Building an Honest Microfinance Organization: Embezzlement and the Optimality of Rigid Repayment Schedules and Joint Liability

44 Pages Posted: 19 Jul 2007

See all articles by Doh-Shin Jeon

Doh-Shin Jeon

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences

Domenico Menicucci

Universita' degli Studi di Firenze

Date Written: September 2005

Abstract

We consider the agency problem of a staff member managing microfinancing programs, who can abuse his discretion to embezzle borrowers' repayments. The fact that most borrowers of microfinancing programs are illiterate and live in rural areas where transportation costs are very high make staff's embezzlement particularly relevant as is documented by Mknelly and Kevane (2002). We study the trade-off between the optimal rigid lending contract and the optimal discretionary one and find that a rigid contract is optimal when the audit cost is larger than gains from insurance. Our analysis explains rigid repayment schedules used by the Grameen bank as an optimal response to the bank staff's agency problem. Joint liability reduces borrowers' burden of respecting the rigid repayment schedules by providing them with partial insurance. However, the same insurance can be provided by borrowers themselves under individual liability through a side-contract.

Keywords: Microfinance, Group Lending, Joint Liability, Embezzlement, Hierarchy, Contract

JEL Classification: O16, D82, G20

Suggested Citation

Jeon, Doh-Shin and Menicucci, Domenico, Building an Honest Microfinance Organization: Embezzlement and the Optimality of Rigid Repayment Schedules and Joint Liability (September 2005). Available at SSRN: https://ssrn.com/abstract=1001622 or http://dx.doi.org/10.2139/ssrn.1001622

Doh-Shin Jeon (Contact Author)

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
(34) 93 542 16 57 (Phone)
(34) 93 542 17 46 (Fax)

Domenico Menicucci

Universita' degli Studi di Firenze ( email )

via delle pandette 9
Firenze, 50127
Italy
+39-055-4374666 (Phone)
+39-055-4374913 (Fax)

HOME PAGE: http://www.dmd.unifi.it/index.php?loc=personal&id=d.menicucci

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
122
Abstract Views
773
rank
274,909
PlumX Metrics