Keywords

Sustainability has become a mainstream concern in both the business and academic settings in recent decades. Professional bodies and Institutional investors also recognize the importance of sustainability factors as a driving force for improving company values (Bernow, Klempner, & Magnin, 2017). In addition, sustainability issues have become even more significant for long-term investors. Similarly, academic institutions and scholars devoted a long list of studies examining the impact of sustainability performance on companies. Researchers interested in Islamic finance and Sharī‘ah governance have also contributed to the richness of sustainability studies. The latter focus primarily on the role of Islamic financial institutions and Muslim entrepreneurial activities in advancing sustainability.

Our study on sustainability, Sharī‘ah governance and financial performance in the context of the Indonesian financial market explores two sets of relationships: sustainability practices and the financial performance of companies under consideration, as well as their Sharī‘ah compliance and financial performance connecting the second set with sustainability concerns. We seek to answer the main research question of whether sustainability, Islamicity and profitability together work complementarily or adversely. Numerous studies have positively linked sustainability practices and financial performance (Ali, Danish, & Asrar-ul-Haq, 2020; Buallay, 2019; Fauzi & Idris, 2009; Lukman, Suhendah, & Evan, 2020; Waddock & Graves, 1997; A. J. Wibowo, 2012). However, research on Sharī‘ah governance in relation to financial performance is limited (Jan, Marimuthu, & Hassan, 2019a, b; Zyadat, 2017), while an inquiry combining sustainability, Islamic principles and financial performance is even rarer, especially when it is applied to the Indonesian context. This study fills this gap.

1 Sustainability and Corporate Financial Performance

Since the term ‘sustainability’ has not yet received a univocal definition, our review therefore draws on studies linking corporate financial performance with sustainability utilizing several terms, often used interchangeably by researchers to indicate this concept. The most common are: corporate social responsibility (CSR); ‘environmental, social and governance’ (ESG); ‘corporate social performance’ (CSP); and ‘socially responsible investment’ (SRI), in addition to the term ‘sustainability’ itself.

One can observe some inconsistencies in the current literature, however most of them are related to the measurement technique. Corporate social performance (CSP) is a multi-dimensional construct whose behavior starts from the internal (e.g. treatment of women and minorities) to external behavior (environmental strategy). However, the measure used in some empirical works was often one-dimensional (such as corporate governance only). This problem is exacerbated when this one-dimensional procedure is applied to a small sample size.Footnote 1 It becomes even more problematic when it is utilized on a survey methodology which usually has inherent problems with the response rate. To address the above measurement problems, Waddock and Graves (1997) proposed a self-constructed index. It measures CSP and corporate financial performance attributes based on the Kinder, Lydenberg, and Domini (KLD) database which provides consistent scores across the entire Standard and Poors 500. They find that CSP is positively related to both previous and future financial performances.

However, much consensus has been established on the positive impact of sustainability practice on financial performance. Ali et al. (2020) find that corporate social responsibility has a significant effect on the company's financial performance. They suggest that this positive correlation stems from a positive image created among stakeholders, thereby lowering overall costs as a result of disclosing sustainability factors. Buallay (2019) shows a significant positive impact of aggregate ESG disclosure on corporate financial performance, while the environmental disclosure specifically has a positive effect on the ‘Return on Assets’ and ‘Tobin’s Q’. In contrast, social disclosure demonstrates a negative effect on ROA, ROE and Tobin’s Q, while corporate governance disclosure has a negative effect on ROA and ROE, but a positive effect on Tobin's Q. This reveals on the one hand, the complexity of issues being studied, and on the other hand that the results are being affected by measurement proxies. The inconsistencies can also occur because ‘Return on Assets’ and ‘Return on Equity’ have different exposures to the economic environment. ROA—being the income earned per dollar deployed—may be less influenced by the capital structure, and thus by the economic circumstances. In contrast, ROE—being the net profit realized by the shareholders for every dollar invested—may be more susceptible to economic pressure. This is due to the fact that a portion of the company’s capital may have come from borrowing in addition to investment by shareholders; therefore there is leverage involved when measuring ROE. In a good economic condition ROE is high due to the leverage effect, while in a declining economy it tends to be low. This effect can also lead to inconsistencies in research findings.

