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American Journal of  Applied 
Statistics and Economics (AJASE)

Structural Equation Modeling Analysis of  Equity-Based Islamic Financing for Nigerian 
Small-Scale Enterprises Growth

Jamiu O. Badru1, Kamilu A. Saka2*

Volume 4 Issue 1, Year 2025
ISSN: 2992-927X (Online)

DOI: https://doi.org/10.54536/ajase.v4i1.4424
https://journals.e-palli.com/home/index.php/ajase

Article Information ABSTRACT

Received: January 19, 2025

Accepted: February 22, 2025

Published: May 10, 2025

This study investigates within Covariance-based Structural Equation Modeling (CV-SEM) 
the potential causal relationships between Islamic equity-based financing and Nigerian Small 
Scale Enterprises (SSEs) expansion. A quantitative survey design was employed to collect 
questionnaire-based, cross-sectional primary data from 512 educated SSE owners and 
managers in eight business districts in the Abeokuta metropolis. STATA 12.1 software was 
utilized to estimate CV-SEM with the maximum likelihood method. Intuitively, the Principal 
Component Analysis (PCA) estimator was applied to derive continuous data scores for 
the latent variables. The fit indices tested (RMSEA, CFI and TLI) indicate that the study 
structural models fit the observed data. From the CV-SEM estimations, musharakah and 
mudharabah have potentially positive and significant impacts on the sales growth of  SSEs in 
the study area. Findings reveal further that Islamic equity financing tools such as musharakah, 
diminishing musharakah, and mudharabah are more likely to enhance the development of  
SSEs in the Abeokuta metropolis significantly and indirectly through the Islamic finance legal 
framework. The study affirms that the expansion of  small enterprises in the study area will 
be directly, positively, and significantly influenced by Islamic shared finance (Musharakah) 
and Islamic joint partnership (Mudharabah). However, the indirect positive and significant 
impact of  Islamic equity finance through a legal framework (mediating factor) is stronger 
for the development of  small firms than the direct impact. The study advocates that the 
federal government of  Nigeria should institute a suitable legal framework for Islamic equity 
financing to enhance the operational capacity of  small-scale businesses.

Keywords

CV-SEM, Islamic Finance, PCA

1 Department of  Mathematics and Statistics, The Federal Polytechnic, Ilaro, Nigeria
2 Department of  Banking and Finance, The Federal Polytechnic, Ilaro, Nigeria
* Corresponding author’s e-mail: kamilu.saka@federalpolyilaro.edu.ng

INTRODUCTION
Small and medium-scale enterprises (SMEs) serve as 
a framework through which the economic growth of  a 
country can be achieved due to their potential to generate 
employment opportunities, create wealth and reduce 
poverty (Asian Development Bank [ADB], 2022; Sojoodi 
& Jalili, 2022; Shinkafi et al., 2023; World Bank, 2023). 
This category of  businesses section, SMEs, operates 
virtually in manufacturing and service sectors and thus 
provides employment opportunities for both skilled and 
unskilled people. Consequently, the industry contributes 
to developing economies where it receives necessary 
encouragement. However, the incentives for SMEs to 
operate efficiently depend on important factors including 
cognitive skills, non-cognitive skills, a friendly business 
environment, financial support from financial institutions 
and government through access to finance, inclusive 
institutional framework and others. Although financing 
problem still exists among SMEs in the Asian region 
improved SME access to finance has long been regarded 
as a major driver behind economic improvements and 
success of  Indonesia, Thailand, Taiwan, and Singapore 
(ADB, 2022). 
However, SMEs in developing economies including 
Nigeria often encounter acute credit financing problems 
from conventional banks which eventually limit their 
growth potential (Adedeji, 2021; Shinkafi et al., 2023; 
Sonita, Miswardi and Nasfi, 2021; World Bank, 2023). 

