I continue to fret about what the world would look like if all finance were 'Islamic'. What would equity look like? The liabilities of a normal company are typically split between about 10% of 'equity' and 90% of 'debt'. The debt is a deterministic liability that involves the repayment of principal at a determined maturity, and an agreed and fixed coupon payable at agreed intervals. The equity is merely the difference between the current value of the assets and the debt. This gives two advantages to the person who owns the equity. (1) Any of the asset income stream that remains after the coupon has been paid belongs to the equity holder, as does any capital gain resulting from the increase in asset value. And (2) if the asset value falls below the debt, the equity holder can walk away from the company, which will fall into the hands of the creditors, the owners of the debt (at least, assuming the company is limited liability). The first advantage gives a strong incentive to the equity holder to reduce costs of the assets, and maximise the income. The second means that the losses of the equity holder are limited to the equity. This gives a chance for those with limited capital to set up in business, without the risk of materially large losses.
Under an Islamic system, no deterministic liabilities (i.e. 'debt') are allowed. All investors in the company must share the risk of a fall in the value of the assets, and all must share the rewards. In effect, it makes every investor an equity holder, and dilutes the possibility of extraordinary profits available under the debt-equity system. Could a modern capitalistic economy thrive under such a system?