Research on sustainability issues in relation to financial performance in Indonesia is still rare, but a few have investigated this matter based on data collected from sub-segments of sustainability. Lukman et al. (2020) explore forty-five manufacturing companies listed on the Indonesia Stock Exchange, looking at the effect of their environmental performance reporting (EPR) and CSR activities on their financial presentation as measured by ‘Return on Assets’. Their study assesses the data provided by the Indonesian Ministry of Environment and Forestry through its Environmental Management Rating Program (PROPER) that measures corporate sustainability practices. The forty-five firms during 2014–2015 are rated according to the PROPER rating system from best to worst as gold, green, blue, red, and black. This shows that corporate CSR activities produce no effect on financial performance, while sustainability disclosure does have a positive consequence.

The inconsistencies in such studies may alternatively be explained from the perspective of modern ‘portfolio theory’, which maintains that the objective of investment is to maximize profits and wealth. This theory emphasizes the importance of reducing risk for better returns, which can be achieved through diversification and other means. It further asserts that any restrictions imposed on investments have the potential for a lower performance, implying that sustainability practices by companies reduce their ability to choose certain profitable business strategies or pursue tactical risks. Thus, the mixed results shown in previous studies are consistent with this theory's belief that firms implementing sustainable practices have restricted themselves from choosing more profitable strategies and thereby suffer in their financial performance. Daugaard (2019, p. 15) and Barnett and Salomon (2006) stated as: “The returns initially fall as a fund manager increases their [his or her] screening intensity from weak to medium, but then returns rise again as the screening intensity becomes higher.”

In contrast to the above analyses, Wibowo (2012) analyzed twenty-five companies from the SRI-Kehati index on the Indonesia Stock Exchange (2005–2010) and finds a significant relationship between CSR and profitability. Employing ROA as a proxy for financial performance, Wibowo discovers that there is a positive relationship between CSR disclosure and corporate profitability, and vice versa. Likewise, positive results were also demonstrated by the inquiry conducted by Fauzi and Idris (2009) on the relationship between corporate financial performance (CFP) and corporate social performance (CSP). Using a questionnaire-based survey with respondents consisting of managers from state-owned enterprises (Badan Usaha Milik Negara—BUMN) and from private companies, their research found a positive relationship between financial performance and social consciousness.

Despite such lingering inconsistencies, a number of researches investigating the relationship between sustainability and financial performance presented here have reported positive findings. These optimistic results are in line with several other theories such as ‘agency theory’, ‘legitimacy theory’ and ‘signaling theory’. These three theories imply that sustainability disclosure by a company produces a positive image, shields it from negative public scrutiny and lawsuits, and enhances public acceptance, which in turn augments the company's attraction and sales. Since efficiency, acceptability and legitimacy can also have an impact on financial performance. On the basis of above arguments we develop our first hypothesis as:

H1: Sustainability practice has a significant positive relationship with financial performance of the companies listed on the Indonesia Stock Exchange under the Jakarta Islamic Index. This relationship is moderated by the level of Islamic practice.

