The Dynamics of Cooperation in Group Lending: A Microfinance Experiment

This study investigates the behavioral impacts of joint and individual liability in a controlled laboratory environment.

The study conducts an experiment in which subjects decide the effort put into risky investment projects under joint and individual credit contracts. Under the joint liability contract, borrowers face a dilemma. While it would be collectively optimal to exert the highest possible effort, it is individually rational to choose the minimum effort level. In the first run of the experiment, all participants receive group lending contracts. In the second run, participants are converted to individual contracts on the basis of self-selection or repayment success. Study findings include:

• Subjects exert high effort under group lending in all treatments and both runs of the experiment;
• Joint liability contracts are superior to individual contracts in terms of repayment performance;
• Within-group moral hazard persists because subjects choose higher efforts under individual contracts and condition their behavior on partner behavior.

The study points out the necessity to monitor within-group dynamics. Since microbanks establish lasting relationships with their customers, the dynamic interaction within borrower groups might crucially influence the functioning of joint liability.