Building an Honest Microfinance Organization: Embezzlement and the Optimality of Rigid Repayment Schedules and Joint Liability

Doh-Shin Jeon and Domenico Menicucci

No 272, Working Papers from Barcelona School of Economics

Abstract: We consider the agency problem of a staff member managing microfinancing programs, who can abuse his discretion to embezzle borrowers' repayments. The fact that most borrowers of microfinancing programs are illiterate and live in rural areas where transportation costs are very high make staff's embezzlement particularly relevant as is documented by Mknelly and Kevane (2002). We study the trade-off between the optimal rigid lending contract and the optimal discretionary one and find that a rigid contract is optimal when the audit cost is larger than gains from insurance. Our analysis explains rigid repayment schedules used by the Grameen bank as an optimal response to the bank staff's agency problem. Joint liability reduces borrowers' burden of respecting the rigid repayment schedules by providing them with partial insurance. However, the same insurance can be provided by borrowers themselves under individual liability through a side-contract.

Keywords: microfinance; Contract; Embezzlement; Insurance; Joint Liability (search for similar items in EconPapers)
JEL-codes: D82 G20 O16 (search for similar items in EconPapers)
Date: 2015-09
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Working Paper: Building an honest microfinance organization: Embezzlement and the optimality of rigid repayment schedules and joint liability (2006)
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