2 Sharī‘ah Compliance and Corporate Financial Performance

This segment reviews the literature on Islamic Finance in relation to corporate sustainability practices, with reference to Muslim majority nations. The text sources in this specific field are still scanty, based, however, researchers tried to establish a solid alliance between sustainability practice and Sharī‘ah application on the corporate financial outlook. They explained this three-dimensional relationship (sustainability, Sharī‘ah-compliance, and profitability) utilizing various performance measures. Jan et al. (2019a, b) explore the relationship between sustainability practice and financial performance of Malaysian Islamic banking for the period of 2008–2017. Looking from the three different perspectives of management, shareholder and market, they argued that company financial performance can be measured by various financial ratios to indicate its business outlook: ‘Return on Assets’ points to the nature of the management; ‘Return on Equity’ to the benefits of the shareholders; and ‘Tobin's Q’ from the market view point. They find a significant and positive relationship between sustainability practices and financial indicators, suggesting good management practices by the banking industry as well as healthy returns for the shareholders. This study found that the impact of sustainability on the market is insignificant. Conducting an in-depth analysis to learn the reason for the above inconsistencies, they learnt that market participants are not appreciative of the bank’s appropriation of its resources to fulfill its social and environmental efforts. The market views that the bank is institutionalized to make profits and to maintain its own economic sustainability without regard to social and ecological responsibility. Zyadat (2017) analyzes the effect of sustainability on the financial performance of Jordanian Islamic banking during the period 2008–2014. He collects the data from the country’s two major Islamic institutions, namely the Jordan Islamic Bank and the Arab Islamic Bank. This study finds a statistically significant positive effect of sustainability on financial performance as measured by ROA and Earnings per Share (EPS), but demonstrates a negative outcome when measured by ROE. Ur Rehman et al. (2020) investigate the impact of corporate social responsibility disclosure on financial performance in the Islamic banking industry in Pakistan from 2012 to 2017. They find a significant negative relationship between aggregate sustainability disclosure and corporate financial performance. Nevertheless, when observed individually the disclosure of the environmental and economic dimensions reveals a meaningful positive effect on the bank’s financial performance, while the disclosure of social practices does not positively affect its financial performance. Listyaningsih and Krishnamurti (2015) examine the performance of shares in the Indonesia Stock Exchange by dividing the data into two periods: the 2005–2007 phase consisting of JII and non-JII groups, and the 2008–2012 period comprising three groupings of JII, Sharī‘ah and non-Sharī‘ah. This study finds no difference in financial gains between investing in conventional or in Islamic stocks.

Given the inconsistencies of these research findings, several points should be considered. First, the different measurements of input variables, such as aggregate and individual sustainability disclosures, and of outcome variables, such as different performance measures, may have contributed to inconsistent results in previous studies. Secondly, incomplete reporting on sustainability and Sharī‘ah practices by corporations could also be another reason for the limited association between these two practices (sustainability and Islamicity) and financial performance. Peng and Isa (2020) pull ESG scores from the Thomson Reuters ASSET4 database that provides a higher degree of robustness, accuracy, consistency, and validity of information. They examine the impact of sustainability practices on the financial performance of four hundred sixty-one Islamic companies from 20 different countries listed on the MSCI World Islamic Index during the period 2010–2017. Their analysis reveals that the ESG aggregate and its individual components are positively related to the firms’ financial performance and suggest that ESG and Sharī‘ah screening could increase the firm’s value, promote more ethical, responsible and transparent practices, and thereby create new markets for potential investors. In addition, both sustainability practices and Sharī‘ah performances have recently become business strategies for several global large companies due to high demand from their stakeholders. This suggests that companies that comply with these requests will provide good signals to stakeholders, who will eventually value their corporate sustainability and Islamic practices. Therefore, our second hypothesis is:

H2:Islamic practice has a significant and positive relationship with financial performance of companies listed on the Indonesia Stock Exchange under the Jakarta Islamic Index. Islamic practice also moderates the relationship between sustainability practice and financial performance.

3 Conceptual Framework

Figure 16.1 illustrates the the relationship between sustainability and Islamic practice, and the financial performance of selected companies listed on the Jakarta Islamic Index for the period of 2015–2019. In this model, one independent (ESG scores based on the Global Reporting Initiative (GRI) standards), three dependent (Return on Assets’, ‘Return on Equity’ and ‘Ln Net Profit’), one moderating (Islamic Social Reporting (ISR) scores) and one interaction variable is selected. A more detailed explanation of the operationalization of the variables is provided in the Methodology section.

Fig. 16.1
figure 1

Conceptual framework of the sustainability study

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3.1 Methodology

3.1.1 Sampling Procedure

The sample of this study consists of seventy-five firms, year observations derived from the fifteen companies listed on the Indonesia Stock Exchange (IDX) under the Jakarta Islamic Index for 2015–2019. The selection of 2015 as the beginning of our research period is because in that year the Indonesian Financial Services Authority (OJK) issued the Regulation Number 15/POJK.04/2015 concerning the application of Sharī‘ah principles in the capital market.

