Group Lending and the Role of the Group Leader: Theory and Evidence from Eritrea

This paper investigates the strategic monitoring behaviour within a group lending setting. The authors develop a theoretical model that examines why someone would volunteer to become the group leader, given the fact that the activities of the group leader are costly, and assuming that he/she is not paid for these activities. The paper shows that:

• Monitoring efforts of group members differ from each other in equilibrium, as a result of the asymmetry between these members in terms of the future profits they generate with their project;
• The entrepreneur with the project that generates the highest future profits also puts in the highest monitoring effort;
• Monitoring efforts differ between group members due to free-riding;
• One member reduces her level of monitoring if the other increases her monitoring effort;
• This effect was also at play when the authors introduced a group leader in the model;
• The individual who becomes the group leader supplies more monitoring effort than in the benchmark case, because of the reduced per unit monitoring costs related to becoming the leader.

The paper empirically tests the model using data from a survey of microfinance in Eritrea, and shows that the group leader attaches more weight to future periods than non-leaders in group lending, and that this may explain why a large part of total monitoring is put in by the leader.