Ernawati, E. (2016), “Risk of profit loss financing: the case of Indonesia,” Al-Iqtishad: Journal of Islamic Economics), Vol. While these assumptions offer simplicity to the subject, they are not realistic in their dealings with banks. Although incomplete contractual theory provides a number of elements on contractual agreements, the neglect of the adverse selection analysis poses a serious problem. Accordingly, this paper focuses on the negative analysis of the selection of profit-sharing agreements (PLS) to determine whether venture capital can replace Islamic pls contracts, as explained by Al-souwailem (1998). Specifically, we conduct a negative selection analysis to determine the less risky contract for the client and to assess whether venture capital can be a potential model for Musharakah. The theory of the financial contract has also been studied from an Islamic point of view, with an emphasis not only on moral hazard and asymmetrical information problems, but also on the notion of PLS and risk sharing. The aim is to define the optimal system of contracts and incentives, which is compatible with Islamic law. However, the literature has been divided into two main groups in which the former justifies the marginalization of PLS-based contracts, while the latter encourages their adoption. The main objective of our approach is to define the less risky financial instrument for the prime contractor among several contracts, namely Musharakah, Mudarabah and venture capital. Our study aims to identify the contract that maximizes the value of the safety index for the main value taking into account the safety limitation, in terms of market frictions, audit factor and industrial shocks that may be high or low. According to Tauchen (1986) and Adda and Cooper (2002), these shocks follow a first-rate Markov process, which means that the value of the high shock depends on the low shock value. Similarly, this analysis allows us to measure the extent of market frictions that the client can achieve and the level of audit he or she can perform to mitigate the risk of bankruptcy if the equity financing is used.
Our approach is inspired by the study of Ahmed (2002), the author believes that the reimbursement function defines the transfer promised to the client (of the bank) by the agent (of the company) as a function of profit. In particular, the repayment function indicates the report in which the profits are distributed between the entity and the bank. Ahmed (2002, p. 46) argues that “as an incentive agreement is a partnership, we assume that both parties share audit costs A equally.” Although the A is between zero and unit, agents must share the audit costs, indicating that each A value must be evenly distributed between the bank and the company. On the basis of Ahmed (2002), the PSR S (the action that goes to the investor) is derived from the following expression: in the event of profit, the agent receives the number of people (ft, lt, t, Z), the range between zero and the unit. Conversely, losses are divided between the client and the agent based on their respective contributions. In this context, the Musharakah contract has explicit costs related to the client`s participation. In the event of a low shock, the share of profits generated is 0.65, which is the optimal share of the agent. As a result, the capital manager receives 0.35 of the profits generated by the company.
In addition, the optimal safety index values for the safety principle subject to the security obligation are 0.2977 and 0.61112 respectively for low and high shocks.
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