Profit ratio Negotiability model in Entrepreneurial Financing Using Game Theory and Agent Based Simulation as an Aid to Decision Making

Profit and Loss (PLS) sharing contracts in Islamic finance are considered to be fair economic practices as they focus on sharing profits and losses between the project’s participants. This mode, however, suffers from asymmetric information in the form of moral hazards and adverse selection. The purpose of this paper is to reduce moral hazards by developing an equilibrium profit sharing ratio’s span of negotiation in a PLS contract involving a financier and a entrepreneur. We aim to establish an agent based model that will help the financier decide whether to accept financing a contract. We make use of game theory techniques and we test our results using an agent based simulation tool (Netlogo). We found theoretical evidence that a Nash equilibrium span of negotiation, for both profit sharing ratios, can be developed which is both rational and incentive compatible to both participants. However, the simulation tool suggests that despite the existence of an average positive span of negotiaton , financial contracts might not be extendes if the number of void contracts in a simulation exceeds a specefied threshold. The usefulness of the agent based simulation tool has added value to our theoretical finding by suggesting when PLS contracts can or con’t be signed

Profit and loss Sharing Negotiations involving a VC and an entrepreneur: A Game Theoretic Approach with Agent Based Simulation [abstract only]

Profit and Loss Sharing contracts (PLS) are forms of financing where profits are shared according to a predetermined ratio and losses are shared according to each participant’s ratio in the project’s capital. We try to reduce moral hazards by solving for an optimal profit sharing ratio that inhibits the entrepreneur from exerting a lower managerial effort. We follow a game theoretical approach under observable and unobservable entrepreneurial effort. We found theoretical evidence, on one hand, that a specific profit sharing ratio can be developed under observable effort. On the other hand, due to asymmetric information under the unobservable efforts case, a profit sharing span of negotiation was developed. This span of negotiation satisfies the participation and the incentive constraints of the game participants. Within this span of negotiation, we propose a model that helps in identifying an optimum profit sharing ratio based on the participants’ bargaining power. Due to the stochastic nature of the model parameters, we develop a simulation of the game in an agent based platform using Netlogo. Besides serving as a quick tool for numerical calculations and analysis, this platform serves as a decision tool for the VC to decide whether or not to extend the funding contract to the entrepreneur

Identification and Risk Management In The Expenditure Process: Risks Leading to Deadline Slippage and Costs, and Building Projects

The objective of this research is the design of a mapping of risks which are mainly related to the processes of expenditure. The research also serves to identify the actions and the necessary measures to control risks and the delays of completing a construction project. The literature from the last two decades related to this field was examined. A quantitative analysis of risks in the expense process of building projects sample representing various regions of Morocco allows identifying the risks and ranking them by determining their occurrences and impacts. Eight major risks, 43 measures, 52 actions and 10 performance indicators are linked to these risks have been identified

Unit Commitment Problem in Electrical Power System: A Literature Review

Unit commitment (UC) is a popular problem in electric power system that aims at minimizing the total cost of power generation in a specific period, by defining an adequate scheduling of the generating units. The UC solution must respect many operational constraints. In the past half century, there was several researches treated the UC problem. Many works have proposed new formulations to the UC problem, others have offered several methodologies and techniques to solve the problem. This paper gives a literature review of UC problem, its mathematical formulation, methods for solving it and Different approaches developed for addressing renewable energy effects and uncertainties

Rethinking Microfinance in a Dual Financial System: An Agent-based Simulation

Critics concerning the real impact of traditional microfinance as a tool for poverty alleviation are becoming frequent. In contrast, the financial crisis brought out interest for Islamic finance, whose models have been increasingly studied. Today, the real challenge lies in evaluating the impact of microfinance in a complex environment, where both Islamic and conventional microfinance institutions exist and address evolving clients in constant interaction. New methods and models are therefore needed in order to test the efficacy and assess the impact of introducing Islamic microfinance products, compared to the conventional system. In this context, this paper proposes an approach to build an Agent-Based Modeling (ABM) framework, which is aiming to test the effects of such products implementation using Islamic interest-free group loans. It also helps assess the impact of the behavioral biases as well as agents’ interactions within the repayment process.JEL Codes - C63; G2

Adverse selection and moral hazards reduction in corporate financing: A mechanism design model for PLS contracts