The Jakarta Islamic Index (JII) is a Sharī‘ah stock index consisting of the thirty most liquid Islamic stocks listed on the IDX, and these shares derive from the List of Sharī‘ah Securities (Daftar Efek Syariah—DES) issued by the OJK. The JII constituents are reviewed by the IDX twice a year following the DES review by the OJK. The selection criteria involve two stages. First, sixty shares listed on DES that have sat on the ISSI index for the past six months are selected according to the order of the highest average market capitalization for the past one year. Secondly, of these sixty stocks, thirty are selected based on the highest average daily transaction value in the regular market. Consistent with the selection criteria, some stocks are removed from the index while other new shares enter the system to complete the number of thirty stocks at every review period. Thus, the Indonesia Stock Exchange is only responsible for selecting the JII list based on its market capitalization and market liquidity, whereas OJK is the organization responsible for issuing the List of Sharī‘ah Securities or DES (Summarized from https://www.idx.co.id/idx-syariah/indeks-saham-syariah/).

The DES review is carried out by the OJK periodically and incidentally. Periodic evaluation is executed twice a year on fixed dates and the shares meeting the criteria according to OJK Regulation Number 35/POJK.04/2017 remain on the list. Incidental assessment is performed when the need to revise the DES list outside the fixed dates arise. The necessity for such revision occurs either when a new company is being added to the DES list as a result of an Initial Public Offering (IPO); or when the existing shares on the platform no longer meet Sharī‘ah requirements according to OJK regulations. There are two main conditions for stocks to meet the DES criteria. First, the IDX listed companies perform no business activities prohibited by the Sharī‘ah, such as gambling and ribāwi financial services. Second, public companies do not have more than 45% of the total interest-based debt (ribā) when compared to their total assets, and their total interest income and other non-ḥalāl income is not more than 10% of their total operating revenue.Footnote 2

The above information indicates that the criteria for shares to be on the DES list are not completely Sharī‘ah wheraes there is still a proportion of business activities contravening Islamic law. Allowing non-compliant transactions to be part of the Sharī‘ah shares may have three implications for the development of Islamic Finance in Indonesia. First, it provides an opportunity for the corporate management to design business activities that meet only the minimum DES requirements. Second, the companies on the DES list are not motivated to become Sharī‘ah-driven enterprises in the same way as sustainable companies are. The latter strive to tick every box of sustainability requirements. Had those companies been Sharī‘ah-driven, they would have endeavored to make significant changes to their operations so that their Sharī‘ah compliance would get better over time. Third, allowing the DES companies to be not fully Islamic could provide a setback for Muslim investors who might expect the firms under the Islamic index to be completely Sharī‘ah compliant. However, a similar policy with a lower percentage is also being implemented in Malaysia (Firmansyah, 2017). In spite of a moderate level of Sharī‘ah requirements stipulated by the Indonesian Government, a number of companies were unable to meet these requirements and were removed from the JII index, and thus from our sample.

The sample companies comprise seven business sectors from the nine segment areas available on the Indonesia Stock Exchange. The IDX classifies the businesses of stock issuers into nine sectors following the Jakarta Stock Industry Classification (JASICAFootnote 3) Index: (1) agriculture, (2) basic industry & chemical, (3) consumer goods, (4) construction & property & real estate, (5) finance, (6) infrastructure, (7) utilities & transportation, (8) mining miscellaneous industries, and (9) trade & services & investment. The two segments not included in our sample companies are agriculture and finance, because none of the companies under these two segments meets the sampling criteria outlined above.Footnote 4 Our sample companies have been listed on the IDX for various times ranging from five to thirty-seven years according to their IPO dates. Thus our selection of sample companies is random. The list of these firms and their seven sectors is presented in Table 16.1.

