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Joint liability versus individual liability in credit contracts

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  • Malgosia Madajewicz

    () (Columbia University - Department of Economics)

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    Abstract

    I compare welfare generated by a credit contract with individual liability and a contract with joint liability. The problem is credit rationing caused by limited liability and unobservable investment decisions. Joint liability induces borrowers to monitor each other, however the lender can also monitor. I show that wealthier borrowers may prefer riskier investments when liability is joint, which causes the lender to offer them smaller loans than he would if liability were individual, even if he cannot monitor the individual-liability loan. Therefore, wealthier borrowers prefer individual-liability loans. The result may explain why small businesses grow larger when funded with individual rather than with joint-liability loans. Poorer borrowers may prefer joint-liability loans, because borrowers monitor more efficiently, even when their monitoring technology is the same as the lender, making joint-liability loans cheaper.

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    Bibliographic Info

    Paper provided by Columbia University, Department of Economics in its series Discussion Papers with number 0304-18.

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    Length: 42 pages
    Date of creation: 2004
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    Handle: RePEc:clu:wpaper:0304-18

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    1. Tirole, Jean, 1986. "Hierarchies and Bureaucracies: On the Role of Collusion in Organizations," Journal of Law, Economics and Organization, Oxford University Press, vol. 2(2), pages 181-214, Fall.
    2. Ashok S. Rai & Tomas Sj–str–m, 2004. "Is Grameen Lending Efficient? Repayment Incentives and Insurance in Village Economies," Review of Economic Studies, Wiley Blackwell, vol. 71(1), pages 217-234, 01.
    3. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
    4. Stiglitz, Joseph E, 1990. "Peer Monitoring and Credit Markets," World Bank Economic Review, World Bank Group, vol. 4(3), pages 351-66, September.
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    Cited by:
    1. Dean Karlan & Xavier Gine & Jonathan Morduch & Pamela Jakiela, 2006. "Microfinance Games," Working Papers 936, Economic Growth Center, Yale University.

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