In this paper , we apply game theory to corporate financing using profit and loss sharing (PLS) contracts. We employ mechanism design theory using two agents, a bank and a corporation which seeks financing through PLS mode. We seek to find the usefulness of mechanism design in helping the bank separating low type from high type corporations by designing two bundles of contract with each contract directed in a compatible way towards the appropriate type of corporation. We found theoretical as well as simulation evidence that our model helps in minimizing asymmetric information in the form of adverse selection by forcing the corporation to reveal its type. The model also helps in reducing asymmetric information in the form of moral hazards. This is achieved by having the selected high type corporation select a high type contract using a moral hazard premium as an incentive

Does Empathy Matter in Entrepreneurial Financing? A Dynamic Game Theoretic Mode (abstract only)

This paper tries to reduce moral hazards in an entrepreneur-Angel financing relationship. This relationship is usually characterized by mutual empathy as opposed to it being absent in a VC relationship. We seek to identify optimal payments to an entrepreneur under effort shirking in a contract where terms of payments are set at the beginning of the project. We use multi-period game theoretic approach and compare the results under VC and angel financing. The study founds similar insights to VC financing where optimal contracts lies in back loading the payments to the entrepreneur. However, if mutual empathy exists, then the preference to back-load payments is lessened. Another distinguishing feature under angel, as opposed to Vc financing, is that increased mutual empathy induces the entrepreneur to be less concerned about the back-loading of payments. This leads to the conclusion that, due to empathy, the entrepreneur becomes more patient in receiving compensations. We also found that mutual empathy leads to higher effort excreted by the entrepreneur under angel financing than under Vc financing. Another finding is that mutual empathy leads to the entrepreneur being less sensitive to changes in payments as compared to Vc financing. The findings shed lights on the importance of investing in developing a mutual empathetic relationship in entrepreneurial financing. The fact that the entrepreneur is less sensitive to payments changes, under an empathetic relation, gives the financier an opportunity for cost savings. The fact that the entrepreneur is less sensitive to payments timing gives the financier the opportunity to even backload the payments and extend the exit stage

Entrepreneurial financing under uncertainty : Performance comparison between ROMCA and conventional microloans using agent based simulation

In this research we create a complex simulation environment where we compare the performance of two micro-financing modes in a group lending context under uncertain market and price conditions : A classical conventional mode and a proposed Profit and loss sharing model called ROMCA (Rotating Musharakah). Both models are based on group lending of entrepreneurs over a specified period. We identify four cases of market and price conditions and use Netlogo as a simulation tool to assess the performance of the two modes in terms of employment , enterprises , investment , tax proceeds and wealth creation. We found a simulation evidence that ROMCA performs better than conventional lending in terms of creating wealth, new enterprise (and therefore new employment opportunities) and better consumption level even under adverse market conditions. On the other hand, Conventional lending is found to dominate ROMCA in terms of employment under favorable market conditio

PLS ratios negotiability: A repeated game incentive mechanism approach

PLS contracts in Islamic finance are fair economic practices as they focus on sharing profits and loss between the project’s participants. Despite its ethical dimension, moral hazards and adverse selection are the paramount risks in this type of contracts. In this paper we seek reducing moral hazards in the form of the entrepreneur’s effort shirking and if a project optimum lifetime can be identified. To answer these questions, we use a game theory approach in one stage and in a repeated framework. Under each scenario, the participants either fix the capital contributions or negotiate over the sharing ratio or vice-versa. We found theoretical evidence that cooperation can be sustained over a one period game. Cooperation can be sustained in a repeated game only if an appropriate monetary incentive is introduced. However, this incentive can only be given for a specific period before the project’s NPV starts to drop. Indeed, we managed to find that period, called duration, for which the financier NPV is maximized. This duration can be proposed to be used as the optimum lifetime of the contract

Managing Operational Risk Related to Microfinance Lending Process using Fuzzy Inference System based on the FMEA Method: Moroccan Case Study

Managing operational risk efficiently is a critical factor of microfinance institutions (MFIs) to get a financial and social return. The purpose of this paper is to identify, assess and prioritize the root causes of failure within the microfinance lending process (MLP) especially in Moroccan microfinance institutions. Considering the limitation of traditional failure mode and effect analysis (FMEA) method in assessing and classifying risks, the methodology adopted in this study focuses on developing a fuzzy logic inference system (FLIS) based on (FMEA). This approach can take into account the subjectivity of risk indicators and the insufficiency of statistical data. The results show that the Moroccan MFIs need to focus more on customer relationship management and give more importance to their staff training, to clients screening as well as to their business analysis.JEL Codes - G21; G32; C0