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Does the Classic Microfinance Model Discourage Entrepreneurship among the Poor? Experimental Evidence from India

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  • Erica Field
  • Rohini Pande
  • John Papp
  • Natalia Rigol

Abstract

Do the repayment requirements of the classic microfinance contract inhibit investment in high-return but illiquid business opportunities among the poor? Using a field experiment, we compare the classic contract which requires that repayment begin immediately after loan disbursement to a contract that includes a two-month grace period. The provision of a grace period increased short-run business investment and long-run profits but also default rates. The results, thus, indicate that debt contracts that require early repayment discourage illiquid risky investment and thereby limit the potential impact of microfinance on microenterprise growth and household poverty.

Suggested Citation

  • Erica Field & Rohini Pande & John Papp & Natalia Rigol, 2013. "Does the Classic Microfinance Model Discourage Entrepreneurship among the Poor? Experimental Evidence from India," American Economic Review, American Economic Association, vol. 103(6), pages 2196-2226, October.
  • Handle: RePEc:aea:aecrev:v:103:y:2013:i:6:p:2196-2226
    Note: DOI: 10.1257/aer.103.6.2196
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    References listed on IDEAS

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    1. Glennon, Dennis & Nigro, Peter, 2005. "Measuring the Default Risk of Small Business Loans: A Survival Analysis Approach," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 923-947, October.
    2. Madajewicz, Malgosia, 2011. "Joint liability versus individual liability in credit contracts," Journal of Economic Behavior & Organization, Elsevier, vol. 77(2), pages 107-123, February.
    3. Barnea, Amir & Haugen, Robert A & Senbet, Lemma W, 1980. " A Rationale for Debt Maturity Structure and Call Provisions in the Agency Theoretic Framework," Journal of Finance, American Finance Association, vol. 35(5), pages 1223-1234, December.
    4. Pascaline Dupas & Jonathan Robinson, 2013. "Savings Constraints and Microenterprise Development: Evidence from a Field Experiment in Kenya," American Economic Journal: Applied Economics, American Economic Association, vol. 5(1), pages 163-192, January.
    5. Leland, Hayne E & Toft, Klaus Bjerre, 1996. " Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Journal of Finance, American Finance Association, vol. 51(3), pages 987-1019, July.
    6. Benjamin Feigenberg & Erica Field & Rohini Pande, 2013. "The Economic Returns to Social Interaction: Experimental Evidence from Microfinance," Review of Economic Studies, Oxford University Press, vol. 80(4), pages 1459-1483.
    7. Dean Karlan & Jonathan Zinman, 2009. "Observing Unobservables: Identifying Information Asymmetries With a Consumer Credit Field Experiment," Econometrica, Econometric Society, vol. 77(6), pages 1993-2008, November.
    8. Christopher Udry & Santosh Anagol, 2006. "The Return to Capital in Ghana," American Economic Review, American Economic Association, vol. 96(2), pages 388-393, May.
    9. Erica Field & Rohini Pande, 2008. "Repayment Frequency and Default in Microfinance: Evidence From India," Journal of the European Economic Association, MIT Press, vol. 6(2-3), pages 501-509, 04-05.
    10. Craig McIntosh, 2008. "Estimating Treatment Effects from Spatial Policy Experiments: An Application to Ugandan Microfinance," The Review of Economics and Statistics, MIT Press, vol. 90(1), pages 15-28, February.
    11. Suresh de Mel & David McKenzie & Christopher Woodruff, 2009. "Returns to Capital in Microenterprises: Evidence from a Field Experiment," The Quarterly Journal of Economics, Oxford University Press, vol. 124(1), pages 423-423.
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    More about this item

    JEL classification:

    • A21 - General Economics and Teaching - - Economic Education and Teaching of Economics - - - Pre-college
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • I32 - Health, Education, and Welfare - - Welfare, Well-Being, and Poverty - - - Measurement and Analysis of Poverty
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance
    • L26 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Entrepreneurship
    • O15 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Economic Development: Human Resources; Human Development; Income Distribution; Migration
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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