Altruism, Identity and Financial Return

77 Pages·2012·3.57 MB·English

EVIDENCE-BASEDRESEARCHONCHARITABLEGIVING

Altruism,
 Identity
 and
 Financial
 Return:
 An

Experiment
 on
 Microfinance
 Lending

Josie
 I
 Chen
 and
 Louis
 Putterman

Brown
 Un
  iversity

Brown
 Un
  iversity

Working
 Paper
 No.:
 133

March
 2015
Altruism, Identity and Financial Return:
An Experiment on Microfinance Lending1

This version: February 21, 2015

Josie I Chen and Louis Putterman

Abstract. We design a laboratory experiment to study willingness to lend and preference
over borrowers in one-to-one on-line micro-finance lending. We find that both financial
return and intrinsic (philanthropic) motivation affect the amount lent, with no evidence
that the former crowds out the latter. Ethnic and other forms of identity have long been
found to play a part in charitable and trust game contributions, but past studies have not
ruled out impacts of face-to-face social pressures and differential assessments of
riskiness. Our design eliminates social pressure and lets us control for two factors we
elicit from the lenders/subjects: assessments of the likelihood of repayment by borrowers,
as well as perception of their deservingness. We find that lenders are willing to trade
greater risk in order to help more needy borrowers, but at a rate sensitive to the financial
return condition. We find that lenders still show a statistically significant preference for
borrowers with whom they share gender and ethnic similarity even after controlling for
perceived riskiness, neediness, and other factors including physical attractiveness and
weight.

Keywords: microfinance, social entrepreneur, pro-social preferences, identity, gender,
ethnicity
JEL codes: C91, D64, J15, J16

1
 We thank Pedro Dal Bó, Andrew Foster, Mark Dean and seminar participants at Brown’s Theory
Workshop and at 2014 Economic Science Association International Meetings for helpful comments. This
research was supported in part by Russell Sage Foundation and by William R. Rhodes Center.

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1. Introduction
After Mohammad Yunus and the Grameen Bank were awarded the Nobel Peace
Prize in 2006, innovation in microfinance has been progressing and providers of
financial services to the poor continue to evolve. Recently, social entrepreneurs have
combined microfinance lending and on-line crowd-funding investment allowing for
increased accessibility. On average, the microfinance borrowers pay 30% interest, most
of which goes to the financial intermediaries to cover their operating expenses, rather
than to the lenders.2 It is difficult to rule out that substantial amounts of surplus cash
might be obtainable from savers in developed countries such as the United States --
where interest rates on savings and checking accounts are quite low -- if a small fraction
of the interest paid by microfinance borrowers could be shared with them. At least
hypothetically, such sharing of interest between intermediaries and individual online
lenders could benefit both the lenders and the severely capital-constrained micro-
entrepreneurs in less-developed countries. However, most intermediaries steer clear of
offering interest for fear of destroying the philanthropic appeal of microfinance lending.
What we see now is that the scale of existing rich country to poor country lending via
microfinance intermediaries remains small.3 4

2 See Rosenberg, Richard, et al. "Microcredit interest rates and their determinants: 2004–2011."
Microfinance 3.0. Springer Berlin Heidelberg, 2013. 69-104.
3 Kiva.org is perhaps the largest microfinance websites in the world, with about $0.6 billion lent since its
founding in 2005. Lenders at kiva.org recoup repaid principal but do not receive interest. There are many
microfinance platforms differing in some substantial ways, including the amount of information given
about the borrowers, whether lenders receive the principal and whether lenders earn interest. For example,
lenders at worldvision.org select the initial loan recipient, but when the loan is repaid, World Vision keeps
the cash and recycles it over and over again to the other entrepreneurs in the same country- similar to the
wokai.org offering in China. Lenders at microplace.org select different "loan groups" with specific interest,
but without knowing which specific borrowers made up these loan groups. When the loan group repays the
loan, the lenders receive the loan amount and also the interest. Lenders at zidisha.org, select the loan
recipient and receive the principal and interest when a loan is due.
4 According to the World Bank, there are approximately 2.5 billion people who do not have bank accounts
and whose business could benefit from microcredit. However, data reported at the 2014 Microcredit

