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Does PLS financing solve asymmetric information problems?

  • Ouidad Yousfi

    ()

    (MRM - Montpellier Research in Management - UPVD - Université de Perpignan Via Domitia - Groupe Sup de Co Montpellier (GSCM) - Montpellier Business School - Université Paul Valéry - Montpellier III - UM2 - Université Montpellier 2 - Sciences et Techniques - UM1 - Université Montpellier 1)

Discussion of Islamic private equity (PE) financing modes rarely provides detailed analytical insights into their properties: there is no rigorous analysis of their features. The current paper analyzes how and when Profit Loss Sharing (PLS) financing methods can solve asymmetric information problems. I focus on Mudarabah and Musharakah financing schemes and consider agency models under moral hazard. The model shows some interesting results. First, I show that Mudarabah financing provide powerful incentive schemes to the entrepreneur. As the Islamic PE fund is not actively involved in the project and the project success depends on the entrepreneur's effort, it leads to the first best solution. Second, my results provide evidence that Musharakah financing cannot solve moral hazard problem. One explanation could be the fact that the project is jointly funded by the two parties and that both of them provide non-contractible efforts which diminish their incentives.

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Date of creation: 2013
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Publication status: Published in Journal of Islamic Economics, Banking and Finance, 2013, 9 (3), pp.13
Handle: RePEc:hal:journl:hal-00785325
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