Can Real Options Reduce Moral Hazards in Profit and Loss Sharing Contracts?: A Behavioural Approach Using Game Theory and Agent Based Simulation

EL FAKIR, Adil, TKIOUAT, Mohamed, FAIRCHILD, Richard and PAKGOHAR, Alireza (2021). Can Real Options Reduce Moral Hazards in Profit and Loss Sharing Contracts?: A Behavioural Approach Using Game Theory and Agent Based Simulation. Journal of Islamic Business and Management, 10 (2), 284-302.

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Official URL: https://jibm.org/archieves/volume10-issue2/article...
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    Abstract

    In this paper, we try reducing the moral hazard of profit misreporting in Profit and Loss Sharing Contract (PLS). In this kind of contracts , the corporate manager has a temptation to misreport profits which can lead to either project failing or to financiers receiving an unfair allocation of profits. To help in solving this problem we propose a new model that includes a real option that gives the corporate manager (agent) the right, but not the obligation, to gradually buy shares in the corporation from the financier/bank. We compare our results with the standard case of PLS without real options. We show, using a multi-agent simulation (Netlogo) that embedding real options in the PLS contract can reduce the profit misreporting case. The fact that PLS contracts are riskier compared to other forms of financing such as debt, provides an incentive for the creation of models that reduce their risk to capital providers. Given the results obtained from our real options model, the latter could prove to be of practical use to financial institutions willing to engage in PLS financing.

    Item Type: Article
    Identification Number: https://doi.org/10.26501/jibm/2020.1002-001
    Page Range: 284-302
    SWORD Depositor: Symplectic Elements
    Depositing User: Symplectic Elements
    Date Deposited: 29 Mar 2021 16:27
    Last Modified: 29 Mar 2021 16:30
    URI: http://shura.shu.ac.uk/id/eprint/28459

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