|This centre is a member of The LSE Research Laboratory [RLAB]: CASE | CVER | CEP | SERC | STICERD||Cookies?|
Paper No' EOPP 023: | Full paper
Save Reference as: BibTeX File | EndNote Import File
Keywords: investment choice; informal insurance, risk sharing, contract design, microfinance, experiment.
JEL Classification: O12, D81, C91, C92, G21
Is hard copy/paper copy available? YES - Paper Copy Still In Print.
This Paper is published under the following series: Economic Organisation and Public Policy
Share this page: Google Bookmarks | Facebook | Twitter
Abstract:Few microfinance-funded businesses grow beyond subsistence entrepreneurship. This paper considers one possible explanation: that the structure of existing microfinance contracts may discourage risky but high-expected return investments. To explore this possibility, I develop a theory that unifies models of investment choice, informal risk sharing, and formal financial contracts. I then test the predictions of this theory using a series of experiments with clients of a large microfinance institution in India. The experiments confirm the theoretical predictions that joint liability creates two inefficiencies. First, borrowers free-ride on their partners, making risky investments without compensating partners for this risk. Second, the addition of peer-monitoring overcompensates, leading to sharp reductions in risk-taking and profitability. Equity-like financing, in which partners share both the benefits and risks of more profitable projects, overcomes both of these inefficiencies and merits further testing in the field.
Copyright © RLAB & LSE 2003 - 2015 | LSE, Houghton Street, London WC2A 2AE | Contact: RLAB | Site updated 08 October 2015