Table 16.1 Sample companies in the JII index 2015 to 2019
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3.1.2 Data and Variables

The Dependent variable in this study is financial, measured by three proxies: ‘Return on Assets’, ‘Return on Equity’ and ‘Ln Net Profit’. A Study by Firescu (2015) shows that managers are interested in the overall performance of the company, while investors in the profitability of their investments. Therefore, managers concentrate on the accounting return, commonly known as ‘Return on Assets’, and investors on the return of their investments, widely referred to as ‘Return on Equity’. Both these ratios are rooted in the net profit, and therefore we also utilize ‘Ln Net Profit’ as our third performance measure. The data to assess performance measures are collected from the companies’ annual reports. This study measures sustainability practice by ESG disclosure scores based on the ninety-two items of the Global Reporting Initiative (GRI) standards. Content analysis is performed manually to extract ESG disclosure scores from sample companies’ annual and sustainability reports (see Appendix 1 for GRI Standard Items). Moderating variable is Sharī‘ah practice measured by the disclosure of Sharī‘ah items based on the Islamic Social Reporting (ISR) To assess Sharī‘ah performance by the sample companies, we adopt the ISR 43-item disclosure index developed by Haniffa and Hudaib (2002), and modified by Othman et al. (2009) who added corporate governance to the index. This modified ISR index consists of six themes: (1) finance and investments, (2) products and services, (3) employees, (4) society, (5) the environment, and (6) corporate governance. We perform content analysis manually to extract ISR disclosure scores from the companies’ annual reports (see Appendix 2 for ISR Items).

The several variables in this study are controlled to avoid scale and spurious bias estimates in our research results. First is the company size as measured by the logarithm of total assets (Arayssi et al., 2016; Duque-Grisales & Aguilera-Caracuel, 2019; Lourenço et al., 2012). Second is leverage, we measure leverage by the ratio of total debts to total assets, known as ‘financial leverage ratio’, to describe the extent of loans used by the company to finance its assets (Baird et al., 2012; Carini & Chiaf, 2015; Khan et al., 2016). Third variable is inventory turnover. This variable describes the level of corporate sales activity, which is another determinant of financial performance, we measure inventory turnover using cost of goods sold divided by average inventory. Fourth control variable is the age of company, it is measured by the length of time it has been listed on the stock market. Data for control variables are collected from the companies’ annual reports. The variable measurements are described in Table 16.2.

Table 16.2 Variable measurements
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3.1.3 Data Analysis Technique

In this study data is analyzed by employing ‘Robust Multiple Least Square Regression’ models with the statistical software Stata. We apply robust regressions in order to avoid estimation bias from potential outliers in the data. Given the small sample size we chose not to remove the potential outliers.

FinPerf1 = α0 + α1Sustain + α2ISR + α3 Sustain*ISR + α4 Size + α5Lev + α6InvTurn + α7Age + ε. (Model 1)

FinPerf2 = α0 + α1Sustain + α2ISR + α3 Sustain*ISR + α4 Size + α5Lev + α6InvTurn + α7Age + ε. (Model 2)

FinPerf3 = α0 + α1Sustain + α2ISR + α3 Sustain*ISR + α4 Size + α5Lev + α6InvTurn + α7Age + ε. (Model 3)

Where:

FinPerf::

ROA (Model 1); ROE (Model 2); Ln Net Profit (Model 3)

Sustain::

Sustainability practice

ISR::

Islamic practice

Size::

Company size

Lev::

Company leverage

InvTurn::

Inventory turnover

Age::

Company age

4 Results and Discussions

Table 16.3, Panel A provides descriptive statistics of the research variables. Both ROA and ROE are ratio variables with a mean value of 0.1130551 (11.30%) and 0.2696375 (26.96%) respectively; whereas net profit is a continuous variable so we transform this variable using log 10. The log net profit or Ln Net Profit has a mean value of 3.466945. Independent variable denoting Sustain is the weighted average of ESG disclosure index based on the GRI standards, so it is also a ratio variable. The minimum ESG disclosure index is 0 and the maximum net score is 0.7804878 (78.05%). The mean value of Sustain (ESG disclosure index) is 0.1547971 (15.48%), indicating that on average, the companies only have 15.48% disclosure of the 92 total items (100%) of the Global Reporting Initiative (GRI) standards. The percentage of average disclosure is significantly low. This limited disclosure can be seen more clearly when we look at the ESG disclosure value shown in Panel B, where the average value is just 12.69333 items of the 92 total disclosure standards. Considering sustainable disclosure is voluntary in nature, its level of disclosure is left to the discretion of the company. Usually, the more the company focuses on sustainability, the better the disclosure level becomes. Thus, the low level of disclosure by our sample companies indicates the lack of their commitment towards sustainability agenda.

