Financial Constraints and Cost of Equity: Empirical Study of Shariah Compliant Firms in Indonesia

Abstract

This study is to investigate the relationship between financial characteristics and the cost of equity capital from sharia-based companies, which tend to be financially constrained. Using 276 observations, the results of this study indicate that financial constraints which are proxied by free cash flow have a role in influencing the cost of equity capital. This study also builds an indirect relationship of free cash flow and capital costs by proposing investment efficiency as a mediator variable. By using the causal step approach from Baron and Kenny, the test results show that investment efficiency mediates the effect of free cash flow on the cost of equity capital with an indirect effect that is stronger than the direct effect. This study also found evidence that leverage has no role in strengthening the effect of free cash flow on the cost of equity capital.