Principal Trading Arrangements: When Are Common Contracts Optimal?

Many financial arrangements reference market prices that are yet to be realized at the time of contracting and consequently susceptible to manipulation. Two of the most common such arrangements are as follows: (i) guaranteed volume-weighted average price (VWAP) contracts, which reference the VWAP prevailing over an execution window, and (ii) market-on-close contracts, which reference the price prevailing at the window’s end. To study such situations, we introduce a stylized model of financial contracting between a client, who wishes to trade a large position, and the client’s dealer. We provide conditions under which guaranteed VWAP contracts are optimal in this principal-agent problem. In contrast, market-on-close contracts generally cannot be optimal. These results explain the use of guaranteed VWAP contracts in practice, question the use of market-on-close contracts, and suggest considerations for the design of financial benchmarks. This paper was accepted by Haoxiang Zhu, finance.

Venture waqf in a circular economy

Purpose This paper aims to enhance the impact of incorporated waqf institutions by blending their resources to promote responsible small businesses that are inclusive of human development, service to society and preservation of ecological environment and other species. This is expected to shift the paradigm of businesses from the current waste-oriented linear economy to ideally a zero-waste circular economy. Design/methodology/approach This is an analytical study building on the experience of European Venture Philanthropy Organizations (VPOs) that work with the primary objective of making impactful businesses successful, with capital protection and return on investment being of secondary concern. This paper suggests an incorporated institutional design that blends resources for promoting responsible businesses using a new hybrid financial mechanism, namely, equity-at-default (EaD) to replace collateral and foreclosure requirements with responsibility and compassion. Findings The research calls for changing the business paradigm from linear to circular, an incorporated institutional framework for venture waqf, purpose of the waqf to make impactful small businesses successful and designing a financial contract to loan in favor of responsible businesses that convert to equity stake for the waqf in case of default (EaD) replacing collateral and foreclosure requirements. Research limitations/implications This is a theoretical study motivated by the success of VPOs but assigns a new role to waqf institutions. Furthermore, the incorporated nature of waqf is a new idea and EaD is a new mechanism. Being new, these ideas have the risk of not being implemented. However, the broader message that waqf shall promote businesses that are inclusive of ecological concerns is generally applicable. Practical implications The paper has a significant practical implication to transform the responsibility and consciousness of businesses. Waqf is fundamentally a compassionate institution, and it must enhance the responsibility of businesses to become more inclusive of the environment and other species. It should also become more compassionate toward businesses that are in distress and default. In this sense, the paper tries to internalize compassion in financial contracting that can potentially change the architecture of lending. Social implications Altering businesses’ mindset from a waste-driven extractive linear economy to inclusive circular economy has a tremendous transformative role. This will have implications for enhancing business consciousness and responsibility. As poverty is a phenomenon of state of mind, changing the society’s state of thought in Muslim communities is expected to have basic positive implications. Entrepreneurs with a new mindset can have far-reaching positive impacts on the society. Originality/value The paper offers potentially innovative perspectives in four key areas and blends the different resources in an incorporated waqf that makes responsible entrepreneurs assume a partnership role in times of distress through EaD. Furthermore, the integration of compassion in financial contracting could have better implications for return on investment as well. The ideal state of an economy is where waste is turned into wealth and well-being is something that all policymakers must keep on the top of their agendas.

A Literature Review of Financial Contracting Theory from the Islamic and Conventional Overviews: Contributions, Gaps, and Perspectives

This paper discusses the financial contracting theory from the conventional and Islamic perspectives. It provides an overview of the contributions in this field and discusses the gaps in the literature. In addition, it proposes two relevant approaches namely the financial contracting enforceability approach and the adverse selection analysis in order to deal with conflicts of interest among economic agents. The first approach is meant to assess the contract that maximizes the value of the firm subject to the enforcement constraint for the agent and the participation constraint for the principal. The second approach considers an adverse selection framework in order to determine the principal’s subjective perception of the risk of default when equity and debt financings are used. Similarly, it suggests avenues for future research. Firstly, it calls for a deeper understanding of venture capital as a potential model of mushārakah. Secondly, it puts stress on the importance of examining crowd-funding functioning from the principal-agent point of view. Thirdly, it sheds some light on the necessity to yield financial explanation about the excessive use of murābaḥah instead of ijārah. In a nutshell, we assume that the alternative approaches can be adopted to provide relevant insights regarding the proposed future researches.