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Financing Experimentation

Mikhail Drugov () and Rocco Macchiavello ()

American Economic Journal: Microeconomics, 2014, vol. 6, issue 1, 315-49

Abstract: Entrepreneurs must experiment to learn how good they are at a new activity. What happens when the experimentation is financed by a lender? Under common scenarios, i.e., when there is the opportunity to learn by "starting small" or when "noncompete" clauses cannot be enforced ex post, we show that financing experimentation can become harder precisely when it is more profitable, i.e., for lower values of the known arm and for more optimistic priors. Endogenous collateral requirements (like those frequently observed in microcredit schemes) are shown to be part of the optimal contract.

JEL-codes: D82 G21 G32 L25 L26 (search for similar items in EconPapers)
Date: 2014
Note: DOI: 10.1257/mic.6.1.315
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Handle: RePEc:aea:aejmic:v:6:y:2014:i:1:p:315-49