An Incentive Mechanism Game Theory Approach to Musharakah Contracts
Keywords:
Musharakah, sharing contracts, incentive mechanism, strictly dominant strategies, social value, moral hazard, Nash equilibrium.Abstract
Musharakah represents an Islamic practice of profit and loss sharing contracts. It isclaimed to be a fair economic mode of investment as it entails the sharing, by theparticipants, of profits and risks. This mode of financing, however, suffers from asymmetricinformation in the form of adverse selection and moral hazards. In this researchwe focus on reducing moral hazards and investigate whether introducing an incentivemechanism can have a positive effect on participants’ payoff in a profit and loss sharingcontract. We use a two agents’ game theoretical approach involving a financier and anentrepreneur. We found that an entrepreneur can be induced to participate with highercapital contribution as long as a specified minimum of incentive is put in place. Wealso found evidence that given the same incentive mechanism, the financier is indifferentbetween profit and loss sharing ratios. Under the same incentive mechanism we caninduce the agent to perform a higher effort contributing to a higher social value. Wealso found that, in case of the project success, the entrpreneur can also be an incentivegiver ensuring a fairer distribution of profits. Due to its positive outcomes our modelcan definitely be commercialized.References
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