This incidence of  funding gap from interest-based formal 
banks, in part, further dampens the development of  
SMEs in developing countries. In Nigeria, for instance, 
the share of  SME loans and advances (represented 
by loans to trade and general commerce) to Deposit 
Money Banks total loans in 2023 is just a paltry 7.97% 
(Central Bank of  Nigeria Statistical Bulletin, 2023). Such 
funding issues might have contributed to the sector’s less 
impressive performance that year. Therefore, creating an 
alternative financing model mechanism for substantial 
advancement to improve access to capital for SMEs in 
developing countries (such as Nigeria) beyond traditional 
bank credit is essential. The relevance of  Shariah-
compliant financing models for higher performance of  
SMEs and the economy at large has been documented 
by researchers, policymakers, countries and international 
bodies (World Bank-Islamic Development Bank, 2015; 
Adedeji, 2021; Shinkafi et al., 2023; United Nations 
Development Programme-Islamic Development Bank, 
2023). However, innovative Islamic financing models like 
fully fledged equity-based Islamic financing which has 
been proven worthy elsewhere for ameliorating funding 
issues faced by SMEs are still limitedly unexplored in 
Nigeria (Fitch Ratings, 2023).  
In Nigeria, armful studies by Adam (2020); Adedeji 
(2021), and Shinkafi et al. (2023) found that Islamic 
financing has a significant and positive effect on the 
performance of  the country’s SMEs. However, certain 



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flaws are found with the analysis method used by 
these studies to arrive at such results. These include 
heteroscedasticity, non-disclosure of  linearity, and normal 
distribution assumption, where least square methods 
are used. Furthermore, to our knowledge, we found 
that a robust technique (such as Structural Equation 
Modeling – SEM) that addresses all these estimation 
issues in Islamic finance studies has not been applied in 
the context of  Nigerian Small-Scale Enterprises (SSEs). 
More worryingly, previous studies worldwide have 
ignored the estimation of  the indirect effects of  the 
Islamic equity financing legal platform which provides 
the operational framework for the conduct of  Islamic 
finance activities. Against this backdrop, the current study 
aims to extend existing finance literature by evaluating the 
reliability of  Musharakah, Diminishing Musharakah and 
Mudharabah as equity-based Islamic finance approaches 
towards growth of  Small Scale Enterprises (SSEs) in 
Nigeria with a specific focus on Abeokuta metropolis. 
With the Islamic equity financing legal framework serving 
as a mediating variable, a critical question is raised under 
Covariance-based Structural Equation Modeling (CV-
SEM) on what indirect effect Islamic finance has on the 
growth of  SSE firms in Abeokuta metropolis, Nigeria. 
From the analysis conducted, it was indicated that both 
Musharakah and Mudharabah financing initiatives have 
positive and significant impacts on stimulating the sales 
growth of  SSEs in the study area. The observed empirical 
evidence shows further that such significant impacts 
would be stronger indirectly when the Islamic equity 
financing legal framework is developed and implemented. 
Thus, Islamic equity-based financing means (Musharakah 
and Mudharabah) can significantly help address the 
unmet financing needs of  SSEs in Nigeria and aid them 
in growing and generating jobs. This paper is divided 
into five sections. The study starts with an introduction 
followed by a literature review. Section three discusses 
the methodology of  the study. The data obtained were 
analysed, interpreted and discussed in section four while 
the conclusion and recommendations are contained in 
section five.

LITERATURE REVIEW 
The literature has no convergence opinion regarding 
the most acceptable definition of  micro and small-scale 
business (Elasrag, 2016). However, some key criteria are 
normally used to draw a line of  demarcation between a 
micro, small, medium and large business. These include 
the number of  employees, turnover, assets size, annual 
sales, annual production, investment and paid-up capital 
(Abdinur & Ondes, 2022; Adedeji, 2021; Al-Dabbas, 
2023; Elasrag, 2016; European Commission, 2015; Small 
and Medium Enterprises Development Association 
of  Nigeria, 2007; International Finance Corporation 
publication, 2020; 2024). International Finance 
Corporation publication (IFC, 2024) used employment, 
assets and sales value criteria to define a micro, small and 
medium enterprise (MSME); however, out of  the three 

