Entrepreneurial talent, occupational choice, and trickle up policies

We study market inefficiencies and policy remedies when agents choose their occupations, and entrepreneurial talent is subject to private information. Untalented entrepreneurs depress the returns to entrepreneurship because of adverse selection. The severity of this problem depends on the outside option of entrepreneurs, which is working for wages. This links credit, product and labor markets. A rise in wages reduces the adverse selection problem. These multimarket interactions amplify productivity shocks and may generate multiple equilibria. If it is impossible to screen entrepreneurs then all agents unanimously support a tax on entrepreneurs that drives out the less talented ones. However, if screening is possible, e.g., if wealthy entrepreneurs can provide collateral for their loans, then wealthy entrepreneurs do not support surplus enhancing taxes.     

The tradeoff between risk sharing and information production in financial markets

The production of information in financial markets is limited by the extent of risk sharing. The wider a stock's investor base, the smaller the risk borne by each shareholder and the less valuable information. A firm which expands its investor base without raising capital affects its information environment through three channels: (i) it induces incumbent shareholders to reduce their research effort as a result of improved risk sharing, (ii) it attracts potentially informed investors, and (iii) it may modify the composition of the base in terms of risk tolerance or liquidity trading. Implications for individual firms and the market as a whole are derived.     

Portfolio choice, attention allocation, and price comovement

This paper models the attention allocation of portfolio investors. Investors choose the composition of their information subject to an information flow constraint. Given their expected investment strategy in the next period, which is to hold a diversified portfolio, in equilibrium investors choose to observe one linear combination of asset payoffs as a private signal. When investors use this private signal to update information about two assets, changes in one asset affect both asset prices and may lead to asset price comovement. The model also has implications for the transmission of volatility shocks between two assets.     

A new measure of financial development: Theory leads measurement

This study presents a new measure of financial development that is directly derived from theory. Our measure, the Marginal Utilization of Debt (hereafter, MUD) comes from the seminal work of Myers (1984), Myers and Majluf (1984) and Shyam-Sunder and Myers (1999). Further, it is directly related to the development facts of Gurley and Shaw (1955). MUD is a global measure that reflects conditions in both debt and equity markets. It varies enormously across nations; from 0.23 in Australia at one extreme to 0.96 in Turkey at the other. Cross‐country variations in MUD are not random; they are related to special‐purpose measures of debt and equity market advancement from the financial development literature. Richer, more advanced nations have smaller average MUDs. We argue that the MUD may be useful for a variety of purposes and provide three example applications.     

Plastic Money Diffusion and Usage: An Empirical Analysis on Italian Households

This paper tries to contribute to the empirical literature on the European consumers’ plastic money payment habits, using the Bank of Italy data over the 1993–2008 period. In line with other evidence on this topic, mainly focused on the US economy, we find that age, education, non‐durable consumptions, regional variation and income are strong predictors of plastic money possession and use in Italy. We also find that households with a higher indebtedness level have a higher propensity to hold credit cards. Furthermore, we find that technological improvements, observed in the last 15 years, do not significantly affect the marginal probabilities to hold and use plastic money conditioned to the main socio‐demographic factors.     

Asymmetric effects of financial development on South-South and South-North trade: Panel data evidence from emerging markets

Using bilateral trade data in total and technology-and-skill-intensive manufactured goods for 28 developing countries that account for 82% of all developing country manufactures exports between 1978 and 2005, this paper explores the effects of financial development on the pattern of specialization in South-South and South-North trade. The empirical results using dynamic panel regressions and comprehensive sensitivity tests suggest that financial development in the South has an economically and statistically significant positive effect on the share of total and technology-and-skill-intensive manufactures exports in GDP, and total exports in South-South trade. In contrast, no such significant or robust effect of financial development is found in South-North trade. Overall, the positive effect of financial development is found to be asymmetric favoring South-South significantly more than South-North trade. In addition, financial development is found to be increasing technology-and-skill-intensive manufactured goods exports significantly more than total manufactured or merchandise goods exports.     

Remittances,financial development,and growth

Despite the increasing importance of remittances in total international capital flows, the relationship between remittances and growth has not been adequately studied. This paper studies one of the links between remittances and growth, in particular how local financial sector development influences a country's capacity to take advantage of remittances. Using a newly-constructed dataset for remittances covering about 100 developing countries, we find that remittances boost growth in countries with less developed financial systems by providing an alternative way to finance investment and helping overcome liquidity constraints. This finding controls for the endogeneity of remittances and financial development, does not depend on the particular measure of financial sector development used, and is robust to a number of robustness tests, including threshold estimation. We also provide evidence that there could be an investment channel trough which remittances can promote growth especially when the financial sector does not meet the credit needs of the population.     

