Profit-loss sharing contract formation under zero interest financial system

Abstract EN

For financing businesses under a Zero Interest Financial System the primary desired mode is Profit Loss Sharing (PLS) contracts.

However, the reality is different.

An alternative, favored and dominant alternative is Mark-up (MU) financing.

Lately, MU’s risk-sharing features and its rate determination process have come under scrutiny.

Moral hazard, tax evasion, duration of financing contracts, etc., are cited as reasons for not using PLS.

Perhaps failure to craft a sound PLS contract has forced a dependence on MU.

Using the profit maximizing microeconomic model of a firm, we investigate a risk-neutral entrepreneur’s willingness to make a PLS contract under two different situations – first, when PLS is the only contract available and second, when both MU and PLS are available.

We were able to determine not only the share rate, but how financing duration, the MU rate, risks borne by the parties, their comparative market power, negotiating aptitude and transparency affect it.