criteria, an enterprise must meet two to be classified as 
either micro or small or medium venture. According 
to IFC, a micro-enterprise is defined as a business with 
some employees of  not more than 10 or with an asset 
value of  less than $100,000 (US dollar) or generates an 
annual sales value of  not more than 100,000 US dollars. 
A small-scale enterprise is defined as an enterprise that 
employs between 10 and 50 workers or with total assets 
value between $100,000 to $3,000,000 or a business that 
realizes between $100,000 to $3,000,000 as annual sales. 
A medium enterprise in line with the IFC classification 
is categorised as an enterprise that recruits between 50 
and 300 workers or a venture with a total asset value 
between $3,000,000 and $15,000,000 or makes between 
$3,000,000 and $15,000,000 as sales revenue in a year. The 
Apex Bank in Nigeria, Central Bank of  Nigeria (CBN), in 
the year 2010 defined a micro enterprise as a one-man 
business that employs less than 10 workers and possess 
total assets (excluding land and building) that is not more 
than five million naira. The CBN further defines small 
and medium scale enterprises as businesses that employ 
between 11 and 200 workers and with total assets less 
than #500 million.
The peculiarities of  MSEs or SMEs in developing 
countries like Nigeria are observed in the ownership 
structure as most are mainly sole proprietorships or 
partnerships with labour-intensive production methods. 
Commercial banks in particular often feel reluctant 
to lend to these categories of  business and when they 
(commercial banks) do they charge higher interest rates 
as costs of  borrowing.  These conventional banks often 
request collateral security with the fear that MSEs or 
SMEs are too risky. In addition, stringent conditions like 
listing requirements further render MSEs incapacitated to 
access funds from capital markets like The Nigeria Stock 
Exchange. Furthermore, most of  the sources of  formal 
SME financing institutions in Nigeria ranging from 
traditional banks such as microfinance banks, universal 
(commercial) banks, merchant banks, and development 
banks to specialised financial institutions offer interest-
based financing facilities to SMEs. Although interest-
based borrowing provides quick access to finance the 
liability of  SMEs increases with such financing means. 
The implication is that profit which serves as an incentive 
for entrepreneurs is affected through the reduction in 
value. In other words, finding alternative noninterest-
based funding options such as Islamic financing product 
offerings will help encourage inclusive growth by MSEs 
and MSEs in the country.
Islamic financing is the provision of  financial services 
that are based on the values, norms, laws and institutions 
found in, and derived from the sources of  Islam such as 
Shari’ah to satisfy wealth material and social needs of  all 
members of  the community including SMEs (World Bank 
Group – Islamic Development Bank, 2015). According 
to Mohieldin et al. (2011) as revealed in WB-IDB (2015) 
the core principles of  Islam underscore social justice, 
inclusion, and sharing of  resources. Unlike conventional 



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finance, Islamic finance is a participatory finance (risk-
sharing relationship) arrangement that is asset-based 
and equity-based. Leveraging asset-based and equity-
based finance arrangements for SMEs and start-ups in 
developing countries and emerging economies such as 
Nigeria could prove crucial to uncovering entrepreneurial 
potential in these markets. The positive impacts of  such 
arrangements include increased economic growth, youth 
empowerment and socioeconomic development. 
In asset-based financing, real economic activity is 
promoted with financial assets as the core requirement 
of  Islamic financial transactions (Askari et al., 2014). The 
two commonly used variants of  this model of  financing 
are sale-based instruments (Murabahah) and leased-based 
instruments (Ijarah). A Murabahah is a contract between a 
bank or financier and a client where the bank or financier 
purchases an asset required by the client and then sells it to 
the client at a cost and profit margin which are disclosed 
to the client and is paid back usually by instalments 
(Abdinur & Ondes, 2022; WD-IDB, 2015; International 
Trade Centre, 2009). Unlike conventional asset-related 
agreements, Murabahah imposes a fixed financing rate 
during the financing term and ensures full transparency 
of  price and mark-up. However, the pricing of  some 
products offered under Murabahah closely parallels or 
sometimes exceeds the pricing of  conventional products 
(WD-IDB, 2015). Ijarah is an Islamic-based leasing 
arrangement where money is exchanged for the use of  an 
asset. Under this arrangement, the financier or bank first 
buys the asset from a supplier and then leases it to the 
client. The main criterion for eligibility for financing as 
differentiation from conventional leasing is the ability to 
generate cash flows to serve the lease agreement, rather 
than providing security (collateral) and credit history. As 
a result of  this criterion factor, Ijarah is widely used to 
finance SMEs (Mohieldin et al., 2011).
On the other hand, equity-based financing is a form of  
financing where the bank or financier has an equity stake 
or interest in the SME business. This arrangement makes 
a financial institution that provides investment capital to 
operate as a partner to the SME. In other words, it is a 
partnership-based contract with a return to the bank or 
financier depending on the actual business performance 
of  the clients (International Trade Centre, 2009). 
There are two types of  SME partnership financing, 
joint venture (Musharakah) and passive partnership 
(Mudarabah). The two differ based on what the partners 
contribute to the partnership.  Musharakah in Arabian 
language refers to sharing between two more entities 
or businesses (partnership). Under this financing, more 
than two parties can be involved, and generally, each 
provides knowledge and skill in management and a share 
of  the capital (Abdinur & Ondes, 2022). Meanwhile, it is 
possible for one partner only to provide capital, in which 
case he or she becomes a sleeping partner. The profits 
from operations are shared based on the pre-agreed 
profit ratio. In the same manner, losses are borne by the 
partners in proportion to the capital they have provided 

