prepared to absorb the impact of adverse effects of economic and other natural crises than smaller firms. Another view is that larger pools of asset mean more resources are available to the firm for use in potential projects.
Touray (2004) mentioned the bigger the asset size of firm relative to other components, the greater is the firm ability to provide secure payment to its lender in the event of crises. This led us to conclude that the bigger the asset size of corporation is, the more likely it will get higher rating. With that the research proposes the following hypothesis:
H1: Other things being equal, the larger the size of total asset of a firm, the greater the likelihood that the sukuk is given a higher rating and vice versa.
Hypothesis Two about Long Term Leverage (H2) Hypothesis Two about Long Term Leverage (H2) Hypothesis Two about Long Term Leverage (H2) Hypothesis Two about Long Term Leverage (H2) Hypothesis Two about Long Term Leverage (H2)
Belkaoui (1980), Kim et.al (2001), Chaveesuk et.al (1999) use long-term leverage ratio as one of variable to determine sukuk rating. Chancharat et.al (2007), Ugurlu (2006), LeClere (2002), Muhammad Sori (2006) also incorporate the same variable in their research for predicting
the company financial distress and financial bankruptcy. There should be a positive relationship between higher leverage and incentive to default on debt. According to them, the transfer of risk to creditors by taking more debt will undoubtedly result in paying a higher premium and consequently lead to lower rating too. Touray (2004) have used the ratio of long-term debt to total invested capital as a proxy measure of leverage and they predict that it is negatively related to rating, since it is the most frequently used ratios in rating studies to represent the degree of leverage. With that the research proposes the following hypothesis:
H2: Other things being equal, the lower the ratio of long term debt to total invested capital, the greater the likelihood that the sukuk gets higher rating than lower rating, vice versa.
Hypothesis Three about Coverage Ratio (H3) Hypothesis Three about Coverage Ratio (H3) Hypothesis Three about Coverage Ratio (H3) Hypothesis Three about Coverage Ratio (H3) Hypothesis Three about Coverage Ratio (H3)
Horrigan (1966), Belkaoui (1980), Kamstra (2001), Touray (2004) argue the interest coverage ratio is a strong indicator of a firm»s financial strength. Gibson (1998), observes that firms in the regulated utility enjoy a lower cost of fund and also have more fund raising ability compared to firms in other sectors. This is due to their stable earning and higher coverage ratio record over time. The interest coverage ratio, which is also known at times as the ≈times interest earned∆ ratio, is a direct measure of long-term debt paying ability computed from the income statement. It shows how much the interest payments are covered from the direct cash flows of the business operations. The higher the interest coverage ratio of firm, the higher the firm rating is. However, according to Touray (2004), there was conflicting findings about the significance of this variable in explaining bond ratings. This study will also include this variable with the following assumption:
H3: Other things being equal, the higher interest coverage ratio of a firm, the greater the likelihood that the sukuk will be given a higher rating, vice versa.
Hypothesis Four about Return on Asset (ROA) (H4) Hypothesis Four about Return on Asset (ROA) (H4) Hypothesis Four about Return on Asset (ROA) (H4) Hypothesis Four about Return on Asset (ROA) (H4) Hypothesis Four about Return on Asset (ROA) (H4)
Chavesuuk (1999), Kim (2001), Kamstra (2001), Cho et.al (2002), use profitability variable as one of important variable in rating determination. Hadju and Virag (1996), Wen-Ying, et.al (2006) and Li and Liu (2009) utilize ROA as one of important profitability variable in modelling financial distress and financial bankruptcy. Liang et.al (2006) also mentioned profitability variable is used to measure how well a corporation is creating profit. The higher the profitability ration will impact to higher rating. In this study we use Return on Asset (ROA) as a proxy measure of profitability which is also used by Kamstra (2001). The following hypothesis is made regarding the effect of this variable:
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Determinant of Sukuk Ratings
H4: Other things being equal, the higher profitability ratio of a firm, the greater the likelihood that the sukuk will be given a higher rating, vice versa.
Hypothesis Five about Beta Company (H5) Hypothesis Five about Beta Company (H5) Hypothesis Five about Beta Company (H5) Hypothesis Five about Beta Company (H5) Hypothesis Five about Beta Company (H5)
According to Kamstra (2001), the actual rating process involves more than just a handful of quantifiable statistical variables. The rating agencies take into account other unquantifiable variables such as leadership quality, management ability, and technology changes. Becker and Milbourn (2008) try to proof the relationship between companies» reputation and rating. All these previous research lead this study to provide a variable which can represent the existence of other qualitative variables. With regard to previous finding by Becker and Milbourn(2008), we decided to use beta company as the proxy of companies» reputation. Ghafar and Saharudin (2003) investigate the relation between betas and return of Islamic Fund, which are invested in sukuk and equity instruments. As we know, reputation of company can be seen from its stability of return, in this case stock return. Impson, Karafiath, and Glasscocl (1992) also look at the impact of bond re-grading on the firms beta.
H5: Other things being equal, the lower beta of a firm, the greater the likelihood that the sukuk will be given a higher rating, vice versa.
Hypothesis Six about Guarantee Status Variable (H6) Hypothesis Six about Guarantee Status Variable (H6) Hypothesis Six about Guarantee Status Variable (H6) Hypothesis Six about Guarantee Status Variable (H6) Hypothesis Six about Guarantee Status Variable (H6)
According to Touray (2004), the guarantee status should be an important determinant of bond quality rating which assuming has the same nature with sukuk quality rating. In this case, it is a legal right which gives first payment priority to one kind of debtor over the others in the event of liquidation, etc. This agreement provides strong protection to senior sukuk holders at the expense of junior sukuk holders. Consequently, junior sukuk are always lower than senior sukuk in term of ratings. A the same time, the guarantee status of a bond is a promise that comes from a third party who provides a guarantee of principal and interest payment in the event of default. The third party in this case is mostly viewed as having strong financial capability to honour his promises. Therefore, this variable is included into analysis and model as dummy variable. It will be presented in our model as suggested by Gujarati (1995) and Touray (2004) as follows: number 1= represents any sukuk that has a guarantee status and number 0 = will stand for sukuk without guarantee status. The following hypothesis is made regarding the effect of this variable:
H6: It is hypothesized that sukuk with guarantee payment status has a greater likelihood of being given a higher rating than a sukuk without such guarantee.