Comparison of the Efficiency of Mudarabahh Contract with Conventional Methods of Financing - Signalling Effect of Component Profit Sharing Ratio Approach

Abstract

The failure of the credit market resulting from the asymmetric information space leads to adverse selection and moral hazard. While exploiting the game theory's signaling effect approach, it is possible to modify the phenomena, which provides the motivation for designing the optimal financial contract. Based on this, while explaining the effect of signaling the profit sharing ratio of Mudarabah, we seek to answer the following questions. Is the variable profit sharing ratio of Mudarabah a motivational signaling effect for contracting parties in arranging an optimal financial contract? Based on the ROE, how is Mudarabah's performance compared to the other alternative financing methods (debt and equity)? Accordingly, due to the lack of realization of the conditions for the realized Islamic contracts, a simulated model has been used to investigate and answer these questions; so that, when the variable profit sharing ratio decreases the equity returns index increases. Also, based on the sensitivity analysis of the reported return index, Mudarabah contracts are more efficient than the other financing methods mentioned, while reducing the cost of representation, it makes this contract attractive.

Keywords

• Asymmetric information
• Debt Finance
• Equity Finance
• game theory
• Rate of Equity