“Contract Structure, Risk Sharing and Investment Choice," [pdf]
Abstract: Few microfinance-funded businesses grow beyond subsistence entrepreneurship. Most remain at a very small scale, with little capital and no employees. This paper considers one possible explanation: 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 insurance with limited commitment, and formal financial contracts. I then test the predictions of this theory with clients of a large microfinance institution in India using a series of experiments that allowed precise variation of both financial contracts and information. The experiments confirm the theoretical predictions that joint liability creates two inefficiencies. First, in the absence of effective mechanisms for peer monitoring, borrowers free-ride on their partners, making risky investments without compensating partners for this risk. Second, the addition of peer monitoring through project approval overcompensates, leading to sharp reductions in risk-taking and profitability. The theoretical prediction that group lending will crowd out informal insurance is not borne out by experimental evidence. While observed levels of informal insurance fall well short of the constrained Pareto frontier under both individual and joint liability, joint liability increases observed insurance transfers. 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.
“Keeping it Simple: Financial Literacy and Rules of Thumb,” with Antoinette Schoar and Alejandro Drexler [pdf]
Abstract: Individuals and business owners engage in an increasingly complex array of financial decisions that are critical for their success and well-being. Yet a growing literature documents that in both developed and developing countries, a large fraction of the population is unprepared to make these decisions. Evidence on potential remedies is limited and mixed. Two randomized trials test the impact of financial training on firm-level and individual outcomes for microentrepreneurs in the Dominican Republic. We find no significant effect from a standard, fundamentals-based accounting training. However, a simplified, rule-of-thumb training produced significant and economically meaningful improvements in business practices and outcomes.
“Investment Choice and Inflation Uncertainty: Evidence from Dominican Microentrepreneurs" [pdf]
Abstract: This paper investigates the relationship between inflation uncertainty and the investment decisions of small, microfinance-funded firms in the Dominican Republic. An extensive literature documents the array of opposing factors linking inflation uncertainty and investment; ultimately this relationship is theoretically ambiguous. Using loan-level panel data from microfinance borrowers in the Dominican Republic, I find that periods of increased inflation uncertainty were associated with substantially lower investments in fixed assets and reduced business growth. This finding is robust to specifications controlling for other forms of systemic risk and aggregate economic activity, suggesting inflation uncertainty creates potentially large distortions to the investment decisions of poor entrepreneurs.
“Efficiency and Rent Seeking in Local Government,” with Esther Duflo and Raghabendra Chattopadhyay [revision forthcoming]
Abstract: The decentralized provision of local public goods involves a tradeoff between the local government’s ability to elicit and serve the preferences of the citizens (efficiency) and the risk of elite capture (rent seeking). This paper proposes and implements a test of local government efficiency by using a policy in India that set aside leadership positions in local governments to members of disadvantaged minority groups. The set-asides, or “reservations,” are randomly assigned to villages, allowing unbiased estimates of their effects on the quantity and the types of public goods provided. If local governments are efficient, even if they discriminate against minority groups by supplying fewer public goods, they should still supply the public goods that minority groups value most. With homothetic preferences, when reservations increase the bargaining power of minorities, expenditures across all types of public goods should increase proportionately. We find that when leadership positions are reserved for disadvantaged minorities, hamlets in which these minorities live receive a greater allocation of public goods. Moreover, we can reject that this increase in public goods in minority hamlets is proportional to the distribution of goods when the leadership position is unreserved, suggesting local governments are not efficient.
"Spanning the Chasm: Uniting Theory and Empirics in Microfinance Research" (with Maitreesh Ghatak) , Forthcoming in the Handbook of Microfinance , (eds) Beatriz Armendáriz and Marc Labie, World Scientific, 2010. [pdf]
"Eliciting and Utilizing Willingness to Pay: Evidence from Field Trials in Northern Ghana" (with Jim Berry and Raymond Guiteras) [coming soon]
Abstract: We utilize the Becker-Degroot-Marschak (1964) mechanism to estimate the willingness to pay for clean drinking water technology in northern Ghana. Under certain conditions, the BDM mechanism has attractive properties for empirical research, allowing us to directly estimate demand, compute heterogeneous treatment effects, and study the direct and screening effect of prices with minor modifications to a standard field experiment setting. We demonstrate the implementation of BDM along these three dimensions, compare it to the standard take-it-or-leave it method for eliciting willingness-to-pay, and discuss practical issues for implementing the mechanism in true field settings.
“Repayment Frequency and Lending Contracts with Present-Biased Borrowers"(with Maitreesh Ghatak) [coming soon]
Abstract: This paper analyzes the theoretical underpinnings of high-frequency repayment, a feature in nearly all microfinance contracts that has been largely overlooked by theorists. The pervasive belief among practitioners that frequent repayment is critical in achieving high repayment rates is puzzling. Classically rational individuals should benefit from more flexible repayment schedules, and less frequent repayment should increase neither default nor delinquency. This paper proposes a simple explanation based on present bias. For such individuals, more frequent repayment can increase the maximum incentive compatible loan size. However, the welfare effects are ambiguous. More frequent repayment can lead to over-borrowing, reducing welfare as it increases loan sizes.
Last updated:
27-Mar-2011
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