Vertical integration and investor protection in developing countries

The industrial organization of developing countries is characterized by the pervasive use of subcontracting arrangements among small, financially constrained firms. This paper asks whether vertical integration relaxes those financial constraints. It shows that vertical integration trades off the benefits of joint liability against the costs of rendering the supply chain more opaque to external investors. In contrast to the commonly held view that pervasive input and capital market imperfections are conducive to vertical integration, the model predicts that the motives for vertical integration are not necessarily higher in developing countries. In particular, vertical integration is more likely to arise at intermediate levels of investor protection and better contract enforcement with suppliers reduces vertical integration only if financial markets are sufficiently developed. Evidence supporting both predictions is discussed.     

Moral hazard,insurance claims,and repeated insurance contracts

Abstract The paper develops a simple model of repeated automobile insurance contracts, providing a framework for analyzing changes in aggregate insurance data in periods of changes that affect driver incentives. Experience rating of premiums gives drivers an incentive to exert effort to avoid accidents (ex ante moral hazard), and an incentive to hide accidents (ex post moral hazard). The empirical analysis, using data from the competitive insurance markets in Ontario and Alberta over a period of major legislative changes in Ontario, suggests that much of the recent decline in accidents in Ontario was due to an increased incentive to hide accidents.     

Subcontractors for tractors: Theory and evidence on flexible specialization,supplier selection,and contracting

Buyer–Seller networks are pervasive in developing economies yet remain relatively understudied. Using primary data on contracts between the largest tractor assembler in Pakistan and its suppliers we find large variations in prices and quantities across suppliers of the same product. Surprisingly, “tied” suppliers – those that choose higher levels of specific investments – receive lower and more unstable orders and lower prices. These results are explained by developing a simple model of flexible specialization under demand uncertainty. A buyer faces multiple suppliers with heterogeneous types to supply customized parts. Specific investments raise surplus within the relationship but lower the seller's flexibility to cater to the outside market. Higher quality suppliers have a greater likelihood of selling outside and so this cost is greater for them. Therefore even if a buyer typically prefers high types, some low type suppliers might be kept as marginal suppliers because of their greater willingness to invest more in buyer-specific assets. Further empirical examination shows that the more tied suppliers are indeed of lower quality.     

Financial liberalization,financial sector development and growth: Evidence from Malaysia

The objective of this paper is to examine whether financial development leads to economic growth or vice versa in the small open economy of Malaysia. Using time series data from 1960 to 2001, we conduct cointegration and causality tests to assess the finance-growth link by taking the real interest rate and financial repression into account. The empirical evidence suggests that financial liberalization, through removing the repressionist policies, has a favorable effect in stimulating financial sector development. Financial depth and economic development are positively related; but contrary to the conventional findings, our results support Robinson's view that output growth leads to higher financial depth in the long-run.     

Optimal collective contract without peer information or peer monitoring

If entrepreneurs have private information about factors influencing the outcome of an investment, individual lending is inefficient. The literature typically offers solutions based on the assumption of full peer information to solve adverse selection problems and peer monitoring to solve moral hazard problems. In contrast, I show that it is possible to construct a simple budget-balanced mechanism that implements the efficient outcome even if each borrower knows only own type and effort, and has neither privileged knowledge about others nor monitoring ability. The mechanism satisfies participation incentives for all types, and is immune to the Rothschild–Stiglitz cream skimming problem despite using transfers from better types to worse types. The presence of some local information implies that the mechanism cannot be successfully used by formal lenders. Thus a local credit institution can emerge as an optimal response to the informational environment even without peer information or monitoring. Finally, I investigate the role of monitoring in this setting and show how costly monitoring can increase the scope of the mechanism.     

Financial constraints and occupational choice in Thai villages

Financial constraints and entrepreneurship are key factors affecting economic performance in developing countries. I formulate and solve a model of occupational choice with moral hazard under three alternative financial market environments: savings only, borrowing and lending with default and moral hazard constrained insurance. I use computationally efficient techniques based on mechanism design, genetic algorithms and maximum likelihood to estimate and statistically test these models of financial constraints. Using occupational choice data from Thai villages I find evidence that the saving only regime is rejected in favor of regimes allowing for borrowing and/or insurance, especially in higher-wealth data stratifications. A direct test between the borrowing and insurance regimes reveals that neither can be rejected in favor of the other. Allowing ex-ante lotteries over wealth improves the explanatory power of the model. I also find evidence for differences in the best fitting regimes by region, wealth, and access to formal credit.     

