Group lending and the role of the group leader

This paper investigates strategic monitoring behavior within group lending. We show that monitoring efforts of group members differ in equilibrium due to the asymmetry between members in terms of future profits. In particular, we show that the entrepreneur with 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 into the model. The individual who becomes the group leader supplies more monitoring effort than in the benchmark case. 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 nonleaders in the group, which may explain why a large part of total monitoring is done by the leader.