(International Trade Centre, 2009). This arrangement 
underscores the Islamic principle of  sharing responsibility 
for Shari’ah-based financing products.
The Mudarabah, passive partnership, transaction is a 
partnership transaction in which only one partner named 
the capital-providing investor or Rab al Maal contributes 
capital, and the other partner known as the business 
manager or Mudarib contributes skill and expertise. 
According to ITC (2009), the relationship between the 
partners is founded upon trust, with the investor relying 
heavily on the business manager, and his or her ability 
to manage the business and be honest with profit share 
payments. In this financing arrangement, the client does 
the management work in the business while the financier 
or bank only provides capital. However, this increases 
the bank’s exposure to business risks. With a diminishing 
Musharakah contract, one partner promises to acquire 
the equity share of  another person’s business by gradual 
payment until he makes the final payment to become 
the owner (Hussain et al., 2015). This type of  financing 
arrangement is mostly famous among Iranian business 
enterprises.
Theoretically, the model of  discrete choice (DCM) 
provides a framework for justifying the potential use of  
Islamic finance in this study by SMEs. The utility-based 
model, DCM, explains a rational situation in which a 
decision maker selects the best alternative from a list of  
two or more choices. Selection of  a preferred option is 
premised on the objective of  maximal satisfaction derived 
from the best alternative.  The proponents of  Islamic 
finance have argued through empirical data that owners 
and managers of  SMEs often prefer Islamic financing 
options to conventional funding models (Al Dabbas, 2023; 
Baloch & Chimenya, 2023; Shamsudheen, 2023). This 
preference is due to greater benefits offered by Islamic 
finance based on the principles of  Islam and Shariah laws. 
For instance, Baloch and Chimenya (2023) opined that 
Islamic financing is presumed to be desired by SMEs and 
other users because of  its ethical considerations (such as 
prohibition of  interest-based transactions, gambling, and 
undue returns) that plague conventional options. In other 
words, this study hypothesizes that the sampled SMEs in 
the study area would prefer Islamic financing options to 
traditional alternatives.
Al Dabbas (2023) employed descriptive analysis to 
investigate how Islamic finance affects the development 
of  100 Jordan-based SMEs and found that Murabaha 
is an important and famous financing option among 
users of  Islamic finance. This study asserts that Islamic 
finance is a critical driver of  SME development in 
Jordan. Similarly, in 2022, a research study by Abdinur 
and Ondes shows via a bivariate regression analysis of  
148 primary observations obtained from selected SMEs 
in Lasanod, Somalia that a higher level of  Islamic finance 
promotes firms’ business performance. At a macro level, 
Ledhem (2022) assessed the impact of  Islamic finance for 
entrepreneurial business on the growth of  the Malaysian 
economy based on quarterly data from 2014 to 2021. It 



