Group Lending and the Role of the Group Leader: Theory and Evidence from Eritrea

Abstract

This paper investigates the strategic monitoring behaviour within a group lending setting. We develop a theoretical model, showing that monitoring efforts of group members differ from each other in equilibrium, as a result of the asymmetry between these members in terms of the future profits they generate with their project. In particular, we show that the entrepreneur with the project that generates the highest future profits also puts in the highest monitoring effort. Moreover, monitoring efforts differ between group members due to free-riding: one member reduces her level of monitoring if the other increases her monitoring effort. This effect is also at play when we introduce a group leader in the model. The individual who becomes the group leader will supply more monitoring effort than in the benchmark case, because of the reduced per unit monitoring costs related to becoming the leader. We empirically test the model using data from a survey of microfinance in Eritrea and show that the group leader attaches more weight to future periods than non-leaders in group lending and that this may explain why a large part of total monitoring is put in by the leader.

Keywords: group lending, group leader, moral hazard, monitoring, Eritrea

JEL Classification: D82, G29, O16