Table 16.3 Panel A. Descriptive statistics for research variables. Panel B. Descriptive statistics for sustainability and islamic disclosure. Panel C. ESG disclosure by year. Panel D. ISR disclosure by year. Panel E. Pearson’s correlation coefficient
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The moderating variable of Sharī‘ah practice measured by the Islamic Social Reporting index is also a ratio variable. The mean value of sample companies’ ISR is 0.4651163 (46.51%), with the minimum value of 0.3953488 (39.53%) and the maximum of 0.5348837 (53.48%). Considering that there are only 43 items (100%) in the ISR index, this average value of about 50% (46.51% of 43 items) also reflects the relatively low level of Islamic practice, although comparatively higher than that of Sustain. This subdued score becomes even more apparent when we look at the average score of 20 in Panel B. The depleted level of ISR disclosure reflects the companies’ meager commitment to meeting Sharī‘ah requirements. Considering the Indonesian Financial Services Authority (OJK)’s prerequisites to be considered “Islamic”, the companies’ limited commitment to Sharī‘ah obligation is not surprising. As discussed earlier, companies must meet certain criteria to be on the DES list, which is a steppingstone to enter the Jakarta Islamic Index. Low requirements could be the reason for the limited level of commitment. It suggests that these companies are motivated by a business opportunity to be placed on the Sharī‘ah platform, rather than by Islamic ethics or both. Therefore, the companies are not inspired to faithfully fulfill ISR standards and engage in better disclosure—instead, they observe the bare minimum. Given the relatively low ESG and ISR disclosures by the companies under consideration, the interaction variables of the two are also not high with an average value of 0.0727436 (7.27%), a minimum value of 0 and a maximum of 0.3630176 (36.30%).

As for control variables, the mean values ​​are 4.617849 for Size (firm size); 1.074351 for Lev (firm leverage); 11.25262 for InvTurn (inventory turnover); and 20.46667 for Ln_Age (firm age), implying that sample companies’ differences in size and leverage structure are relatively insignificant. This is not surprising because the overall JII companies are based on market capitalization and market liquidity, so that the company size measured by total assets does not differ much from one another. Likewise, the leverage structure of sample firms is not far removed from each other since JII companies are prohibited from appropriating high debt. However, a high variety in the value of inventory turnover and company age is observed. Regarding years of existence, samples have had a minimum life-span on the stock market of five years and the maximum of thirty-seven. Age gaps represent the different stages of corporate maturity in sample companies.

The following panels demonstrate three key areas of inquiry: Sustainability, Islamic performance and moderating factor. Panel C exhibits the corporations’ ESG disclosure by year and the results show an insignificant trend from year to year. The maximum value of 64 out of 92 items occurred in 2015, which declined thereafter reaching its lowest point of 18 in 2017. From there, the disclosure increased to the value of 30 in 2018 and 53 in 2019. Several reasons can be suggested for this inconsistent sustainability performance by our sample companies. First, sustainable practice is a voluntary effort and the decision to implement it is left to the discretion of the company. Second, awareness of sustainability practices in the country’s business world remains relatively low and therefore there is limited culture of mimicking a role model in sustainability practice. The awareness issue also points to the lack of investors’ demand for sustainability information, thus less pressure for the companies to produce it. Finally, the lack of pressure from the investors, the government and the public at large makes corporate sustainability remote from mainstream discourse. However, the situation has improved since 2017 when the Indonesian Financial Services Authority issued the Regulation Number 51/POJK.03/2017 regarding the Implementation of Sustainable Finance. This regulation requires financial service institutions, stock issuers, public companies and others to publish their sustainability reports: banking sector companies have to meet this requirement by 2019, and other issuers by 2020 (Woodhead 2020). This regulation may explain the improved sustainability disclosure by our sample companies in 2018 and 2019 as described above.