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was discovered with bootstrap quantile regression that 
Islamic finance for SMEs promotes Malaysian economic 
growth. In Africa, scanty empirical evidence on the 
reliability of  Islamic finance for enhancing SME business 
performance is available. Haruna et al. (2024) investigated 
how the Islamic financing approach affects the innovation 
capacity of  small-to-medium businesses in Cameroon 
through a sample of  1358 SME owners and/or managers. 
A multivariate probit model estimation by the study 
reveals that Islamic financing significantly and positively 
promotes product, process, and marketing innovation. 
The study implies that greater Islamic financing enhances 
SMEs’ innovation capacity in Cameroon. 
In Nigeria, a few studies by Adam (2020), Adedeji (2021), 
and Shinkafi et al. (2023) found that Islamic financing 
has a significant and positive effect on the performance 
of  the country’s SMEs. However, the common use of  
sensitive assumptions-based Ordinary Least Square 
(OLS) method to analyze primary data limits the extent 
of  acceptability of  results obtained by these scanty studies 
in the field.  Unless converted into continuous form, the 
assumption of  linearity for categorical data distribution is 
often impractical via primary data. In other words, using 
OLS for non-linear relationships can produce biased 
and unreliable estimates (Gujarati, 2004; Wooldridge, 
2010). Again, the heteroscedasticity in OLS with primary 
data can lead to incorrect inferences (Gujarati, 2004). 
Errors are likely to vary substantially across all levels of  
predictors with categorical data. Regrettably, identified 
issues with the OLS technique for primary data analysis 
were overlooked by previous studies. Additionally, past 
studies worldwide have ignored the estimation of  the 
indirect effects of  the Islamic equity financing legal 
platform which provides the operational framework. 
Meanwhile, successful stories of  Islamic financing in 
Asian countries have been attributed to the efficient legal 
framework underpinned by Islamic principles (Hussain 
et al., 2015; United Nations Development Programme 
and Islamic Development Bank, 2023). Therefore, a 
suitable method for handling primary data and a robust 
technique that accounts for heteroscedasticity is required. 
Consistent with the gap, this study employs the Structural 
Equation Modeling approach to estimate the reliability of  
Islamic financing towards the growth of  SMEs in Nigeria 
with a specific focus on the Abeokuta metropolis. The 
potential use of  the SEM technique is premised on the 
need to provide better efficient estimates and improve the 
precision of  results on the relationship between Islamic 
finance and SME growth in the study area.  

MATERIALS AND METHODS
The current study applies a quantitative survey research 
design. The use of  the research strategy is informed by 
its ability to yield information about the study population 
via a sample. The study population are all Small Scale 
Enterprises (SSEs) in Abeokuta town, Ogun State, 
Nigeria. However, a specific focus was on SSE owners 

and/or managers with at least secondary or post-primary 
education. Unfortunately, due to poor (or lack) record 
keeping in developing countries like Nigeria (McKenzie 
and Sakho, 2010), it was not statistically easy to ascertain 
the precise population of  educated SSE owners and/or 
managers in the study area. Consequently, the study utilizes 
Krejcie and Morgan’s (1970) sample size for an unknown 
population to determine the required sample size.
The formula is specified as thus:
S = ( ( Range / 2 )2 ) / ( ( ( Accuracy Level ) / ( Confidence 
Level))2                 (1)
Where;
Range = Range of  SSEs that have educated owners or 
managers (assumed to be between 10,000 firms and 
100,000 firms) = 100,000 – 10,000 = 90,000 firms
Confidence level = 1.96 (2-tailed) at a 5% level of  
significance
From equation 1, a sample size of  384 SSEs is obtained. 
However, the derived sample size is adjusted to control for 
at least a 75% response rate. This is necessary because the 
empirical evaluation of  a large-scale Islamic equity-based 
model requires a higher response for the eventual analysis 
outcome to be well accepted.   Therefore, equation (1) is 
adjusted in equation (2) as thus:
S*=  (Obtained sample size)/(desired response rate)    (2)
From equation (2), S  is 512 SSEs. These SSEs are 
represented by firm owners or managers where appropriate 
and were administered well-structured questionnaires. 
Moreover, the study employs a systematic random 
sampling technique to select every 5th SSE approached 
during the field survey. Hitherto to the main analysis, a 
pilot study was conducted in eight business-populated 
areas in Abeokuta to determine the appropriateness 
of  the data instrument (structured questionnaire) and 
suitable respondents (SSE owner/manager with at least 
secondary education) for main data administration. Four 
(4) business districts (BDs) were purposively selected 
from each of  the two local government areas (LGAs) 
in the metropolitan city of  Abeokuta – Abeokuta South 
LGA and Abeokuta North LGA. The business districts 
selected in Abeokuta South LGA include Sapon Itoku 
BD, Asero Adatan BD, Isabo Kuto BD, and Oke-Ilewo 
Onikolobo BD. In Abeokuta North, Saje Elega BD, 
Lafenwa Sabo BD, Olomore Ita-Oshin BD, and Sanni 
Rounder BD were surveyed. With the assistance of  four 
Research Assistants (RA), the respondents were met 
physically for face-to-face questionnaire administration 
from 4th March to 4th December 2024.
Furthermore, the study develops a Covariance-based 
Structural Equation Modelling (CV-SEM) framework to 
ensure a better understanding of  the reliability of  Islamic 
financing toward SSE growth in Nigeria using Abeokuta 
town - a frontier study area. CV-SEM as a powerful 
technique helps to overcome measurement errors and 
specification issues in a complex study (Kline, 2011). 
Before the CV-SEM modelling procedure, Principal 
Component Analysis (PCA) analyses were performed 