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Motivated by the idea that microfinance lending might be falling short of its
potential for scaling up, we study how intrinsic and extrinsic incentives influence the
willingness of rich country residents to lend to small entrepreneurs in developing
countries.5 A few studies have shown that existing microfinance lenders were motivated
mostly by intrinsic incentives (Choo et al., 2014; Liu et al., 2012). Specifically, Chen et
al. (2014) has explored how intrinsic incentives such as team competition could boost
peoples’ willingness to lend. A large amount of research into donation, volunteering,
and public goods shows that increasing extrinsic incentive may decrease peoples’
willingess to “do good things” (i.e. things with a positive externality), because the
intrinsic incentives are diminished by the existence or strength of extrinsic incentives.
The evidence of this “crowd-out effect” is shown in the empirical data, natural field
experiments, and lab experiments (Ariely, Bracha and Meier, 2009; Deci, 1971; Frey,
1994; Frey and Oberholzer-Gee, 1997; Gneezy, Meier and Rey-Biel, 2011; Greezy and
Rustichini, 2000; surveys in Lane, 1991; surveys in Ryan and Deci, 1985; and Titmuss,
1971).
These studies, however, vary across just one of the dimensions, either intrinsic or
extrinsic. It is unknown how these two incentives interact. For example, given an
extrinsic incentive, does addition of an intrinsic incentive boost peoples’ willingness to
do good things? If so, is the marginal effect of the intrinsic incentive increasing or
decreasing in the strength of the extrinsic one? To explore how the dimensions of
financial inducement and pro-social motives interact in motivating micro-finance

Summit in Mérida, Mexico shows that only 116 million of the world’s poorest are reached by microfinance
as of December 30, 2012.
5 We note, as an aside, that the extent of the benefits and possible harms caused by micro-finance are
debated (see, for example, Morduch, 2013). That discussion must remain beyond the scope of our paper.

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lending, we vary these two dimensions across treatments. In the first stage of our
experiment, we ask subjects to choose a loan amount. We vary the first dimension of
whether or not borrowers have a financial stake in their loan’s repayment and how
profitable the lending could be. On the other hand, to shape the perception of neediness
and the intrinsic incentives, we vary the second dimension of whether or not the initial
description of the lending opportunity emphasizes its potential philanthropic appeal.
We find that subjects are motivated to lend to microfinance borrowers both by
financial inducement and by pro-social motives. While financial incentives matter, their
importance decreases when lenders know that borrowers are micro-entrepreneurs from
poor developing countries. While subjects who are informed that borrowers are micro-
entrepreneurs lend more than subjects who are not informed, the difference is significant
only when there is no financial stake for subjects.
We explore the effect of financial returns not only upon lenders’ willingness to
lend but also on their preference over borrowers. Research has shown that given
different financial return conditions, lenders’ choices of borrowers are different:
conditional on no possibility of repayment, which makes the lending decision more like
a donation, research suggests that donors choose borrowers from a more needy, socially
preferred, or morally preferred group in order to maximize the social impact (Eckel and
Grossman, 1996; Fong and Oberholzer-Gee, 2011). Conditional on a given positive
interest rate, standard theory suggests that lenders will choose a borrower perceived as
having lower default risk (henceforth, “a less risky borrower”) in order to maximize the
expected payoff. It is not currently known whether lenders still prefer less risky

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borrowers in the former case and whether lenders still prefer more needy borrowers in
the latter case.
After eliciting subjects’ willingness to lend, influenced by rate of return and
philanthropic or neutral description of lending opportunity, we ask them to report their
assessments of the likelihood of repayment by each of twelve specific borrowers, as well
as those borrowers’ individual levels of neediness. We then have subjects rank order
their three most preferred loan recipients. We find that there is a trade-off between
borrowers’ neediness and riskiness, at a rate sensitive to the financial return condition.
When there is a financial stake, lenders’ preferred ranking of borrowers responds
equally positively to a 1 standard deviation increase in perceived neediness or a 2
standard deviation decrease in perceived riskiness level. When there is no financial
stake, the impact on the ranking of a 1 standard deviation increase in perceived
neediness level is roughly equal to that of a 1 standard deviation decrease in perceived
riskiness level.
Our second stage structure also allows us to assess whether gender or ethnic ties
influence microfinance lending. Ethnic and other forms of identity have long been
thought to play an important role in private and non-profit contributions. Recent research
has documented the importance of such factors in charitable and microfinance donation
as well as in dictator game and trust game contributions (Fershtman and Gneezy, 2001;
Fong and Luttmer; 2009; Galak, Small, and Stephen, 2013; Glaeser et. al, 2000;
Rotemberg, 2012). A reason contributors may have shown a preference towards those
sharing the same ethnic or racial identity could be that the ability of givers and recipients
to view one another in the same room or track each other by name may have engendered

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a sense of social pressure to cooperate or donate more, where a co-ethnic was a potential
borrower. In addition, the reason such identity effects apply to microfinance lending and
trust games could be that contributors may feel that people with whom they share an
identity are lower-risk borrowers, who will generate higher expected returns. As far as we
know, no study has ruled out both mechanisms, nor have studies of ethnic and gender
preference in microfinance had available to them the detailed data on lender
characteristics we collect from our subjects. Our online setting eliminates the social
pressure effect, since the prospective recipients (borrowers) cannot look back at the
subjects (prospective donors). Our experiment also lets us identify whether decrease in
perceived risk is the main factor at work. First, in one condition but not the other, none of
the repayment from borrowers is returned to lenders. By comparing lenders’ choices of
borrowers in these two conditions, we can see whether the lenders show a stronger
preference for certain borrowers when their own money is as risk. Second, our
experiment lets us control for assessments of the likelihood of repayment by borrowers,
as well as perception of their deservingness, both of which we elicit from the
lenders/subjects.
We find evidence of an identity effect: lenders have a bias towards lending to
borrowers of matching ethnicity6 and to borrowers of the same gender. Moreover,
controlling for perceived riskiness and neediness levels does not significantly reduce the
identity effects, nor does the presence of a financial stake A rough calculation suggests
that when lenders have a financial stake (or when lenders have no financial stake), they
are willing to sacrifice 0.36 (0.29) standard deviations of perceived riskiness in order to

