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Principal-Agent Preferences In Imperfect Markets: Theoretical Analysis On Murabahah And Ijarah

Author

Listed:
  • Hechem Ajmi

    (International Islamic University Malaysia)

  • Hassanuddeen Abdul Aziz

    (International Islamic University Malaysia)

  • Salina Kassim

    (International Islamic University Malaysia)

  • Walid Mansou

    (Saudi Arabian Monetary Authority)

Abstract

This paper aims to determine the optimal contract for the principal and the agent in imperfect markets, when murabahah and ijarah are used. The financial contracting enforceability approach is employed to determine the contract that maximizes the value of the firm subject to agents’ constraints when the shock is low and high, and regarding market frictions. Furthermore, this approach allows us to assess the level of market frictions that agents may bear in case of low shock and high shocks. Findings reveal that the simulated values of the market frictions’ parameters for both contracts increase when moving from the low shock to the high shock. Such evidence implies that the agent is more likely to cheat and hide significant information about the project when the shock is high. As a response to this higher risk, the simulated values of the profit margin parameters for the principal rise also when the shock is high in order to compensate for the increase of market frictions and mitigate conflicts of interest. By comparing both contracts based on the simulated optimal values of the firm, it is noticeable that the gap between both contracts is very tight, which can be attributed to their common debt-based financial arrangements. However, the results show that ijarah allows the principal and the agent to generate the highest value in case of low shock and high shock, comparing to murabahah. Therefore, ijarah seems to be more attractive for the principal and the agent than murabahah

Suggested Citation

  • Hechem Ajmi & Hassanuddeen Abdul Aziz & Salina Kassim & Walid Mansou, 2019. "Principal-Agent Preferences In Imperfect Markets: Theoretical Analysis On Murabahah And Ijarah," Journal of Islamic Monetary Economics and Finance, Bank Indonesia, vol. 5(1), pages 117-144, February.
    • Handle: RePEc:idn:jimfjn:v:5:y:2019:i:1f:p:117-144
    DOI: https://doi.org/10.21098/jimf.v5i1.1050
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    More about this item

    Keywords

    Murabahah; Ijarah; Conflict of Interest; Monte-Carlo Simulation; Market Frictions; Optimal Contract;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • L24 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Contracting Out; Joint Ventures
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance

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