While previous studies have linked Islamic finance to investment efficiency in Muslim-majority countries, existing work has not clearly isolated governance effects from broader cultural influences. This study aims to examine whether Islamic governance is statistically associated with investment efficiency in secular European markets, where overt religious or cultural explanations are less salient.
This study tested four hypotheses investigating main effects, crisis moderation, investment types and asymmetric effects by analyzing 16,750 firm-year observations in 20 EU countries (2000–2019) using the FTSE Shariah Global Index classification and propensity score matching.
Sharia-compliant firms show investment efficiency 8%–9% higher than comparable firms, by one standard deviation. Efficiency gains peaked during 2007–2013, when crisis conditions stemmed from excessive leverage and speculation, and align with Sharia constraints, specifically, Sharia supervisory board oversight, gharar (uncertainty) prohibition and asset-backing requirements, providing discipline where conventional governance weakened. These effects are asymmetric, mainly reducing overinvestment rather than underinvestment.
The results provide investors with governance signals beyond traditional ESG metrics. Crucially, this study demonstrates how Sharia-compliant governance complements European regulatory frameworks (e.g. SFDR, MiFID II) by reinforcing capital discipline. Conventional firms may improve capital allocation practices by incorporating Islamic governance elements, such as leverage limits and ex-ante investment screens.
To the best of the authors’ knowledge, this study is among the first to examine Sharia governance in developed secular markets while explicitly accounting for cultural confounding factors, documenting both the potential benefits for investment efficiency and the inherent governance growth tradeoffs.