Globalization and financial development

This paper argues that globalization is a key factor in stimulating institutional reforms in developing countries that promote financial development and economic growth. Advanced countries can help in this process by supporting the opening of their markets to goods and services from emerging-market countries. By encouraging these countries to increase their participation in global markets, advanced countries can create exactly the right incentives for developing countries to implement the reforms that will enable them to have high economic growth.     

The role of the government in financial sector development

This study examines the impact of two dimensions of the government, namely, size and quality, on two dimensions of the financial sector, size and efficiency, in a cross section of 71 economies. The study finds that increased quality of the government as measured by governance and legal origin positively influences both financial sector size and efficiency. The size of the government proxied by government expenditure and the government ownership of banks has a negative effect on financial sector efficiency, and a positive impact on financial sector size, particularly in the low income economies.     

Asymmetric Information,Auditing Commitment,and Economic Growth

We analyze in this paper the growth and welfare consequences stemming from the lack of auditing commitment in a credit market with costly state verification. By studying two endogenous growth models, one of which allows lenders to commit to costly auditing strategies, whereas the other does not, we show that the inability to commit serves as a source of informational friction that results in more stringent contractual terms, which, in turn, result in lower capital accumulation, growth, and welfare. From the policy perspective, our analysis suggests a new micro‐economic channel through which institutional failings hinder economic growth and social welfare.     

Designing credit agent incentives to prevent mission drift in pro-poor microfinance institutions

Credit agents in microfinance institutions (MFIs) must be given incentives to acquire information on potential borrowers and select them in accordance with the MFI's objectives. We show that while giving incentives has no cost in for-profit MFIs, it is costly in pro-poor MFIs: When repayment and wealth are positively correlated, a pro-poor MFI cannot obtain the selection of poor clients in the proportion it wishes with incentives based solely on repayment. It then becomes necessary to audit the share of very poor borrowers selected by an agent in order to provide the latter with adequate incentives. When audit costs are large, pro-poor MFIs may have to forego selection on wealth — and use other targeting devices such as working in impoverished geographical locations. Driven by donor concerns with ‘mission drift’ away from the poor, audits on the wealth status of clients have been introduced at the level of MFIs. We show that introducing pro-poor incentives requires extending such audits to the level of credit agents.     

Repayment performance in group lending: Evidence from Jordan

Using data from a survey of 160 urban borrowing groups of the Microfund for Women in Jordan, we investigate the effect of screening, peer monitoring, group pressure, and social ties on borrowing groups' repayment behavior as an indirect test of different theoretical models. The dependent variable used captures the intensity of default measured by the total number of days of late repayment after each due date, allowing us to use count data models with cluster standard errors. As theory predicts, our empirical analysis suggests that peer monitoring, group pressure, and social ties reduce delinquency. The paper uncovers interesting evidence about the role of social ties and religion. Most notably, in an area where religion contributes to attitudes and beliefs of individuals, we find that religiosity improves repayment performance.     

Moral hazard and Marshallian inefficiency: Evidence from Tunisia

We formalize the link between optimal cost-sharing contracts and the production technology in the presence of moral hazard by appealing to several well-known results from duality theory. Building on intuitions from the interlinkage literature, we show that optimal contractual structure is determined by the (i) substitution possibilities that exist between different observable factor inputs, as well as (ii) between these inputs and unobservable effort. We endogenize contractual choice using landlord characteristics as instruments, exploiting the fact that, in our dataset, landlords interact with several tenants and vice versa. The approach is applied to an unbalanced plot-level panel of cost-sharing contracts in a Tunisian village, using a translog representation of the restricted profit function. Contractual terms are found to be a significant determinant of input use and therefore lead to Marshallian inefficiency, while the optimality of the underlying contractual structure is rejected.     

Simple contracts, renegotiation under asymmetric information, and the hold-up problem

In this article it is demonstrated that voluntary bargaining over a collective decision under asymmetric information may well lead to ex post efficiency if the default decision is non-trivial. It is argued that the default decision may be interpreted as a ‘simple’ contract that the parties have written ex ante. This result is used in order to show that simple unconditional contracts which are renegotiated may allow the hold-up problem to be solved, even if the parties’ valuations are private information.