Contract Design, Business Growth, and Female Entrepreneurship: Evidence from Microfinance in India

Building on a previous randomized experiment that assessed the impact of reduced liquidity needs on investment in microenterprises and enterprise growth, this project investigates on a deeper level the effect of including liquidity grace periods in credit contracts.

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This project builds on a randomized experiment conducted in 2007-2008 to assess whether reducing liquidity needs in the early phase of microloans would allow clients to undertake more illiquid but higher-return investments. In an experiment conducted with female clients of Village Financial Services in India, clients in the treatment group were granted a grace period of two months before paying the first installment, while the control group was assigned to the standard repayment schedule requiring the first installment immediately after loan disbursement.

Follow-up data on profits, income, and repayment revealed that clients who had been provided a grace period contract increased their business investments and doubled their likelihood of starting a new business in the short run, and had 17% higher income three years after the initial loan. This suggests that the immediate repayment obligations of the classic microcredit contract inhibit investment in microenterprises and limit household income and enterprise growth.

To date, three waves of surveying have been completed: a baseline collecting typical household and business information; a midline producing short-run data on loan usage and business formation; and the third wave providing data on business performance and final outcomes. The PEDL grant will be used to conduct a fourth and final wave of data collection. This final wave will target four main research questions:

  • What are the determinants of business growth for the 13 per cent of the original sample of microenterprises that grew beyond Rs. 100,000 in terms of capital stock (a significant achievement for a microenterprise)? The survey will include a module on business characteristics along with an inventory of business inputs through the life of the business.
  • Is there persistence in business size differences across treatment and control group clients? This will allow the researchers to directly examine the long-run impact of their intervention.
  • Are there significant differences between male and female entrepreneurial performance within the sample? The survey enquires about the gender of the primary manager of the microenterprise. This will produce findings relevant for policy that seeks to increase the status of women, and it will contribute to the current debate in academic literature on this topic.
  • Are there effects on households and their businesses stemming from the microfinance liquidity crisis that India has been facing since late 2010? The survey will include a module designed to   determine the extent to which clients have access to alternative sources of financing. Moreover, this module will also be used to detect any gender differences in entrepreneurial behaviour in the face of an economic shock.

This survey wave will go into significant detail on the business practices and long-term business growth of the project’s initial sample of micro-entrepreneurs. The survey will also provide information on other outcomes including household characteristics, health, and credit, thereby completing what will be a unique and sizable seven-year panel dataset.