Bank Structure and Entrepreneurial Finance:

Experimental Evidence from Small-Business Loans in India

Martin Kanz Harvard University

This version: November 25, 2010

Abstract This paper analyzes the eect of organizational structure on bank lending, using a framed eld experiment in the Indian market for small enterprise loans. The experiment varies the structure of decision-making among participating loan ocers by assigning authority over lending decisions to senior risk-managers or the banks front-line loan ocers. Within this setting, I show that supervision adds substantial value, reducing defaults by 15 percent and increasing loan-level prot by 12 percent of the median loan size. This, however, comes at a cost: greater hierarchical distance between the initial screener and the originator of a loan discourages both the collection and use of qualitative information. Incentive contracts using performance pay to improve the alignment of interests at dierent tiers of the banks decision-making process can moderate these adverse eects. When loan ocers and managers face identical performance pay, screening eort is unaected, information communicated to supervisors is a more informative predictor of default and loan-level prot increases by 24 percent of the median loan size. These ndings shed new light on the nature and importance of agency conict within the bank, and suggest that performance pay can play an important role in mitigating information and agency problems in the provision of entrepreneurial nance in an emerging market.

Keywords: Banking, Entrepreneurship, Organizations, Development, Experiments

Department of Economics, Littauer Center, 1805 Cambridge Street, Cambridge, MA, 02138 USA. Phone: +1 (617) 230 8974. E-mail kanz@fas.harvard.edu. l thank Alberto Alesina, Shawn Cole, Andrei Shleifer and Jeremy Stein for their guidance and support. I would also like to thank Ruchir Agarwal, Philippe Aghion, Oliver Hart, Rajkamal Iyer, Leora Klapper, Michael Kremer, Sendhil Mullainathan, Rohini Pande, Benjamin Schoefer, Raphael Schoenle, Antoinette Schoar, Vikrant Vig and seminar participants at Harvard and NEUDC 2010 for helpful comments and suggestions. Financial support from the Paul Warburg Funds is gratefully acknowledged. Atul Agrawal and Samantha Bastian provided excellent research assistance. All remaining errors are my own.
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Introduction

Theories of credit rationing have traditionally focused on information asymmetries between borrowers and lenders (Stiglitz and Weiss 1981).1 More recent evidence suggests that agency conict within the bank can play an important additional role in limiting the provision of credit to informationally opaque borrowers, such as small entrepreneurial rms (Liberti and Mian 2009, Hertzberg et al. 2010). Such internal diseconomies may have far-reaching implications through their impact on the supply of credit. However, empirical evidence remains scarce, due to the challenge of observing the internal dynamics of a banks decision-making processes, and measuring their impact on risk-assessment and lending. This paper uses a framed eld experiment in the Indian market for small enterprise loans to evaluate the eect of organizational design on incentives and decisions within the bank. Using a novel experimental approach, I look directly into the black box of the underwriting process of small enterprise loans in an emerging market and demonstrate that the structure of decision-making within the bank has substantial eects on the collection, transmission and use of qualitative information.2 This aects credit decisions and constrains the protability of lending. However, results from the experiment also suggest that simple incentive contracts using performance pay to align the interests of the initial screener and the originator of a loan are eective in attenuating moral hazard, facilitating the ow of information, and improving the protability of the banks lending. In the experiment, loan ocers from the sta of ve Indian commercial banks evaluated credit applications from a database of actual loans. The experiment randomized loan ocers into three treatments, which varied two features of the decision-making process: the assignment of formal authority over the lending decision, and the alignment of monetary incentives between risk-managers and subordinate loan ocers.3 Lending decisions in the experiment were based on a sample of unsecured small ticket loans, a leading example of a character loan for which the banks ability to incorporate qualitative information into its decisions is especially important (Stein 2002, Berger et al. 2005). Since the loans evaluated in the experiment had been previously made, their performance was observed and
1 See also Jaee and Russell (1976) and Leland and Pyle (1977). The literature on credit rationing in developing countries is reviewed in Ghosh et al. (2000) and Karlan and Morduch (2009). Banerjee and Duo (2008) show evidence of credit constraints among Indian SMEs, suggesting high returns to capital in SME lending even in a comparatively developed emerging nancial market. See Djankov et al. (2007) and Beck et al. (2009) for evidence on private credit and nancial access, Black and Strahan (2002), Cetorelli and Strahan (2006) and Kerr and Nanda (2009) on nance and entrepreneurship and King and Levine (1993) and Levine (2005) on nance and aggregate growth. 2 The denition of qualitative or soft information follows (Petersen 2004) and denes qualitative information as information that has no direct quantitative equivalent and is either prohibitively costly or impossible to verify. 3 The denition of formal authority used throughout the paper follows Aghion and Tirole (1997), who dene formal authority as the right, arising from a formal or informal contract, to decide over pre-specied matters. This idea also relates to the work of Grossman and Hart (1986) and Hart and Moore (1990), who focus on authority conferred by control rights over an asset. The classication of the experiment follows Harrison and List (2004).

