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

Kaouther Jouaber and Meryem Mehri
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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

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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.

Keywords: Islamic Venture Capital; Mudharabah; Profit Sharing Ratio; Adverse Selection; Risk Aversion degree (search for similar items in EconPapers)
Date: 2012-05
Note: View the original document on HAL open archive server: https://hal.science/hal-01525795v1
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Citations: View citations in EconPapers (2)

Published in 29th Spring International Conference of the French Finance Association, May 2012, Strasbourg, France. pp.38

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