Recent corporate finance theories posit that corporate governance is increasingly based on exit strategies rather than on voice. These theories conjecture that, even in the absence of intervention power, dispersed blockholders can govern firms (Edmans 2009; Admati and Pfleiderer 2009). While such a dispersed structure appears to be a barrier for direct intervention, it strengthens the role of a second governance mechanism: disciplining through trading. This behaviour involves an exit strategy upon negative information, thus leading to a stock price that closely reflects the firm’s fundamental value. The drop in the stock price involves the punishment of equity-linked managers, while ex-ante the mere threat of exit raises efficiency as it induces managers to undertake value-enhancing activities.
On the other hand, although conventional demand deposits are not tradeable, they are highly liquid by their very nature. Deposits typically contain a withdrawal option embedded with each account, which licenses the depositor to sell the deposit to the bank at will. Calomiris and Kahn (1991) explain that, in a risk-sharing framework, liquid deposits substantially help to align the bank’s portfolio choice with depositors’ preferences. If the bank fundamentals turn out to be weak, depositors still could exercise power over bank management due to their ability to withdraw their deposits when information indicates poor firm prospects. Such an exit by depositors can be an effective governance mechanism, even when they have no direct intervention power in the operation of the banks. Islamic profit-sharing investment accounts (PSIAs) are hybrid securities bearing features of stocks and conventional deposits. Similar to stocks, PSIAs do not yield present interest rates but rather confer a proportion of profits. Similar to conventional deposits, PSIAs do not grant the control rights that shareholders enjoy and the cash flow rights are separated from the rights to control the investments. Out of this structure a number of questions arise that desperately need theoretical exploration. First, to what extent are PSIAs different from shares and deposits in aligning bank management and PSIA holders’ interests? Second, is the hybrid structure of PSIAs a more effective tool than the disciplining through trading or deposit withdrawals? Given the hybrid nature of PSIAs, we will combine the theoretical approaches of both capital market and depositor market disciplining.