loan ocers could be incentivized based on their decisions and the outcome of loans they approved.4 The idea that a banks organizational structure is integral to the nature and eciency of its lending nds indirect support in a large body of research on bank form and function. Using evidence from the United States (Petersen and Rajan 1995, Berger and Udell 2002) and emerging markets as diverse as Argentina (Berger et al. 2001) and Pakistan (Mian 2006), this literature shows that decentralized banks tend to be more successful providers of nancing to small, informationally opaque rms.5 The experimental approach used in this paper has three important features that allow me to shed new light on the mechanisms underlying this general nding. First, by providing an unusually close look into the underwriting process of small enterprise loans in an emerging market, the experiment makes both eort and the ow of information inside the bank observable. Second, the experiment induces exogenous variation in the structure of decision-making and the strength of managerial incentives. This provides an ideal counterfactual for assessing the extent to which the structure of performance pay can mitigate agency problems inside the bank (see Cole, Kanz, and Klapper 2010 for evidence on performance incentives and lending). Finally, I observe the outcome of each evaluated loan, which allows for the measurement and comparison of protability under alternative organizational regimes. The results of the experiment demonstrate that the organizational design of a banks lending aects performance through two channels. On one hand, the shift towards a more hierarchical lending model increases the probability that bad news about a borrowers creditworthiness will be detected.6 Within the context of the lending environment studied here, I demonstrate that this eect adds substantial value from the banks perspective, increasing prot per loan by 12% of the median loan size. On the other hand, as argued by Aghion and Tirole (1997) and Stein (2002), an increase in hierarchical distance between the screener and the originator of a loan introduces a scope for agency conict inside the bank. This can aect performance by blunting incentives for the collection, transmission, and use of relevant borrower information. I nd compelling evidence for this incentive view of delegation, but also show that these eects are mitigated by performance pay designed to more closely align incentives within the bank; when loan ocers and managers in the experiment faced identical performance pay, eort remained unchanged, information transmitted to managers was a more informative predictor of default and prot per loan was 24% higher than under delegated decision-making.
4 In order to replicate the actual lending environment faced by loan ocers in a commercial bank, the data underlying the experiment also included a subsample of loans that had been declined by the lender. Participating loan ocers had no previous indication about the quality of loans. As in the real lending environment, loan ocers could be incentivized only on outcomes observable to the bank. On average, participants earned Rs 15,000 over the course of their participation in the experiment, which corresponds to approximately 60% of the median participants monthly wage. 5 Mian (2006), shows, that recovery rates for delinquent loans in Pakistan are 28% higher among more decentralized domestic banks compared to their foreign competitors. Using data from banking mergers in the United States, Sapienza (2002) shows that when banks merge, the small-business lending of the combined organization declines. 6 This is argument abstracts from the eect of organizational structure of incentives inside the rm and is akin to the tradeo between errors of commission and errors of omission illustrated in the work of Sah and Stiglitz (1986).

