Adverse Selection and Moral Hazard in Joint Liability Loan Contracts: Evidence from an Artefactual Field Experiment

Giorgia Barboni, Alessandra Cassar, Arturo Rodriguez Trejo and Bruce Wydick
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Giorgia Barboni: Institute of Economics and LEM, Scuola Superiore Sant'Anna, Pisa, Italy
Arturo Rodriguez Trejo: Department of Economics, University of San Francisco, CA, U.S.A.

Journal of Economics and Management, 2013, vol. 9, issue 2, 153-184

Abstract: We design an artefactual field experiment to study the relationship between joint-liability lending and adverse selection, moral hazard and risk preferences. While theories concerning joint-liability lending have highlighted its ability to mitigate adverse selection in credit transactions, our experimental results indicate that joint-liability lending may actually induce problems of adverse selection. The results of our experiment, carried on in partnership with a Bolivian microlender, show that borrowers exogenously endowed with a risky project are disproportionately likely to choose jointly-liability contracts over individually-liable contracts. This behavior does not appear to be motivated by risk-diversification, but rather by free-riding, as these subjects disproportionally switch from safe to risky projects when exogenously given a joint-liability contract instead of an individual contract. Thus the results of our experiment offer a possible explanation why joint liability loans have diminished in popularity in recent years among both borrowers and microfinance lenders.

Keywords: joint-liability lending; microfinance; asymmetric information; adverse selection; social capital; artefactual field experiment (search for similar items in EconPapers)
JEL-codes: C9 O1 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (2)

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