Monitoring by Peers or by Delegates? Joint Liability Loans and Moral Hazard
I analyze the conditions under which joint liability loans to encourage peer-monitoring would be offered and chosen instead of monitored individual liability alternatives on a competitive loan market when production and monitoring activities are costly and subject to moral hazard. The case for joint liability loans does not rest on an assumed monitoring or information advantage by borrowers but instead on a incentive diversification effect that cannot be replicated by outside intermediaries. Joint liability clauses are chosen to implement a preferred Nash equilibrium in a multi-agent, multi-task game, where each borrower must be given incentives to remain diligent as a financed entrepreneur and as a monitor of others. The framework can be shown to encompass earlier analyses based on costless monitoring and also allows for relative performance evaluation.
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