To guide the empirical analysis, I model the source of agency conict inside the bank as an incomplete contracting problem between the banks information-collecting loan ocers and its senior managers. In the model, as in the experiment, formal authority over the lending decision is exogenously assigned to a senior manager or delegated to a subordinate loan ocer, who may disagree about the optimal use of the banks capital. The model illustrates how the structure of decision-making aects incentives inside the bank and generates three testable predictions. First, supervision limits a reporting loan ocers ability to aect the banks nal lending decision, thereby reducing incentives for the collection of information. Second, the potential for disagreement between managers and loan ocers also introduces frictions in the transmission of relevant borrower information. Third, both of these eects are mitigated by incentive contracts that improve the alignment of interests at the dierent levels of the banks corporate hierarchy. The model thus highlights the tradeo between the benet of additional screening (a higher probability that bad news about a borrowers creditworthiness are detected) and the disincentive eects of supervision, which arise from an increase in hierarchical distance between the initial screener and the originator of a loan. In the experiment, I test these predictions by means of three treatment conditions. These treatments reect salient features of lending models used in the Indian market for small enterprise loans, and induce exogenous variation in the structure of the decision-making process. In the Baseline Treatment, lending decisions were delegated to the banks front-line employees so that loan ocers had full autonomy over the lending decision and could not be overruled by the intervention of a senior manager. In the second treatment, the basic Supervisor Treatment, loan ocers faced a senior manager who could review and decline any loan suggested for approval. Managers in this treatment were more strictly incentivized on the quality of their lending portfolio than their subordinates, and faced a penalty for approving loans that subsequently became delinquent. The third treatment, the Aligned Supervisor Treatment, is designed to distinguish the eect of supervision from the eect of divergent incentives between employees at dierent levels of the banks corporate hierarchy, and matched the informationcollecting loan ocer with a supervisor who faced identical performance incentives. By analyzing loan ocers eort, subjective assessment of credit risk and lending decisions under each treatment, I identify the nature of agency conict inside the bank and quantify its eect on real outcomes, such as the quality of lending decisions and loan-level prot. Within this setting I establish three main ndings on the importance, the nature, and the impact of agency problems inside the bank. First, in line with incentive theories of delegation (Cr emer 1995, Aghion and Tirole 1997, Stein 2002) I show that the shift towards a more hierarchical lending model blunts incentives for the collection of information. Loan ocers who were matched with a supervisor 3

spent 7% less time reviewing each proposed loan. This eect disappears when monetary incentives at the two levels of the banks corporate hierarchy are more closely aligned. When information-collecting loan ocers and loan-approving managers face identical monetary incentives, screening eort increases by up to 9%, relative to the Supervisor Treatment and is statistically indistinguishable from eort under the Baseline Treatment, which delegated lending decisions to the banks loan ocers.7 Second, I use internal credit ratings to measure how the structure of decision making aects incentives for the transmission and use of qualitative information. I nd that the misalignment of monetary incentives between reporting loan ocers and loan approving managers leads to substantial frictions in the transmission of qualitative information. While reported credit ratings are an informative predictor of default even when nal lending decisions are not made by the information producing loan ocer (a one standard deviation improvement in a loans overall risk rating is associated with a 10% decrease in the probability of default), risk ratings become a signicantly more informative predictor of default as monetary incentives between the two tiers of the banks corporate hierarchy are more closely aligned. Third, the eect of hierarchical distance on the banks ability to incorporate qualitative information into nal lending decisions is more nuanced: While managers decisions do not respond to risk ratings passed on by reporting loan ocers under basic supervision, several sub-components of the qualitative risk rating including business and management risk retain their ability to aect nal lending decisions when the gap in performance pay between loan ocers and risk managers is reduced. What is the eect of these observed distortions on outcomes and performance? Having established that the structure of decision making inside the bank aects incentives to acquire, share and use information, I demonstrate that these distortions aect the quality of lending decisions and loan-level prot. The results show that in the setting of the experiment, the benet of supervision outweighs the costs of agency conict induced by greater hierarchical distance. Prots per loan increase by $266 (12% of the median loan size) relative to the Baseline Treatment when lending decisions are made in a hierarchy. However, the results also demonstrate that disincentives for the collection and use of qualitative information constrain the protability of the banks lending. I show that when incentives at the two levels of the banks corporate hierarchy are aligned, subordinate loan ocers are 12% less likely to recommend non-performing loans and loan level prot is $516 (24% of the median loan size) higher than when decisions are delegated to the banks front-line loan ocers. These results have important implications for the design of lending models in emerging markets,
is worth noting that the observed relationship between incentive alignment and eort also speaks against an explanation based on moral hazard in teams (Alchian and Demsetz (1972), Holmstrom (1982), see also Bandiera, Barankay, and Rasul (2010) for related empirical evidence from a eld experiment). If loan ocers were tempted to free-ride, we would expect eort to decrease, when supervisors are incentivized to exert greater screening eort.
7 It

