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A critical analysis of Mudarabah & a new approach to equity financing in Islamic finance

Author

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  • Shaikh, Salman Ahmed

Abstract

Financial intermediation serves a valuable purpose, but it can also be structured using equity modes of financing. This can relieve the financee and increase diversity of entrepreneurial undertakings as in debt based commercial financing, there is little room for diversity with obligatory and stipulated servicing of debt. Using Islamic equity modes of financing poses the challenge of the agency problem and moral hazard. The extent of this agency problem in Mudarabah and its impact on economic payoffs between counterparties is analyzed in this study with a simulation model. Based on review of alternate solutions proposed, the author presents two possible covenants which could make Mudarabah mode of financing more acceptable and widely usable in financial intermediation. This would also further the egalitarian objectives of an Islamic economic order.

Suggested Citation

  • Shaikh, Salman Ahmed, 2011. "A critical analysis of Mudarabah & a new approach to equity financing in Islamic finance," MPRA Paper 19697, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:19697
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    File URL: https://mpra.ub.uni-muenchen.de/19697/1/MPRA_paper_19697.pdf
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    References listed on IDEAS

    as
    1. Abbas Mirakhor & Mohsin S. Khan, 1991. "Islamic Banking," IMF Working Papers 91/88, International Monetary Fund.
    2. Shaikh, Salman Ahmed, 2010. "Proposal for a New Economic Framework Based On Islamic Principles," MPRA Paper 23000, University Library of Munich, Germany.
    3. Abdel-Fattah A.A. Khalil & Colin Rickwood & Victor Murinde, 2002. "Evidence on agency-contractual problems in mudarabah financing operations by Islamic banks," Chapters,in: Islamic Banking and Finance, chapter 4 Edward Elgar Publishing.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. 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.
    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.
    3. repec:dau:papers:123456789/9551 is not listed on IDEAS

    More about this item

    Keywords

    Interest free economy; Islamic Economic System; Mudarabah; Agency Problem; Moral Hazard; Adverse Selection;

    JEL classification:

    • L38 - Industrial Organization - - Nonprofit Organizations and Public Enterprise - - - Public Policy
    • I31 - Health, Education, and Welfare - - Welfare, Well-Being, and Poverty - - - General Welfare, Well-Being
    • O10 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - General

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