Inside the production function, the effect of financial contracts on growing firms' technology use: Evidence from a field experiment in Uganda

Madestam, Andreas and Gulesci, Selim and Stryjan, Miri and Loiacono, Francesco (2018). Inside the production function, the effect of financial contracts on growing firms' technology use: Evidence from a field experiment in Uganda. [Data Collection]. Colchester, Essex: UK Data Archive. 10.5255/UKDA-SN-853034

We examine how key aspects of the most common form of financing-debt-may inhibit young firms' expansion. Starting a business entails learning and risk taking, implying that project returns to investment can start low but increase over time (in other words, be "back-loaded") or be uncertain. Also, indivisible start-up costs often require large investments. Meanwhile, standard debt contracts available for micro-entrepreneurs from the formal or semi-formal financial sectors of many developing countries (such as microfinance) stipulate a constant repayment stream and caps on the initial loan size. The interaction of such features of the loan contract and the firm's production technology, may distort investment toward inputs that involve less learning, less uncertainty, and smaller projects; hampering firm growth. To shed light on the extent to which these theoretical mechanisms limit the effectiveness of microloans, we plan to collaborate with BRAC Uganda's Small Enterprise Lending Program to study the effect of the credit terms on starting firms' input use, profits, and repayment performance. As such, our project contributes to the DFID-ESRC Growth Research Programme's focus on Finance and Growth in Low Income Countries. Small and medium-sized firms are the engines of the Ugandan economy, comprising over 90 % of the private sector and BRAC Uganda has been lending to such firms since 2008 through its Small Enterprise Lending Programme. The loans range from 2.5 million to 13 million Ugandan Shillings (630 to 3,300 GBP) and are repaid monthly with a maturity of 12 months at an annual interest rate of 25%. The research project will select, among firms applying for BRAC loans from mid-2014, a representative sample of 1600 firms to be part of a randomized experiment. In order to investigate whether standard contractual terms in microloans from formal or semi-formal sources are restrictive for firms that face indivisible costs and/or are characterized by backloaded or uncertain project returns, we will (randomly) implement the following interventions for different groups of firms by: (i) changing the repayment frequency to distinguish the effects of uncertain project returns from those of backloaded returns; (ii) offering subsidies to ease the purchase of indivisible goods; and by (iii) offering consultancy services to shorten the learning process about the use of certain inputs to alleviate problems of backloadedness. We will survey these firms at baseline and upon completion of the loan-cycle (1-year after) to measure the change in firms' production and profits. In addition, we will use detailed and high frequency firm data to trace how the financial structure, a firm's learning curve, or the ease with which an indivisible good is acquired affects the use of machines and labor and how this in turn impacts profits and repayment performance. The project will provide unique evidence on the constraints caused by the interaction of financial structure and technology use that complements the recent emphasis on access to finance.

Data description (abstract)

The data files contain data from interviews with Ugandan small business owners that are part of a randomized experiment evaluating the effect of loan contract structure on business performance. The aim of the project is to examine how alterations of the standard microfinance contract structure affect borrowing business owners' use of the loan and their business performance, measured in a variety of ways. The experiment was carried out in collaboration with the NGO BRAC Uganda and their Small Enterprise Lending (SEP) program that targets existing business owners. Beginning in 2014, we collaborated with the BRAC SEP program in 76 local branch offices in Central, Western, and Eastern Uganda. Every firm in the sample is a BRAC borrower in the catchment area of one of these branch offices, belonging to one of the business sectors we had pre-selected, that has been approved by BRAC credit officers and is eligible for a loan. Upon being eligible, firms are asked to participate in a Baseline survey. Once the survey is conducted with firms that gave their consent to participate, they are randomized into one of the treatment (and control) arms. Data was collected from clients in several waves: before assignment to a treatment or control group (Baseline), during the loan cycle (Diaries), and after completion of the loan (end-line). Each of these types of data are described in more detail in the metadata files User Guide and Readme.

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