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Contract structure, risk sharing and investment choice

Fischer, Gregory (2013) Contract structure, risk sharing and investment choice. Econometrica, 81 (3). pp. 883-939. ISSN 0012-9682

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Identification Number: 10.3982/ECTA9100


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 potential 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.

Item Type: Article
Official URL:
Additional Information: © 2013 Econometric Society
Divisions: Economics
Subjects: H Social Sciences > HB Economic Theory
JEL classification: C - Mathematical and Quantitative Methods > C9 - Design of Experiments > C91 - Laboratory, Individual Behavior
C - Mathematical and Quantitative Methods > C9 - Design of Experiments > C92 - Laboratory, Group Behavior
D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty
G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
O - Economic Development, Technological Change, and Growth > O1 - Economic Development > O12 - Microeconomic Analyses of Economic Development
Date Deposited: 31 May 2013 09:20
Last Modified: 18 Jun 2024 07:36
Funders: Russell Sage Foundation, George and Obie Shultz Fund, National Science Foundation's Graduate Research Fellowship, Economic and Social Research Council's

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