Handbook of Empirical Research on Islam and Economic Life
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Handbook of Empirical Research on Islam and Economic Life

Edited by M. Kabir Hassan

In Islamic jurisprudence, a comprehensive ethic has been formulated governing how business and commerce should be run, how accountability to God and the community is to be achieved, and how banking and finance is to be arranged. This Handbook examines how well these values are translated into actual performance. It explores whether those holding true to the system are hindered and put at a disadvantage or whether the Islamic institutions have been able to demonstrate that faith-based activities can be rewarding, both economically and spiritually.
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Chapter 25: Profit- sharing ratio as a screening device in venture capital

Meryem Mehri, Kaouther Jouaber- Snoussi and M. Kabir Hassan

Abstract

Both Islamic and conventional venture contracts suffer from information asymmetry and incentive problems. The venture capitalist and the manager have an agency relationship because of the insufficient information about the financed investment and/or the manager type. This chapter presents a literature review of agency problems in venture contracts and proposes a theory of profit sharing ratio (PSR) with information asymmetry about the manager type. In order to avoid the adverse selection, the negotiated PSR acts as a screening device in this theoretical framework. We show that adverse selection is signalled when the manager accepts a PSR set beyond a given critical value. This threshold of the PSR corresponds to the maximum payoff to the venture capitalist. Likewise, the negotiation of the PSR offers a new tool for the screening managers’ type. We suggest that the PSR level may complete the carried interest in conventional venture contracts.

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