Inside the Production Function: the Effect of Financial Contracts on Growing Firms' Technology Use. Evidence from a Randomized Experiment in Uganda

This investigation aims to provide evidence on the effect of credit contract terms on nascent firms' use of inputs, profits, and repayment performance through a rigorous pilot survey.

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It is widely accepted that access to credit is an important engine for growth. Credit rationing is also believed to be a common feature of developing credit markets, because of weak legal institutions and a lack of collateral. Another central but less well recognized constraint is how key aspects of the most frequent form of financing, debt, inhibit the expansion of young and newly established firms. Starting a business entails learning and uncertainty, implying that project returns tend to be back loaded or uncertain. Moreover, indivisible startup costs usually require large initial investments. Features of the standard debt contract, such as a constant repayment stream and caps on the initial loan size, may distort investment toward the use of inputs that involve less learning, less uncertainty, and smaller project size.

In cooperation with BRAC Uganda and their Small Enterprise Lending Program, we aim to shed light on the issue by providing experimental evidence on the effect of credit contract terms on starting and newly established firms’ use of inputs, profits, and repayment performance.

The exploratory grant will support a pilot survey that intends to provide important information for the larger experiment to come. A first step will be to carry out a census of all the firms in our setting, where the census forms the listing of firms for sample selection. Based on this listing, we will choose a representative sample and rigorously pilot the firms in order to help us design the ideal survey instrument that will capture the variables we are interested in. The types of hypothetical questions we have in mind concern firms’ investment choices under different contractual schemes, as well as a credit demand analysis of the various contracts that may be offered. The exploratory grant will also provide detailed evidence on how constraints may vary across different sectors including motor repairs, carpentry, wholesalers, and supermarkets.