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American Economic Journal: Microeconomics: Vol. 6 No. 1 (February 2014)

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Financing Experimentation

Article Citation

Drugov, Mikhail, and Rocco Macchiavello. 2014. "Financing Experimentation." American Economic Journal: Microeconomics, 6(1): 315-49.

DOI: 10.1257/mic.6.1.315

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.

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Authors

Drugov, Mikhail (U Carlos III de Madrid)
Macchiavello, Rocco (U Warwick)

JEL Classifications

D82: Asymmetric and Private Information; Mechanism Design
G21: Banks; Depository Institutions; Micro Finance Institutions; Mortgages
G32: Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
L25: Firm Performance: Size, Diversification, and Scope
L26: Entrepreneurship

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