Problem of agency in Mudarabah contract

Abstract

This study evaluated agency problem in mudarabah (profit sharing) contract and suggests some prudent and comprehensive mechanisms to mitigate this problem from Islamic perspectives. Agency problem in mudarabah contract can cause a number of difficulties if there is no effective information transfer between the contracting parties. Full disclosure of information from the entrepreneur (agent or mudarib) that manages the fund on behalf of a capital provider (principal or rabbulmaal) can help to reduce misinformation and assist decision making. Some approaches that can be taken to avoid asymmetric information are compatible incentive contract, screening and monitoring process, shuratic (social learning) process and execution of Islamic code of conduct. This study highlights the roles of the Islamic code of conduct and shuratic process in mitigating agency problems in mudarabah contract. © 2019 Kolej University Islam Sultan Azlan Shah.