This research paper investigates the capital structure decisions of financially distressed Shariah-compliant firms, focusing on the dynamics between short-term debt and equity. Using a sample of Shariah-compliant firms classified as financially distressed, the study fills a significant gap in the existing literature by examining this unique sector under the constraints of Islamic financial principles, which prohibit interest-based financing and emphasize ethical considerations. The research employs a comprehensive analysis of key determinants influencing capital structure, including liquidity, profitability, efficiency, growth opportunities, firm size, and tangible assets. The study's methodology includes a rigorous variable selection process, ultimately excluding political connection and corporate governance from the final model. This exclusion highlights the relative insignificance of these variables for the sample of Shariah-compliant firms, challenging conventional assumptions about their impact on capital structure. Our findings reveal that liquidity and profitability play critical roles in shaping capital structure decisions, while efficiency, growth opportunities, firm size, and tangible assets also significantly influence the balance between short-term debt and equity. The results underscore the importance of operational metrics and financial performance in managing capital structure during financial distress, providing new insights into the unique challenges faced by Shariah-compliant firms. This paper contributes valuable knowledge to both academic research and practical financial management. It suggests that financial managers and policymakers should focus on improving liquidity and profitability as primary strategies for managing capital structure in distressed Shariah-compliant firms. Additionally, the research provides a basis for future studies to explore broader contexts and additional factors affecting capital structure decisions. In conclusion, this paper advances the understanding of capital structure dynamics in Shariah-compliant firms and offers actionable insights for enhancing financial stability and decision-making in this distinct sector.
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