A Theory of Profit Sharing Ratio With Adverse Selection: The Case of Islamic Venture Capital

International audienceThis paper presents a theory for the Islamic venture capital named 'Mudharabah' under adverse selection problem. In order to avoid selecting a low type entrepreneur for a given good project, the framework defines the profit sharing ratio (PSR) as a screening device. We then develop a Profit Sharing Ratio model for Islamic venture capital and find the optimal PSR as function of the risk aversion degree of both the entrepreneur and the IVC (Islamic venture capitalist). We find that their respective risk aversion degree influences their decision to fix the PSR during the negotiation stage. We show that the high type entrepreneur will tolerate to the IVC a PSR which is higher than the PSR accepted by the low type