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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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 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:	http://onlinelibrary.wiley.com/journal/10.1111/%28...
Additional Information:	© 2013 Econometric Society
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:	31 May 2013 09:20
Last Modified:	04 Apr 2024 16:24
Funders:	Russell Sage Foundation, George and Obie Shultz Fund, National Science Foundation's Graduate Research Fellowship, Economic and Social Research Council's
URI:	http://eprints.lse.ac.uk/id/eprint/46796

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