Fischer, Gregory (2011) Contract structure, risk sharing and investment choice. Economic Organisation and Public Policy Discussion Papers (EOPP/2011/23). Suntory and Toyota International Centres for Economics and Related Disciplines, London, UK.
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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.
| Item Type: | Monograph (Discussion Paper) |
|---|---|
| Official URL: | http://sticerd.lse.ac.uk |
| Additional Information: | © 2011 The Author |
| Divisions: | Economics STICERD |
| 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: | 14 Feb 2012 11:40 |
| Last Modified: | 11 Sep 2025 04:28 |
| URI: | http://eprints.lse.ac.uk/id/eprint/41890 |
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