378 AN INTRODUCTION TO ISLAMIC FINANCE
businesses in which the listing companies are engaged, and that there is suf-
fi cient legal, regulatory and supervisory protection against such things as
insider-trading transactions.
Where these things are lacking, the problems of moral hazard and
adverse selection raise their ugly heads. Having enforceable laws and cred-
ible institutions in place can serve to assure investors of the honesty of
publicly listed fi rms and of the full transparency and accuracy of their
reporting and information. These laws governing fi nancial disclosure
and securities, for example, would be backed up by strong sanctions for
anyone tempted to defraud investors through false or misleading infor-
mation. Sanctions imposing risk of liability (to investors) on account-
ants, lawyers, traders or investment bankers in retaliation for false
reporting, fraudulent, misleading information or faulty endorsements
can be powerful tools for dissuading all concerned from defrauding
investors. Requiring intermediaries to be licensed — with the attendant
threat that licenses can be revoked — is another powerful regulatory tool,
particularly when this is backed by the additional threat of heavy fi nes
or criminal proceedings for abusing the system. Stock exchanges, too,
have a critical role to play through implementing and enforcing strin-
gent listing standards, again backed by the threat of heavy fi nes or the
delisting of companies that violate disclosure rules. An active, dynamic,
well - informed fi nancial press can be valuable in creating a culture of
disclosure, which would be closely monitored by a strong, independent
regulatory agency.
While the above policies and institutions are crucial in reducing the
cost of participation in stock markets and thus promoting widespread
risk sharing, governments need to do more: they must lead by example.
They could become active in markets for risk sharing. Generally, gov-
ernments do share risks with their people through, for example, their
tax and social expenditure policies. They are silent partners. They share
the risks of the fi nancial system through monetary policy and deposit
guarantees. They could choose to fi nance part of their budget, at least
their development spending, through risk sharing and direct owner-
ship of development projects with their citizens. In this way, they would
reduce the debt burden on the budget. This reduction in government
borrowing reduces the burden on monetary policy as well. Governments
undertake public - goods projects because the characteristics of these
goods — indivisibility and non - exclusivity — prohibit their production
by the private sector and therefore are undertaken by governments.
However, their social rate of return is substantial and much higher than
private rates of return. A recent popular proposal suggests that these
projects should be undertaken jointly with the private sector, hence the
“public–private partnership” (PPP) label. However, this proposal has a
number of problems — market distortion, and informational and govern-
ance problems being just three.