AGENCY THEORY IN THE CAPITAL STRUCTURE OF ISLAMIC BANKING

Modigliani and Miller (1958), the leading pioneers of a firm s behaviour of capital structure choices, motivated other researchers to investigate the behaviour of a firm, beginning with the corporate capital structure decisions for financial and non-financial firms. The theory of corporate capital structure provides a useful framework for analysing bank capital structure especially in the presence of agency costs. There are several fundamental differences between financial firms and non-financial firm s capital structure. The major differences are in the form of bank liabilities and capital regulations. Hence, the aim of this paper is to examine the determinants of bank capital structure composition by using a bank performance indicator Return on Equity (ROE) as a proxy for agency cost of outside equity in the bank capital structure literature. The size of a bank and market concentration are also included in the estimation model, being determinants of bank capital structure choices, as control variables. Using time-series cross-sectional estimation from the year of 1996 to 2003 for 15 Islamic banks in Malaysia, the result shows that there is a negative relationship between ROE and equity capital. Moreover, an increase in bank size will increase bank equity capital, whilst an increase in market concentration will affect bank equity capital negatively.