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to estimate index scores for the study predictors. PCA is 
applied to derive a single value (index) for each of  latent 
predictor through their respective observed variables. In 
the most recent time, studies in Finance have presented 
evidence that the PCA technique produces a thorough 
way of  estimating index scores (Chon, 2020; Sun, Wang, 
Xu and Balezentis, 2022). Four correlated items were 
observed for each of  the latent predictors. The PCA 
equation for each predictor is specified thus:

MUSscore =                 (3)

Where, MUSscore = Musharakah Index score; F = absolute 
factor loadings; x= set of  observed variables for MUS.

DMUscore =                (4)

Where, DMUscore= Diminishing Musharakah Index score; 
F = absolute factor loadings; x= set of  observed variables 
for DMU.

MUDscore=                 (5)

Where, MUDscore= Mudharabah Index score; F = absolute 
factor loadings; x= set of  observed variables for MUD.
The study CV-SEM model is developed in Figure 1 as 
thus:

Figure 1: CV-SEM Islamic Equity-based Financing Model for Nigerian SSEs Growth

Figure 1 depicts hypothesised relationships between 
measures of  Islamic finance and sales growth of  SSE 
firms in the study area based on the assumptions of  the 
DCM framework. From the diagram, IEF (Islamic equity 
finance legal platform) serves as an intervening variable 
which moderates the relationship between predictors of  
Islamic equity financing and firm growth. Consequently, 
two structural models are developed in equations (6) 
and (7) respectively. These are direct and indirect effects 
models. The equations are specified as thus.
SSGi= α+β1MUSi+β2DMUi+β3MUDi+ε4              (6) 
(Direct Effects Model)
SSGi = α+β4IEFi+ε4    (7)(Indirect Effects Model)
The main predictors (MUS, DMU and MUD) as latent 
variables are determined via the Principal Component 
Analysis (PCA). 
The dependent variable, SSG, is measured by:

SSGi=  ((st-S(t-1)))/St 
Where,
St=current sales level (in 2024)
S(t-1)=sales three years ago (in 2021)
A prior Expectation
From the study structural models, β1,…β3 and β4>0 
The study structural models were analyzed using the 
maximum likelihood method of  SEM in STATA 12.1 
statistical software at a 5% significance level.

RESULTS AND DISCUSSION
This sub-section presents the results from the maximum 
likelihood estimation of  the CV-SEM-based relationship 
between Islamic equity financing (IEF) and turnover 
growth of  SSE firms in the Abeokuta metropolis. The 
CV-SEM estimation was conducted using the STATA 
12.1 SEM Modeling framework and commands.

Table 1: CV-SEM Estimated SSE Growth Impact of  Islamic Equity Financing
(DV: SSG)
Effect Coef. Std. Err. z-value Prob. Value (p>.05)

Direct effects Structural
MUS <- IEF 0.62 0.06 9.74 0.000
DMU <- IEF 1.11 0.04 25.67 0.000
MUD <- IEF 1.26 0.03 34.10 0.000



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In the preliminary analysis, PCA analyses were performed 
to derive index scores for all the predictors. These 
continuous index scores have normal distribution 
(multivariate normality) properties, satisfying two 
important assumptions of  CV-SEM analysis. The 
derivation of  index scores for the latent variables obviates 
the need to estimate measurement models. A simple 
descriptive analysis (mean, maximum and minimum 
values not shown due to space issues) of  PCA index scores 
depicts no incidence of  extremely higher or lower values 
in the data distribution (that is, the absence of  outliers). 
Hence, PCA provides plausible and parsimonious data 
scores for causal relationship estimations in SEM analysis. 
The results of  CV-SEM estimations are presented in 
Table followed by Table 2 which showcases post-analysis 
diagnostic test statistics. From Table 1, it is revealed 
that 449 observations out of  coded 476 entries into 
the software were used for the final analysis. Thus, this 
indicates a paltry 27 observations were dropped for the 
final analysis due to missing responses at random. The 
number of  observations used for the analysis represents 
87.7% of  the study’s total sample size (512). 
However, for one reason or another, 56 administered 
questionnaires were not returned by the respondents when 
the data analysis took effect (December 4, 2024). The 
number of  data (449) used illustrates that approximately 
41 observations per 1 parameter are estimated in the 
SEM analysis. In Figure 1, 11 parameters were identified 
(7 regressions and 4 variances). The higher observations 
to parameters ratio shows the study sample adequacy 
(Schreiber et al., 2006). More so, some fit indices (Chi-
square test – X2 -; RMSEA; CFI and TLI) as reflected 
in the Table indicate better model fitness of  the study 

