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Communication and Hidden Action: Evidence from a Person-to-Person Lending Experiment

Martin Brown (), Jan Schmitz and Christian Zehnder

No 1819, Working Papers on Finance from University of St. Gallen, School of Finance

Abstract: We conduct a laboratory experiment to study whether pre-play communication mitigates opportunistic behavior in a person-to-person lending context. We implement a trust game in which the investment income of the borrower (second-mover) is uncertain and not revealed to the lender (first mover). In this "hidden action" condition lenders cannot distinguish strategic defaults from forced defaults. We compare a treatment in which the borrower can send pre-play text messages to the lender to a treatment without such communication. We find that communication does not have a significant positive effect on credit volumes or repayment rates in this hidden action condition. We compare these findings to the effect of communication in a baseline condition in which borrower income is deterministic and strategic defaults cannot be hidden from lenders. In this baseline condition, communication leads to higher credit volumes and repayment rates implying higher payoffs for both lenders and borrowers. Comparing borrower communication and behavior in the hidden action condition to the baseline condition we find that borrowers are much more likely to renege on promises to repay in the hidden action treatment.

Keywords: Strategic Default; Communication; Trust Game; Relationship Lending (search for similar items in EconPapers)
JEL-codes: G01 G02 C91 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cbe, nep-exp and nep-gth
Date: 2018-08, Revised 2018-11
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