6 As further defined, below.

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lend to a borrower of a matching ethnicity, and they are willing to sacrifice 0.32 (0.55)
standard deviations of perceived riskiness to lend to a borrower of the same gender.
While comparing the choice of borrowers and the loan amount in different
microfinance platforms might be a potentially interesting way to address these issues, we
choose instead to conduct a lab experiment in which subjects make choices at a website
of our own construction. Our website shares some features of a microfinance platform but
has an additional degree of experimenter control and information capture. Our reasons for
conducting an experiment in this way include: (i) it is difficult, if not impossible, to
identify demographic information (including ethnicity and gender), risk-bearing level and
time preference of lenders from the data of existing platforms; (ii) we can structure the
available borrower set in a manner that is infeasible on the existing websites; and (iii) on
the existing websites, researchers have only collected data about those people who visit
and make a loan, but have not collected data about those who may not have heard of or
been motivated to visit the site, or those who visit the sites but do not make a loan. The
motives of inexperienced agents and experienced agents may be very different. For
example, in charity giving, research has found significant differences between cold list
donors and warm list donors (Karlan, List and Shafir, 2011). Our aim is not so much to
learn about the motives of existing lenders to microfinance, but rather to learn how
varying the factors we focus on might affect lending by a broader cross-section of
individuals (including ones who might be drawn to interest-bearing microfinance
products yet to be designed).
Our results are of interest not only in terms of possible ways of attracting more
lenders and funds into microfinance but also insofar as they contribute to the literature on

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social identity. In the former respect, our results suggest that offering interest to lenders
will not only attract more lenders to make a loan, but also boost the average loan amount.
In the latter respect, we provide evidence of positive effect of ethnic/gender ties in a
setting free of mutual visibility, and when controlling for other borrower qualities
including physical attractiveness and weight. These results suggest that riskiness and
neediness, while important, do not explain the tendency for individuals to support
individuals with whom they share certain common features. Thus, regardless of the
financial return condition, matching lenders’ and borrowers’ ethnicities/genders can be an
effective tactic. However, the probability of a borrower receiving a loan given his/her
subjective qualities, such as their perceived neediness level and perceived riskiness level,
might be affected by the repayment condition.
Before concluding this summary, we think it important to mention an important
caveat to bear in mind when interpreting our results regarding crowding out. While our
participants’ philanthropic motivation is never entirely annulled by offering a financial
return, the concern of microfinance website designers that such private gains might turn
off lenders may have greater applicability when lenders perceive their gain to come at the
expense of the poor borrower; our design reduces this perception given that most of the
return can be attributed to the experimenter. We consider the impact of this concern for
our study’s external validity in the concluding section of the paper.
The rest of this paper proceeds as follows: Section 2 describes our experimental
design. Section 3 reports results, and Section 4 is our conclusion.

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2. Methodology
2.1 Experiment procedure
The experiment consists of a set of pre-stage games and a core two-stage game. In
the pre-stage games, we elicit subjects’ time preference and risk preference by two
standard choice list tasks.7 Subjects are informed that with probability 0.1 one of the pre-
stage decisions will be randomly chosen for payoff realization, and that if this occurs,
they will learn the payment result at the end of the experiment, which prevents
contamination of ensuing choices by a wealth effect. The risk aversion task confronts
subjects with 10 rows, in each of which they must choose between an uncertain option
and a certain one. The uncertain option is a lottery consisting of a 90% chance of getting
$30 and a 10% chance of getting $0. The certain option is initially $16, and is increased
by $2 in each subsequent row, reaching a maximum of $34. The great majority of
subjects prefer the uncertain option initially and switch to a certain option at or before the
latter’s maximum. Our measure of risk aversion is directly decreasing in the level of
certain payoff at which a subject switches from the uncertain to certain option. In the time
preference task, subjects are given 9 rows and are asked to choose between two certain
options with different timing. One option is always receiving $10 at the end of the
experiment session. The other option is an amount to be received in 18 months, which is
$10 in the first row and rises by $5 in each subsequent row to a maximum of $50. Our
measure of present time preference is directly decreasing in the level of the first delayed
payoff the subject prefers to receiving $10 the same day.

7 The instruments used are chosen and revised from Sutter, Kocher, Glätzle-Rützler, and Trautmann (2013).
This method has been widely used in experiments, see also Holt and Laury (2002).

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