Contractual Restrictions and Debt Traps

45 Pages Posted: 21 Feb 2020

See all articles by Ernest Liu

Ernest Liu

Princeton University - Princeton University

Benjamin Roth

Harvard University - Business School (HBS)

Date Written: February 17, 2020

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.

Suggested Citation

Liu, Ernest and Roth, Benjamin, Contractual Restrictions and Debt Traps (February 17, 2020). Harvard Business School Entrepreneurial Management Working Paper No. 20-088, Available at SSRN: https://ssrn.com/abstract=3541123 or http://dx.doi.org/10.2139/ssrn.3541123

Ernest Liu

Princeton University - Princeton University ( email )

Joseph Henry House
Princeton, NJ 08542
United States

Benjamin Roth (Contact Author)

Harvard University - Business School (HBS) ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

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