Optimal Collective Contract Without Peer Monitoring
Arup Daripa ()
Development and Comp Systems from EconWPA
If entrepreneurs have private information about factors influencing the outcome of an investment, individual lending is inefficient. The literature emphasizes improvements through non-market organizations that harness local information through peer monitoring. I investigate the complementary question of designing a credit mechanism when local information is limited, disabling peer monitoring. I show that a pooling mechanism that does not rely on peer monitoring can implement a market for rights-to-borrow, restoring efficiency. The mechanism achieves a strict Pareto improvement - providing incentive for each type of agent to join. Further, even though the mechanism involves pooling - and consequent implicit transfers from better types to worse types - it has a ``collective'' feature that makes it immune to the Rothschild-Stiglitz cream-skimming problem under competing contracts. Finally, the presence of even weak local information implies that the mechanism cannot be successfully used by formal lenders. Thus a local credit institution can emerge as an optimal response to the informational environment even without peer monitoring. I apply the results to contracts offered by rural moneylenders in developing countries.
Keywords: Informal Credit; Market for Rights-To-Borrow; Participation Incentives; Competition in Contracts and Cream Skimming; Local Information; Rural Moneylending (search for similar items in EconPapers)
JEL-codes: O12 D78 D82 (search for similar items in EconPapers)
Note: Type of Document - pdf; pages: 27
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Working Paper: Optimal Collective Contract Without Peer Monitoring (2005)
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Persistent link: https://EconPapers.repec.org/RePEc:wpa:wuwpdc:0511019
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