where the provision of entrepreneurial nance promises high returns to capital, but small businesses often lack collateralizable wealth and a documented history of formal sector borrowing. In 2009, less than 10% of small businesses in India were covered by a credit bureau report (World Bank, 2010). This implies high information costs, which are often cited to explain why commercial lending in emerging markets tends to be heavily skewed in favor of large corporate loans for which standard hard information is more reliable. My results demonstrate that in this environment, the organizational design of a banks lending plays a crucial role in shaping incentives for the collection and use of qualitative information and determining the banks ability to screen borrowers and provide credit. The results presented in this paper complement the existing empirical literature on agency problems in banks (Liberti 2003, Liberti and Mian 2009, Agarwal and Wang 2009, Hertzberg et al. 2010) and incentives within rm more broadly (Lazear 2000, Bandiera, Barankay, and Rasul 2007, 2009, Paarsch and Shearer 2009, Bandiera, Barankay, and Rasul 2010). By suggesting a causal mechanism that can rationalize the observation that decentralized banks are better providers of nance to small entrepreneurial rms (Petersen and Rajan 1994, Boot 2000, Berger and Udell 2002, Mian 2006), this paper also relates to the literature on bank function and organizational design (Berger et al. 2001, Berger and Udell 2002, Petersen and Rajan 2002, Berger et al. 2005, Mian 2006).8 On the theoretical side, this paper relates most directly to the literature on incentive theories of delegation (Aghion and Tirole 1997, Stein 2002). In contrast to traditional theories of monitoring, the models in this literature argue that supervision reduces the agents ability to aect the decisions of the rm (the lending decision in the context studied here) and therefore blunts incentives at the lower levels of the corporate hierarchy. Thus, within this framework, an important rationale for delegating authority in a bank is to strengthen incentives for the acquisition and use of qualitative information. The experiment allows for a direct test of these propositions. The remainder of the paper proceeds as follows. Section two provides context about the Indian market for small enterprise loans in which the experiment is set, and describes the nancial product on which lending decision in the experiment were based. In section three, I develop a stylized model of the screening process to motivate the subsequent empirical analysis. Section four provides an outline of the experimental design and method of randomization. Section ve provides descriptive statistics on the participant pool and sample of loans used in the experiment. Section six presents the empirical results and section seven concludes.
8 In terms of methodology, this paper also relates to recent work by Gine, Jakiela, Karlan, and Morduch (2010) and Fischer (2010) who use framed eld experiments to study risk-taking and credit decisions in a micronance context.

Environment: Small Enterprise Lending in India

The experiment is set in the market for unsecured small enterprise loans in India. With an estimated 30 million micro-enterprises and SMEs, accounting for 22% of GDP and 12% of net bank credit, Indias market for entrepreneurial nance ranks among the largest in the world.9 However, nancing constraints remain pervasive and represent an important limiting factor to the growth and entry of small businesses (Banerjee et al. 2003, Banerjee and Duo 2008). Despite a long history of directed lending programs requiring commercial banks to extend up to 40% of total credit to agriculture and small-scale industry, fewer than 15% of registered small enterprises in India currently have access to institutional credit (Government of India, 2010). The analysis in this paper studies lending decisions based on a database of previously evaluated loans, compiled in collaboration with a leading commercial lender (hereafter the Lender). The loans are described in greater detail in section 5.2 below. The Lender is one of Indias largest providers of mass-market nance and competes in the market for small enterprise loans through a network of more than 700 local branches across the country. The Lenders small enterprise product range caters to rms with limited access to the formal credit market due to collateral constraints, or with turnover below the amount required to qualify for a working capital loan or a revolving line of credit. These loans are given in the name of an individual rather than the corporate entity, making them a more accessible source of nancing for start-ups and small businesses with limited access to institutional credit.10 To ensure consistency in the type of loans used in the experiment, I focus on unsecured small enterprise loans to self-employed individuals with a ticket size between Rs 100,000 (approximately $2,000) and Rs 500,000 (approximately $11,000). The median loan size in my sample is Rs 150,000 ($3,325), and corresponds to 31% of the average clients annual net income. Loans in this market are generally xed-installment term loans with a maturity of 12 to 48 months and interest rates between 20 and 35% annual percentage rate (APR). Typical uses of this type of loan include the nancing of overhead, small investments and the repayment of higher-interest-rate loans from the informal sector. Prospective borrowers are sourced and screened by the Lenders local branches, which collect all
9 The classication follows the Reserve Bank of India which denes medium enterprises as rms with less than Rs 10 (approximately $200,000) million investment in plants and machinery and small industries as rms with xed investment in plant and machinery of below Rs 5 million (approximately $100,000). 10 The larger ticket size and limited observability of cash-ows of the loans considered here generally rules out the use of joint-liability contracts that have facilitated the extension of micronance to marginal borrowers, see also de Aghion and Morduch 2005. Broadly comparable products are oered by several commercial lenders in the Indian market. Because India strictly regulates branch banking (see also Burgess and Pande 2005), many private lenders operate as Non-Banking Financial Companies (NBFCs). NBFCs are not allowed to take demand deposits and face limitations in the type of loans they can provide. NBFC can, for instance, give small business term loans to self-employed individuals but are not allowed to provide commercial loans to corporate entities.

