The Right Purpose on the Right Covenant: Does the Loan Purpose Affect the Debt Covenant Through the Ṣukūk Rating?

Abstract

Purpose — This paper aims to determine the influence of the purpose for issuing ṣukūk (operations, financing, and investment/acquisition) on different types of debt covenants (balance sheet, income statement, and collateral-based covenants). It also examines the ability of the ṣukūk rating to mediate the relationship between loan purposes and debt covenants. Design/Methodology/Approach — The research data were 236 ṣukūk that were listed on the Indonesia Stock Exchange (IDX) until December 2020. They were collected through the IDX official website. Logistic regression and the Sobel test were used to test the direct and indirect influences among the variables studied. Findings — The results showed that loan purposes affected the types of debt covenants. Loans for operational purposes seemed to be in accordance with the debt covenant with restrictions on income statement (IS), balance sheet (BS) and collateral. Loans for investment/acquisition were more appropriate to both BS and collateral-based debt covenants, while loans for financing were better suited to BS-based debt covenants. This study also proves that the ṣukūk rating could mediate associations between loan purposes, especially for investment/acquisition, and the types of debt covenants. Practical Implication — This research is useful for ṣukūk investors to consider the investment by looking at the purposes, ratings and ṣukūk covenants. In addition, it is helpful for ṣukūk holders, represented by trustees, in determining debt covenants in the form of ṣukūk with different purposes. Research Implication — The results of this study described how accounting information improved contract efficiency. This research provided important evidence of the association between the structure of debt covenants and loan purposes. It provided empirical evidence of the debt covenant hypothesis in agency theory on the importance of designing debt contracts to reduce monitoring costs. Originality/Value — This study employed the debt covenant on ṣukūk in Indonesia. The use of the ṣukūk rating as an intervening variable between loan purpose and debt covenant has not been studied previously. This study also divided debt covenant into four types by adding the collateral-based debt covenant because ṣukūk are different from other types of debt and require underlying assets in their issuance.