EconPapers    
Economics at your fingertips  
 

Nonlinear Profit-and-Loss-Sharing Contracting versus Equity in Entrepreneurial Finance: Risk Sharing and Managerial Incentives in a Principal-Agent Relationship When the Agent Is Risk-Neutral

Abdulali Hadizada ()
Additional contact information
Abdulali Hadizada: University of Kiel, Kiel, Germany

New Challenges in Accounting and Finance, 2025, vol. 13, 28-51

Abstract: An entrepreneur raises capital to finance their business and extends the effort to facilitate its success. If financing is possible solely with risk-free debt capital, the entrepreneur’s effort will be first-best since they will not share the outcome of their business with an outside financier. However, risk-free debt is usually unavailable due to the significant risk involved in starting any business. Therefore, other financing arrangements involving risk sharing have to be considered. Such arrangements will result in a moral hazard problem and dilute the entrepreneur's managerial incentives to exert effort. Financing with equity capital from an outside partner will result in a second-best level of effort, and there will be no advantage from risk sharing if the entrepreneur is risk-neutral. Since risk-free debt financing is not always possible and financing with equity capital is not optimal for a risk-neutral entrepreneur, a third alternative is considered in this paper. It is shown that a nonlinear profit-and-loss-sharing arrangement can be structured so that the incentives of the risk-neutral entrepreneur to extend effort are not diminished. As such, the nonlinear PLS contract considered in this paper, which is based on Islamic profit-and-loss-sharing contracts, is a feasible alternative to risk-free debt financing.

Keywords: Entrepreneurial Finance; Nonlinear Contracts; Profit and Loss Sharing; Risk Sharing; Moral Hazard Problem (search for similar items in EconPapers)
Date: 2025
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://api.eurokd.com/Uploads/Article/1579/NCAF.2025.13.02.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bco:ncafaa::v:13:y:2025:p:28-51

DOI: 10.32038/NCAF.2025.13.02

Access Statistics for this article

New Challenges in Accounting and Finance is currently edited by Prof. Dr. Orhan Elmacı

More articles in New Challenges in Accounting and Finance from EUROKD
Bibliographic data for series maintained by Sara Gunen ().

 
Page updated 2025-09-27
Handle: RePEc:bco:ncafaa::v:13:y:2025:p:28-51