I would like to thank Esther Duflo, Abhijit Banerjee, and Antoinette Schoar for advice and encouragement throughout this research. I am indebted to Shamanthy Ganeshan, who provided outstanding research assistance. Daron Acemoglu, Oriana Bandiera, Tim Besley, Gharad Bryan, Robin Burgess, David Cesarini, Sylvain Chassang, Raymond Guiteras, Gerard Padró i Miquel, Rob Townsend, Tom Wilkening, and various seminar participants generously contributed many useful comments and advice. I am also grateful to the editor and three anonymous referees for providing thoughtful comments. In Chennai, the Centre for Micro Finance and the management and employees of Mahasemam Trust deserve many thanks. I gratefully acknowledge the financial support of the Russell Sage Foundation, the George and Obie Shultz Fund, the National Science Foundation's Graduate Research Fellowship, and the Economic and Social Research Council's First Grants Scheme.
Contract Structure, Risk-Sharing, and Investment Choice
Article first published online: 16 MAY 2013
© 2013 The Econometric Society
Volume 81, Issue 3, pages 883–939, May 2013
How to Cite
Fischer, G. (2013), Contract Structure, Risk-Sharing, and Investment Choice. Econometrica, 81: 883–939. doi: 10.3982/ECTA9100
- Issue published online: 16 MAY 2013
- Article first published online: 16 MAY 2013
- Manuscript received February, 2010; final revision received October, 2012.
- Investment choice;
- informal insurance;
- contract design;
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.