Using Revenue Sharing for Higher Risk and Return Business Ventures in Microfinance: An Experimental Study

We report a group liability microfinance lab experiment that tests a mechanism to raise repayment rates among borrowers whose business plans carry higher exogenous risk and return. The mechanism is optional revenue sharing among the group of borrowers, agreed to before their individual business outcomes are realized and loan repayment decisions are made. Such revenue sharing makes loan repayment optimal under more business outcome states, thus increasing the expected benefit to each borrower of repayment to qualify for future loans. We further test the effect of allowing the borrowers to renege on revenue sharing agreements after learning their business outcomes, prior to making their loan repayment decisions. Our results illustrate the problem that exogenously higher risk/return borrowing groups achieve lower loan repayment rates than lower risk/return borrowing groups. We then find that introducing optional revenue sharing significantly increases the high risk borrowers’ repayment rates, but that most of this gain is lost when successful borrowers can renege on revenue sharing agreements.