Panel D also displays the ISR disclosure by year, and the scores are rather static over the study period with a slight increase in the last two years (2018–2019). Yet, the level of disclosure remains below 50%. A number of reasons appear to explain the low Islamic application. First, perhaps Sharī‘ah practices are not yet embedded in the operational strategies of the JII companies since they become constituents of the index based on a rather lax DES criteria and this tolerance may be the reason for their low commitment to Sharī‘ah principles. Second, the companies sitting on the JII index seems not to possess a clear incentive to perform beyond the DES Sharī‘ah requirements despite having an opportunity to attract potential Islamic investors. Third, lack of expertise of Islamic finance among the banking practioners seems to be another reason for our companies’ low Sharī‘ah compliance. A study by Iswanaji (2018) on the growth of Islamic banking in Indonesia shows the problem of skill proficiency and argues that the second major challenge encountered by its Sharī‘ah industry, in addition to an inadequate regulatory framework, is the lack of qualified human resources, i.e. ninety percent of the workforce of Islamic banking having no prior Islamic Finance training. Taktak and Farooq (2014) demonstrates that recommendations by experts and analysts have no value-relevance to the Sharī‘ah compliant companies in a similar fashion to non-Sharī‘ah counterparts. Their study supports our argument that Sharī‘ah companies have not been properly considered by investors in making investment decisions. This could be due to a lack of investor confidence or poor awareness of the lucrative potential of Sharī‘ah stocks.

It is clear that disclosure of both sustainability and Islamic performance by sample companies remains at the lower end of the scale (below 50%). We argue that these firms have not fully committed to either ESG or to Sharī‘ah obligations. We also assert that their sustainability practices have not gone hand-in-hand with their Islamic activities to seriously improve their financial performance. The slightly positive trend with regards to their Islamic compliance indicates that these corporations meet the Sharī‘ah requirements prescribed by OJK in order to stay on the Sharī‘ah index. By contrast, they have not found the niche to fully embrace sustainability, with this being reflected in their curvy performances throughout the course of study period. One explanation for such lack of commitment could be that these companies are still following the old school of thought: business for profit making. It also suggests that they have not transformed themselves to the level of high corporate ethics promoted by the United Nations and the world community. In addition, their practice is also a reflection of the country’s overall relatively weak commitment to sustainability.Footnote 5 One weakness of Indonesian public institutions is the level of implementation and legal enforcement: a sound legal standing is not necessarily translated into good policy and action.

In addition to the above descriptive statistics and analysis, we also analyze the correlations of the variables. Panel E provides Pearson’s correlation coefficients among the variables used in regression models. Patterning on this model, statistical analysis indicates that one of predictor variables Sustain is highly correlated with the interaction terms Sustain*ISR. Otherwise, there is no high correlation between the main predictor variables (including independent, moderating and control variables), indicating that multicollinearity is not a serious concern in regressions. Molala (2019) asserts that multicollinearity occurs when an absolute correlation coefficient higher than 0.7. In our results only Sustain and Sustain*ISR have correlation above 0.7 which is at 0.9556. To address the multicollinearity issue, we ran the generalized linear method (GLM) regression as a sensitivity test, and the results (not reported here) are consistent with the main regression tests.

The above descriptive statistics demonstrate that sample companies’ sustainability practice and Islamic performance are still at their infancy, with a great deal of room for improvement. We are convinced that the corporations have to make additional long-term efforts to experience a significant impact of the sustainability practices on their financial performance. The Government and the Sharī‘ah supervising board also have to be more attentive in supervising these firms, not only to ensure their compliance but also to provide a clear incentive to encourage an uptrend performance.

Table 16.4 reports the results of the estimating equations (Models 1, Model 2 & Model 3). The estimated coefficients for Sustain are −2.78717, −6.899427 and −11.18781 respectively, and the results are statistically significant at the 0.01% level with t-statistics −3.9 (Model 1); −3.42 (Model 2) and −4.68 (Model 3). It is observed from the regression results, that t-statistics values in the three models are above critical value, it can be concluded that results are highly significant and support initial hypothesis. Results show that the companies with higher sustainability practices experience lower financial performance. These findings contradict our hypothesis which predicted that sustainability practice is positively associated with financial performance. These results also conflict with those of prior studies by Waddock and Graves (1997) and (Buallay, 2019). In addition, our outcomes contradict the three theories that support sustainability disclosures, namely agency, signaling and legitimacy theories discussed in the literature review. However, our results are in line with modern ‘portfolio theory’ which defies strategic limitations in portfolios. Our predictions for the unexpected results in this analysis are twofold. First, the small sample size in our study may have contributed to the negative results. Second, the minimum average ESG disclosure by our sample companies could be another reason.

