Repayment Flexibility and Risk Taking: Experimental Evidence from Credit Contracts

doi:10.1093/restud/rdad107

Paper

Repayment Flexibility and Risk Taking: Experimental Evidence from Credit Contracts

Published Nov 1, 2018 · Selim Gulesci, Andreas Madestam

Corporate Finance: Valuation

Q1 SJR score

33

Citations

4

Influential Citations

Full textSemantic Scholar

Abstract

A widely held view is that small firms in developing countries are prevented from making profitable investments by lack of access to credit and insurance markets. One solution is to provide repayment flexibility in credit contracts. Repayment flexibility eases both the credit constraint, as it allows for increased spending during the startup phase, and offers insurance, in case of fluctuations in income. In a field experiment among traditional microfinance clients and larger collateralized borrowers in Bangladesh, we randomly assign the option to delay up to 2 monthly repayments at any point during a 12-month loan cycle. The flexible contract leads to substantial improvements in the traditional microfinance clients’ business outcomes, driven by borrowers in the upper tail of the distribution. In addition, we find a significant impact on socioeconomic status, combined with lower default rates. We show theoretically and empirically that these effects are induced by an increase in entrepreneurial risk taking, implying that the primary mechanism is insurance provision. Repayment flexibility also attracts less risk-averse borrowers interested in business expansion. At the same time, the effects for the larger loan are much more modest. Our findings suggest that lack of insurance is an important constraint for small firms but that a simple financial product that increases repayment flexibility can be an effective tool for enabling enterprise growth.

Study Snapshot

Repayment flexibility in credit contracts improves business outcomes and socioeconomic status for microfinance clients, primarily due to increased entrepreneurial risk taking through insurance provision.

PopulationOlder adults (50-71 years)

Sample size24

MethodsObservational

OutcomesBody Mass Index projections

ResultsSocial networks mitigate obesity in older groups.

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Repayment Flexibility and Risk Taking: Experimental Evidence from Credit Contracts

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References

Citations

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