required documentation, including a clients bank statements and tax returns and check whether the client has a credit bureau report (available for 60% of clients in my sample). Additionally, the Lender solicits three independent trade references and veries some of the provided information through a site visit to the clients business. Lending decisions for uncollateralized loans are largely based on estimated cash ows, and approximately 30% of prospective clients are screened out at this stage. While none of the loans in the experiment carried any collateral security, borrowers faced strong incentives for repayment. First, the Lender routinely oers follow-up loans at reduced interest rates to clients with a good repayment history. Second, borrowers who default on their loans are reported to Indias main credit bureau, implying a credible threat of future exclusion from formal sector borrowing. This is especially salient given that for most rms interest rates on these loans while high by formal sector standards are signicantly below the cost of alternative sources of nancing. As a result, default rates are below 5%, which is above the gure for regular commercial loans, but much lower than default rates observed for other uncollateralized products targeting clients with limited nancial access.11 The Lender classies loans as delinquent if a client misses more than two monthly payments and remains 60+ days overdue. Loans that remain unsettled for 90+ days are classied as non-performing assets (NPA), reported to the credit bureau, and referred to the Lenders collections department. A small fraction of loans in the overdue category are restructured in direct negotiation between clients and the Lender. To rule out selection bias, the sample excludes repeat borrowers and restructured loans. The choice of product was guided by several considerations. First, an unsecured small business loan is a prime example of a relationship loan with a comparatively low level of documentation. The cash ow of small businesses is generally dicult to verify, and audited nancials often reect only part of the applicants true nancial position. In this environment, the lending decision relies heavily on the lenders ability to incorporate soft information into the lending decision. Second, covenants for this class of loan have no provisions for review or ex-post adjustments in the terms of lending. This means that risk management occurs primarily through screening at the time the loan is sanctioned (passive monitoring), rather than follow-up once a loan has been originated (active monitoring).12 This ensures that the performance of a loan reects a borrowers actual credit risk, rather than ex-post modications to the terms of lending. Third, the Reserve Bank of India, which regulates lenders in this market, closely prescribes the type of borrower information a lender is required to collect for this class of loan. Thus, while products in this market are somewhat dierentiated across banks, loan ocers
and Zinman (2009) and Bertrand et al. (2010) carry out experiments in the South African market for cash loans and report default rates between 15% and 30%. The loans used as a basis for the experiment reported in this paper have a much larger ticket size, are longer maturity and cater to a segment of with signicantly lower default risk. 12 The distinction between active and passive monitoring is common among practitioners and in the literature, see for example Hertzberg, Liberti, and Paravisini (2010)
11 Karlan

in the experiment were able to base lending decisions on information that was largely standardized, as mandated by the regulator. As a further motivation for the experimental treatments, it is worth noting that, while the market segment I study is served by a range of private and public sector lenders, there are important dierences in the lending models. At public sector banks, the lending decision for personal and small enterprise loans up to a given ticket size tends to be delegated to local branches, such that sales and credit assessment roles may coincide. Among private sector lenders, in contrast, sales and credit assessment roles are generally distinct and the lending decision tends to be centralized.

