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A Theory of Profit Sharing Ratio under Adverse Selection: The Case of Islamic Venture Capital

Author

Listed:
  • Kaouther Jouaber

    (DRM - Dauphine Recherches en Management - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique)

  • Meryem Mehri

    (DRM - Dauphine Recherches en Management - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique)

Abstract

This paper presents a theory for Islamic venture capital namely ‘Mudharabah' contract under adverse selection problem. In order to avoid selecting a low type entrepreneur for a given good project, the framework defines the profit sharing ratio (PSR) as a screening device. We then develop a Profit Sharing Ratio model for Islamic venture capital under adverse selection. We find the optimal PSR as function of the respective risk aversion degree of both the entrepreneur and the IVC (Islamic venture capitalist). Their risk aversion degrees influence their decisions to fix the PSR during the negotiation stage. We show that the high type entrepreneur will tolerate to the IVC a PSR higher than the PSR accepted by the low type. In the negotiation stage, whatever the entrepreneur type, the higher the management fee and the higher the PSR tolerated to the IVC.

Suggested Citation

  • Kaouther Jouaber & Meryem Mehri, 2012. "A Theory of Profit Sharing Ratio under Adverse Selection: The Case of Islamic Venture Capital," Post-Print hal-01525795, HAL.
    • Handle: RePEc:hal:journl:hal-01525795
    Note: View the original document on HAL open archive server: https://hal.science/hal-01525795
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    References listed on IDEAS

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    Cited by:

    1. Muhammad Nouman & Karim Ullah & Saleem Gul, 2018. "Why Islamic Banks Tend to Avoid Participatory Financing? A Demand, Regulation, and Uncertainty Framework," Business & Economic Review, Institute of Management Sciences, Peshawar, Pakistan, vol. 10(1), pages 1-32, March.
    2. Adil EL Fakir & Mohamed Tkiouat, 2016. "Single or Menu Contracting: A Game Theory Application of the Hersanyi Model to Mudaraba Financing," International Journal of Economics and Financial Issues, Econjournals, vol. 6(1), pages 221-230.

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