Joint Lending, not Borrowing: a New Approach to Credit and Entrepreneurship in LDCs

Aspiring entrepreneurs and small businesses in developing countries face notoriously high barriers. One barrier, well-supported by evidence across many countries and contexts, is insufficient credit – more specifically, the inability of poor entrepreneurs to access credit at terms conducive to growing small businesses in risky and less financially-developed environments. But what, precisely, is the relationship between credit and entrepreneurship in developing countries? This project aims to explore the interaction between entrepreneurship in developing countries and the incentives and actions of lenders in microfinance institutions through several channels: first, the dependence of entrepreneurial development on loans administered and risk structure of available business opportunities, and second, the dependence of the composition of investor partnerships on the risk environment of business opportunities and candidate borrowers.

The researchers introduce a theory tying together the riskiness of available business opportunities, the sorting of lenders in strategic partnerships, and the equilibrium of successful business ventures and their owner characteristics. They will use this theory to characterize the optimal composition of investor partnerships and investments funded in equilibrium. They will also conduct a field experiment in which lenders are matched in different ways and must choose portfolios of borrowers and proposed borrower projects under varying degrees of risk. This field work will generate a new and unique data set containing the preferences of lenders, the distribution of lenders’ risk ratings and portfolios, lenders’ screening activities, and the outcomes of the entire applicant pool.

The novel approach of this project could reveal the possibility of an ‘innovation trap’, in which the poorest entrepreneurs and investors are least able to undertake innovative projects and continue with smoothing their consumption instead of growing their returns. The model and dataset will also allow for a better understanding of the impact of market frictions and constraints on the emergence and evolution of entrepreneurship in developing countries. As a result, policymakers will be better placed to encourage successful entrepreneurship. 

Authors

Arun Chandrasekhar

Stanford University