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    Contractual Restrictions and Debt Traps
    14 Apr 2020Working Paper Summaries

    Contractual Restrictions and Debt Traps

    by Ernest Liu and Benjamin N. Roth
    Microfinance has failed to catalyze entrepreneurship in developing countries, despite abundant evidence of high return on investment opportunities. What can account for this? This study presents a theory in which firms that borrow from an informal lender may see their growth stalled and remain in the relationship indefinitely, even though they would have continued to grow in the absence of a lender.
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    Author Abstract

    Microcredit and other forms of small-scale finance have failed to catalyze entrepreneurship in developing countries. In these credit markets, borrowers and lenders often bargain over not only the interest rate but also implicit restrictions on types of investment. We build a dynamic model of informal lending and show this may lead to endogenous debt traps. Lenders constrain business growth for poor borrowers, yet richer borrowers may grow their businesses faster than they could have without credit. The theory offers nuanced comparative statics and rationalizes the low average impact and low demand of microfinance despite its high impact on larger businesses.

    Paper Information

    • Full Working Paper Text
    • Working Paper Publication Date: February 2020
    • HBS Working Paper Number: HBS Working Paper #20-088
    • Faculty Unit(s): Entrepreneurial Management
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    Benjamin N. Roth
    Benjamin N. Roth
    Assistant Professor of Business Administration
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