MICROEQUITY FOR MICROENTERPRISES: EVIDENCE FROM AN ARTEFACTUAL FIELD EXPERIMENT AND SURVEY

Muhammad Meki (muhammad.meki@economics.ox.ac.uk)
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Muhammad Meki: Post-doctoral research fellow in development economics at Pembroke College, University of Oxford

No 1348, Working Papers from Economic Research Forum

Abstract: Access to finance is often listed as one of the most important constraints on the expansion of small firms in low-income countries. However, several recent studies reveal that most microcredit-funded businesses rarely grow beyond subsistence-level entrepreneurship. Other evidence shows that cash and capital grants have delivered high returns to some microenterprises, and that small changes to contract structure can have a long-term effect on investment and profits. In this paper, I investigate the potential of ‘microequity’ contracts, which can be viewed as lying at some point on a spectrum between credit and grants, and provide a more flexible form of capital with performance-contingent repayments and a greater sharing of risk and reward. I present results from work with two of the largest microfinance institutions in Pakistan to investigate the effects of microequity contracts on microenterprises. In the first part of the paper, I describe an artefactual field experiment, designed using a simple model of investment choice under different financial contracts. This is tested with microenterprise owners who are part of a related field experiment that provides them with shared-ownership financing to expand their business. Results reveal that equity-financed microenterprise owners chose investment options with a greater expected profit than those under debt financing, with heterogeneity analysis suggesting a larger effect for the most riskaverse individuals, who also exhibit a stronger preference for equity contracts when offered a choice. In the final part of the paper, I describe qualitative insights for why most microfinance institutions do not implement microequity products, using a field survey and manager interviews, which reveal the practical implementation challenges due to costly state verification, adverse selection into profit-sharing contracts and moral hazard caused by inappropriately-tailored sharing ratios

Pages: 62
Date: 2019-09-20, Revised 2019-09-20
New Economics Papers: this item is included in nep-ent, nep-exp, nep-fdg, nep-mfd and nep-sbm
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