Review and compare debt overhang problems in musharakah sukuk and conventional debt

Musharakah sukuk as the main instrument in the Iran's financial market has held heavy duty collection and allocation liquidity to productive sectors. Given the importance of the issue of financing in the economy, analyzing the various aspects related to bonds is very important The phenomenon of debt overhang is one of the most important issues associated with bonds. It is a conflict between shareholders and bondholders that was introduced for the first time by the Myers (1977). In general, debt overhang refers to a situation where an entrepreneur with an ongoing project, financed to some part with risky debt, has a new investment opportunity with a positive net present value, but is unable to find financing because renegotiation with debtholders is not possible. The current risky debt used to finance the ongoing project will tax the new investment as the returns from the new investment will be used to meet debt repayment obligations to the current debtholders. In this paper debt overhang problems for musharakah financing and bond respectively as Islamic and conventional debt financing is analyzed. The musharakah agreements have been analyzed under two conditions. First, when retained earnings generated by the project are sufficient to finance the project. In this case musharakah agreement display equity characteristics and a debt overhang problem is not present. Second, when retained earnings are not sufficient to finance the new project. In this case debt overhang can prevent a positive net present value project from being undertaken.