PLS-SEM model developed in the methodology section. 
For instance, the result in Table 2 highlights that the null 
hypothesis via chi-square (X2: p-value > 0.5) that there is 
a discrepancy between the baseline model and saturated 
model is accepted at a 5% significance level (Bentler & 
Bonett 1980; Fan et al., 2016; Mulaik et al., 1989; Hu & 
Bentler 1999; Schreiber et al., 2006). Other fit indices 
in Table 2 such as RMSEA (0.03), CFI (0.9750) and 
TLI (0.932) are also above acceptable values (Fan et al., 
1999; Fan et al., 2016; Browne & Cudeck, 1993; Hu & 
Bentler 1999; Schreiber et al., 2006). For this reason, the 
researchers did not perform post-hoc model modification 
as the CV-SEM model developed in the method section 
has good fitness for the observed data. In other words, 
the study inferences drawn from the two structural 
models are considered consistent, reliable and efficient.
From Figure 1, it is indicated that Musharakah (MUS: 
coef. = 0.62; p-value = 0.000), Diminishing Musharakah 
(DMU: coef. = 1.11; p-value = 0.000) and Mudharabah 
(MUD: coef. = 1.26; p-value = 0.00) are significant 
predictors of  Islamic equity financing at a 5% significance 
level. These results imply that these financing means 
are critical for designing, deploying and administrating 
Islamic equity-based financing among small-scale 
firms in Nigeria, particularly the Abeokuta metropolis. 
Mainly, direct effect estimation of  equation (6) shows 
that musharakah (MUS: coef. = 0.03; p-value = 0.003) 
and mudharabah (MUD: coef. = 0.08; p-value = 0.00) 
have potentially positive and significant impacts on sales 
growth of  SSEs in the study area. A unit increase in 
musharakah and mudharabah financing means sales /
turnover of  SSEs in the Abeokuta metropolis will grow 
by 0.03% and 0.08% respectively. The path coefficients 
of  the four predictors have dispersion levels not higher 
than 0.01 per cent. In terms of  indirect effect estimation, 
Table 1 reveals that Islamic equity financing tools like 
musharakah, diminishing musharakah and mudharabah 
can significantly enhance the growth of  SSEs in the 
Abeokuta metropolis indirectly through Islamic finance 
legal framework (IEF: coef  = 0.10; p-value = 0.000).
Interestingly, the positive and significant impact of  
musharakah obtained in this study is consistent with 
previous findings by Shinkafi et al. (2023) who asserted that 
musharakah and mudharabah as finance tools influence 
SMEs growth in Nigeria. Similarly, this study’s finding 
that mudharabah will promote business growth is similar 
to results obtained by Shamsudheen et al. (2023), Baloch 

SSG <-

MUS 0.03 0.01 2.94 0.003
DMU -0.01 0.01 -0.65 0.513
MUD 0.08 0.01 5.50 0.000
IEF 1.42e-07

Indirect effects SSG <-IEF 0.10 0.01 6.35 0.000
No. of  Obs. 449
Method: Maximum 
Likelihood

1840.95

Source: Authors’ Computations from STATA 12.1 Outputs (2024)

Table 2: Post-Diagnostics Tests
Test Statistic
Log likelihood -1840.9498
LR test of  model vs. 
saturated

14353.13 (Prob. > chi2 
= 0.4330)

LR test of  baseline vs. 
saturated

15502.31 (Prob. > chi2 
= 0.7840)

RMSEA 0.03
COMPARATIVE Fit Index 
(CFI)

0.9750

Tucker-Lewis Index (TLI) 0.932
Source: Authors’ Computations from STATA 12.1 Outputs (2024)



