Psychological and social motivations in microfinance contracts: theory and evidence

Social Macroeconomics working paper
Sanjit Dhami
Junaid Arshad
Ali al-Nowaihi

Microfinance contracts have enormous economic and welfare significance. In this paper, the authors study, theoretically and empirically, the problem of effort choice under individual liability (IL) and joint liability (JL) contracts when loan repayments are made either privately or publicly in front of one’s social group. The authors' theoretical model identifies guilt from letting down the expectations of partners in a JL contract, and shame from falling short of normatively inadequate effort under public repayment of loans, as the main psychological drivers of effort choice. Evidence from their lab-in-the-field experiment in Pakistan reveals large treatment effects and confirms the central roles of guilt and shame.

Under private repayment, a JL contract increases effort by almost 100% relative to an IL contract. Under public repayment, effort levels are comparable under IL and JL contracts, which is consistent with recent empirical results. This indicates that shame-aversion plays a more important role as compared to guilt-aversion. Under IL, repayment in public relative to private repayment increases effort by 60%, confirming the authors' shame-aversion hypothesis. Under JL, a comparison of private and public repayment shows that shame trumps guilt in explaining effort choices of borrowers.