COMPARATIVE ANALYSIS OF ISLAMIC AND CONVENTIONAL FINANCING ON FIRM PROFITABILITY: EVIDENCE FROM PAKISTAN’S MANUFACTURING SECTOR

Abstract

This research examines the impact of Islamic and conventional financing on the profitability of manufacturing firms listed on the Pakistan Stock Exchange. Manufacturing companies in Pakistan’s dual financial system face distinct alternatives between Shariah-compliant and conventional banking options. Theoretically, risk-sharing principles in Islamic finance differ from interest-based contracts in conventional finance, yet empirical evidence on performance outcomes for non-financial firms remains mixed. This study evaluates the profitability of 18 listed manufacturing firms (2019–2023), using return on assets, return on equity, and net profit margin. Employing panel data regression and controlling for firm-specific factors such as size, growth, and asset tangibility, the analysis applies fixed-effects and random-effects models to compare the effectiveness of Islamic versus conventional financing. Due to limited debt disclosure, Islamic financing is proxied by Shariah-compliance via PSX Islamic index inclusion. The results indicate that Islamic financing is associated with improved returns on assets and equity for manufacturing firms, though not necessarily with higher profit margins. These findings are interpreted through established capital structure theories, including the pecking order, trade-off, and agency cost theories, within the context of Pakistan’s economic and regulatory environment. This research provides empirical evidence to inform discussions about financing choices and performance in emerging markets and offers valuable insights for corporate managers, investors, financial institutions, and policymakers in Pakistan’s developing financial landscape.

Keywords

Islamic Finance, Conventional Finance, Firm Profitability, Manufacturing Firms