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

38 Pages Posted: 19 Sep 2012

See all articles by Kaouther Jouaber-Snoussi

Kaouther Jouaber-Snoussi

Université Paris Dauphine

Meryem Mehri

Université Paris Dauphine

Date Written: April 28, 2012

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

Keywords: Islamic Venture Capital, Mudharabah, Profit Sharing Ratio, Adverse Selection, Risk Aversion degree

JEL Classification: D82, G21, G23, G24

Suggested Citation

Jouaber-Snoussi, Kaouther and Mehri, Meryem, A Theory of Profit Sharing Ratio Under Adverse Selection: The Case of Islamic Venture Capital (April 28, 2012). 29th International Conference of the French Finance Association (AFFI) 2012. Available at SSRN: https://ssrn.com/abstract=2080083 or http://dx.doi.org/10.2139/ssrn.2080083

Kaouther Jouaber-Snoussi (Contact Author)

Université Paris Dauphine ( email )

France

Meryem Mehri

Université Paris Dauphine ( email )

DRM-Finance, Paris-Dauphine University Place du Ma
Paris
France

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