Financing Experimentation Articles uri icon

authors

  • DRUGOV, MIKHAIL
  • MACCHIAVELLO, ROCCO

publication date

  • February 2014

start page

  • 315

end page

  • 349

issue

  • 1

volume

  • 6

International Standard Serial Number (ISSN)

  • 1945-7669

Electronic International Standard Serial Number (EISSN)

  • 1945-7685

abstract

  • Entrepreneurs must experiment to learn how good they are at a new activity. What happens when the experimentation is financed by a lender? Under common scenarios, i.e., when there is the opportunity to learn by "starting small" or when "noncompete" clauses cannot be enforced ex post, we show that financing experimentation can become harder precisely when it is more profitable, i.e., for lower values of the known arm and for more optimistic priors. Endogenous collateral requirements (like those frequently observed in microcredit schemes) are shown to be part of the optimal contract.

keywords

  • asymmetric information; moral hazard; lending relationships; private information; credit markets; contracts; microfinance; competition; equilibria; innovation