Term Structure of Debt and Entrepreneurship : Experimental Evidence from Microfinance

Financiers across the world structure debt contracts to limit the risk of entrepreneurial lending. But debt structures that reduce risk may inhibit enterprise growth, especially among the poor. Using a field experiment we quantify the shortand long-run tradeoffs associated with the classic microfinance debt contract. We contrast the classic contract which requires that repayment begins immediately after loan disbursement with a contract that provides a two-month grace period before repayment begins. The shift to a grace period contract increased short-run business investments and long-run profits, implying average return to capital of over 8% per month. However, we also observe a significant increase in the variance of profits and a tripling of default rates. In this manner, early initiation of repayment reduces risk to financiers but also reduces the potential impact of microfinance on microenterprise growth and household poverty. ∗The authors are from Harvard University (Field and Pande), Princeton University (Papp) and MIT (Rigol). We thank Emmerich Davies, Sitaram Mukherjee and Anup Roy for superb field work, the Village Financial Services (formerly known as Village Welfare Society) and Center for MicroFinance for hosting this study and Theresa Chen, Annie Duflo, Nachiket Mor and Justin Oliver for enabling this work. We thank ICICI Foundation, Exxon-Mobil and IGC for funding. We also thank Yeunbee Jeanette Park for exceptional research assistance.