Optimal Profit-Sharing Contracts and Investment in an

Optimal Profit-Sharing Contracts and Investment in an Interest-Free Islamic Economy

Interest-Free Islamic Economy
Nadeem Ul Haque
Abbas Mirakhor

November 5, 1986

Abstract:     
In an Islamic financial system, interest is replaced by a profit-sharing system in which risks are shared between lenders and borrowers. Concerns have been expressed that in such a system investment will decline. This paper formulates investment behavior in a profit-sharing system as a principal-agent problem and investigates the relevant issues under conditions of uncertainty and moral hazard. A major conclusion of the paper is that the assertion of investment decline cannot be justified and that, under certain conditions, a profit-sharing system may lead to an increase in investment.

Source:  http://papers.ssrn.com/sol3/papers.cfm?abstract_id=884580