Joint Liability and Peer Monitoring under Group Lending
This paper studies an incentive rationale for the use of group lending as a method of financing liquidity-constrained entrepreneurs. The joint liability feature associated with group lending lowers the liquidity risk of default but creates a free-riding problem. In the static setting, the free-riding problem dominates the liquidity risk effect under a plausible condition, thus making group lending unattractive. When the projects are repeated infinitely many times, however, the joint liability feature provides the group members with a credible means of exercising peer sanction, which can make the group lending attractive, relative to individual lending.
Volume (Year): 2 (2002)
Issue (Month): 1 (July)
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