Optimal Collective Contract Without Peer Monitoring
AbstractIf entrepreneurs have private information about factors influencing the outcome of an investment, individual lending is inefficient. The literature emphasizes improvements through non-market organizations that harness local information through peer monitoring. I investigate the complementary question of designing a credit mechanism when local information is limited, disabling peer monitoring. I show that a pooling mechanism that does not rely on peer monitoring can implement a market for rights-to-borrow, restoring efficiency. The mechanism achieves a strict Pareto improvement - providing incentive for each type of agent to join. Further, even though the mechanism involves pooling - and consequent implicit transfers from better types to worse types - it has a “collective” feature that makes it immune to the Rothschild-Stiglitz cream-skimming problem under competing contracts. Finally, the presence of even weak local information implies that the mechanism cannot be successfully used by formal lenders. Thus a local credit institution can emerge as an optimal response to the informational environment even without peer monitoring. I apply the results to contracts offered by rural moneylenders in developing countries.
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Bibliographic InfoPaper provided by Birkbeck, Department of Economics, Mathematics & Statistics in its series Birkbeck Working Papers in Economics and Finance with number 0519.
Date of creation: Nov 2005
Date of revision:
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Other versions of this item:
- Arup Daripa, 2005. "Optimal Collective Contract Without Peer Monitoring," Development and Comp Systems 0511019, EconWPA.
- O12 - Economic Development, Technological Change, and Growth - - Economic Development - - - Microeconomic Analyses of Economic Development
- D78 - Microeconomics - - Analysis of Collective Decision-Making - - - Positive Analysis of Policy Formulation and Implementation
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
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