Table 16.4 Results of Robust Multiple Least Square Regression of Sustainability Practice on Financial Performance
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Our analysis of Islamic performance by the sample companies is also tested with the same model. The estimated coefficients of the ISR is at 0.6658164 (t-stat 2.02); 0.6658164 (t-stat 2.16); 2.005176 (t-stat 2.02) in Model 1, Model 2 & Model 3 respectively; these results are statistically significant at the 0.5% level. Consistent with our predictions, Islamic practice is positively associated with financial performance. Likewise, the estimated coefficient of the interaction variable, Sustain*ISR was at 5.7140 (t-stat 3.59); 13.9844 (t-stat 3.11); and 23.15008 (t-stat 4.35) across the three models; the results were statistically significant at the 0.01% level. The positive coefficient for the interaction variable indicates that the presence of ISR positively moderates the relationship between sustainability practices and financial performance. These findings strongly support second hypothesis, which posits that better Islamic disclosure leads to improved financial performance; and likewise Sharī‘ah compliance moderates the relationship between sustainability practice and financial performance. These outcomes support our initial prediction that ISR disclosure is positively associated with financial performance and acts as a positive moderator for the relationship between sustainability practice and financial performance. These results are also in accordance with the findings of several other studies by Jan et al., (2019a, b); Peng and Isa (2020); Ur Rehman et al. (2020). Our research findings are also in line with the three agency, signaling and legitimacy theories, thereby highlighting the importance of disclosure for better financial performance.

The models are robust with an adjusted R Square of 68.97% in Model 1; 76.98% in Model 2; and 78.90% in Model 3. These results show that the variables used in this study explain by about 70% financial performance in the three models.

5 Conclusion

This research explores the relationship between sustainability practices and financial performance in the Indonesian context. We reviewed fifteen sample companies listed on the Jakarta Islamic Index during the course of five years (2015–2019) utilizing the three proxies: ROA, ROE and Ln Net Profit. We first hypothesizes that sustainability practices improve financial performance of the companies under consideration, and secondly that Sharī‘ah compliance has a significant positive impact on their financial performance. We further predict that Islamic practice moderates the relationship between sustainability practices and financial performance. Contrary to our first expectation, we find that sustainability practice has a negative and significant effect on these companies’ financial performance. Meanwhile, Sharī‘ah compliance demonstrates a significantly positive relationship with their financial performance, and that this measure also positively moderates the relationship between sustainability and profitability proxies.

Our research contributes to sustainability literature and Islamic Finance in three different ways. First, to the best of our knowledge no previous research has investigated the research models proposed in this study, so this analysis enriches the empirical conceptual model. Second, this inquiry contributes to the current literature by providing evidence of a three-dimensional relationship between sustainability, Islamic practice and financial performance. Third, this study provides new empirical insights to regulators regarding Sharī‘ah compliance as a moderator of the relationship between sustainability practice and financial performance. As such it can be used as a basis for policy formation in advancing and regulating sustainability and Sharī‘ah practices by companies.

Our study is subject to several limitations. First, due to our content analysis methodology, we are unable to establish a high level of data validity. However, we have attempted to use several verification approaches during the data mining process. Second, we focus on a small number of Sharī‘ah-oriented companies, which makes our findings in need of careful consideration when they are generalized for understanding other research contexts. Third, we rely on an established set of company performance measures that may not adequately capture all the performance effects of sustainability and Islamic reporting practices. These limitations suggest important directions for further research. Future studies may explore our research questions by using alternative and broader data-sets from such databases, e.g. Bloomberg, Datastream, and others. This type of replication can help establish the applicability of our results.