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Am. J. Appl. Stat. Econ. 4(1) 32-40, 2025

and Chimenya (2023), and Abdinur and Ondes (2022). In 
contrast, when diminishing musharakah funding (DMU: 
coef. = 0.01; p-value = 0.513) increases by 1 unit, the 
sales level of  SSEs falls by 0.01 per cent leading to a lack 
of  business growth. However, the result further shows 
that the negative impact of  diminishing musharakah 
(DMU: p-value >.05) is insignificant in slowing down 
the operations of  the sampled firms.  This insignificant 
negative impact of  diminishing musharakah illustrates 
that a financing partnership arrangement that will fully 
transfer total equity interest to capital providers in future 
is less important to SSE’s operational performance. As 
obtained, the indirect effects of  Islamic equity financing 
will be more pronounced in Nigeria than the individual 
direct effect offered by the studied financing tools. 
This result highlights the importance of  developing an 
efficient legal framework for operations of  Islamic equity 
financing for enhancing the operational performance of  
SMEs particularly SSEs in Nigeria. Overall, it is learnt 
through the observed empirical evidence that reducing 
the financing gap faced by micro, small and medium 
enterprises in Nigeria particularly in the study area 
(Abeokuta metropolis) requires strategic interventions 
on Islamic equity financing alternatives. First, banks and 
other lending institutions in Nigeria need to design and 
directly offer SSE-targeted Islamic equity financing based 
on the principles of  Musharakah or Mudharabah or both 
alternatives. Businesses need time to grow and using any 
of  these equity finance alternatives can guarantee them the 
confidence to operate for longer periods as fear of  running 
into debts or paying high-interest charges on bank loans is 
allayed.  Finally, the result shows that strengthening Islamic 
equity-based finance in Nigeria through a legal framework 
is essential and provides greater benefit to help SSEs grow 
and generate more employment.

Implications of  the Study
This study obtains empirical evidence that Islamic 
equity finance’s indirect positive and significant impact 
through a legal framework (mediating factor) is stronger 
for developing small firms than the direct impact. Two 
implications of  the study are provided. First, the study 
shows that analysis of  both the direct and indirect effects 
of  Islamic equity finance is particularly important for 
designing and deploying appropriate Islamic financial 
policies that benefit small business operations in Nigeria. 
This effort will enable stakeholders in the country’s 
financial industry to understand the roles of  risk-sharing 
financing initiatives that support small-scale businesses’ 
operational capacity. Second, the use of  the PCA technique 
to estimate data scores for latent variables (Musharakah, 
Diminishing Musharakah and Mudharabah) in the 
current study provides a methodological and analytical 
guide to experts and future studies and consider PCA 
as a plausible alternative to confirmatory factor analysis 
(CFA). However, an alternative SEM method that 
provides greater predictive ability and is less sensitive to 
the sample size issue (e.g. PLS-SEM) would have ensured 

optimal prediction of  Islamic equity-based financing 
reliability toward higher growth of  small businesses in 
the study area. Therefore, future studies in this direction 
are encouraged to use large-scale data for CV-SEM 
evaluations or apply more efficient SEM methods. 
Notwithstanding, the results obtained in this study are 
valid and reliable, particularly with the use of  PCA in 
place of  measurement model estimation.

CONCLUSION
This study applies the maximum likelihood method of  
CV-SEM to estimate the causal relationship between 
Islamic equity-based financing and the growth of  
small businesses in Nigeria with a specific focus on 
the Abeokuta metropolis. The study affirms that the 
expansion of  small enterprises in the study area will 
be directly, positively, and significantly influenced by 
Islamic shared finance (Musharakah) and Islamic joint 
partnership (Mudharabah). However, the indirect positive 
and significant impact of  Islamic equity finance through 
a legal framework (mediating factor) is stronger for the 
development of  small firms than the direct impact. On 
this account, the study recommends that the federal 
government of  Nigeria should institute a suitable legal 
framework for Islamic equity financing to enhance the 
operational capacity of  small-scale businesses. Again, 
private and institutional investors are encouraged 
to promote investments in Islamic banking. For 
administrators of  Islamic finance in Nigeria, greater efforts 
are required to provide musharakah and mudharabah 
equity financing facilities. Finally, users of  Islamic equity 
finance, particularly SSE owners and managers, should 
embrace these alternative finance models.    

Acknowledgements
This work was supported by the Nigeria Tertiary 
Education Trust Fund (TETFUND) Institution-Based 
Research (IBR) Grant 2023 (TETF/DR&D/CE/POLY/
ILARO/IBR/2023/VOL1)

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