44 Pages Posted: 6 May 2010 Last revised: 20 Oct 2012
Date Written: October 17, 2012
Entrepreneurs must experiment to learn how good they are at a new activity. What happens when the experimentation is financed by a lender? Under common scenarios, i.e., when there is the opportunity to learn by "starting small" or when "no-compete" clauses cannot be enforced ex-post, we show that financing experimentation can become harder precisely when it is more profitable, i.e., for lower values of the known-arm and for more optimistic priors. Endogenous collateral requirements (like those frequently observed in micro-credit schemes) are shown to be part of the optimal contract.
Keywords: Experimentation, Moral Hazard, Adverse Selection, Starting Small, Competition
JEL Classification: D81, D86, G30
Suggested Citation: Suggested Citation