Theoretical Framework

To guide the empirical analysis, this section develops a stylized model of the underwriting process. I describe a sequential version of the Aghion and Tirole (1997) model of incentives inside the rm, which provides a number of testable implications. The model takes the benet of additional screening a greater probability that bad news about a borrowers creditworthiness are detected as given and focuses on sources of agency conict within the bank that can be identied in the empirical analysis. In the model, a loan ocer (agent) and a risk manager (principal) are employed by the bank to screen loans. All loans look ex-ante identical and the problem facing loan ocers and risk managers is to choose costly screening eort to dierentiate between borrowers. Because the bank does not observe borrower type, incentive contracts can be based only on the observable outcome of loans that have been approved. The bank has limited capital and principal and agent may disagree over what type of loans to make. Specically, due to limited liability, the agent may have a lower threshold for approving loans than a senior manager.13 The principal, on the other hand, is more concerned about overall portfolio quality and may prefer to decline marginal loans so that the banks capital may be deployed elsewhere at a higher return. The model illustrates how such scope for disagreement shapes incentives for the collection, transmission and use of qualitative information. The model abstracts from the experimental set-up by assuming that the principal, rather than merely deciding whether to approve or decline a loan, has discretion over allocating the banks capital to a recommended loan or an alternative project. The model additionally simplies the setting of Aghion and Tirole (1997), by assuming that when lending decisions are delegated the principal is not involved in the lending decision, such that the agent is entirely autonomous in her decision-making.
13 In an actual lending environment, such a divergence of interests is rather common and may arise from various sources, such as limited liability, career concerns (Gibbons and Murphy 1992), dierences in time horizons, discount rates and monetary incentives between loan ocers and risk-managers. The model is agnostic about the source of divergent interests. The experiment exogenously induces an incongruence a divergence in interests by varying the power of monetary incentives faced by principal and agent and hence their quality threshold for loan approval.

3.1

A Simple Model of Credit Screening

Two agents, a risk manager (principal) and a loan ocer (agent), indexed by i {P, A} are employed by the bank to screen N loans. The problem facing principal and agent is to choose screening eort, infer the quality of a loan and make a protable lending decision. At the beginning of the game, and before any screening takes place, the bank exogenously assigns formal authority, dened as the right to make a nal lending decision, to either the principal or the agent.

3.1.1

Sequence of Play

1. The bank exogenously assigns authority over lending decisions to the principal or the agent. 2. Principal and agent privately and sequentially gather information about loan quality. 3. If formal authority is assigned to the agent, the agent screens loans without the principals interference. If formal authority is assigned to the principal, the agent may recommend a loan for approval and additionally disclose non-veriable information about loan quality to the principal. 4. The party holding formal authority makes a nal and irreversible lending decision. Loan performance is observed and payos are realized.

3.1.2

Loans

Each loan is associated with an ex-ante unknown but ex-post veriable benet B for the principal and b for the agent. A loan made by the principal yields benet B to the agent and a loan suggested by the agent yields benet b to the principal. For simplicity, suppose that N loans are screened, but only two of these loans are relevant so that one loan yields benet B > 0 to the principal and the other yields zero. Similarly, one loan yields benet b > 0 to the agent and the other yields zero. The ex-ante probability that principal and agent agree in their assessment and prefer to approve the same loan is denoted by (0, 1], the parameter of congruence. The experimental treatments, which I describe in the next section, allow me to induce exogenous variation in this parameter.

3.1.3

Information and Screening

At the beginning of the game, all loans look identical and principal and agent must collect information to dierentiate between them. If the agent exerts screening eort e [0, 1) at private cost c(e), he learns his expected benet with probability e and remains uninformed with probability 1 e. Similarly, if the principal exerts screening eort E [0, 1) at private cost c(E ), she becomes informed about her

benet from approving the loan with probability E and remains uninformed with probability 1 E . For both principal and agent, the payo from approving a bad loan is suciently negative that an uninformed party will always prefer to decline a loan. This corresponds to the prior that the average loan in the population yields a negative payo, so that it is never optimal to approve a loan when the screening process does not reveal any information about borrower type. When no loan is made, = principal and agent earn the outside payments B b = 0. As an extension, which allows me to investigate the eect of incentive alignment on communication, I also consider the case in which an informed agent can disclose information he may hold about the quality of the loan to the principal.

3.1.4

Preferences

For simplicity, I assume that principal and agent are risk-neutral, so that for a given level of eort and implemented lending decision, the agents expected utility is uA = b c(e) and the principals expected utility is uP = B c(E ). To further simplify the exposition, and without loss of generality, I assume that eort entails disutility c(E ) = 1/2 E 2 for the principal, and c(e) = 1/2 e2 for the agent, respectively.

3.2
3.2.1

Screening Eort and Lending Decisions

Lending decisions under delegation

To motivate the Baseline Treatment in the experiment, consider rst the case in which formal authority over the lending decision is delegated to the agent, who screens loans without the interference of a supervisor.14 The agent exerts screening eort, which comes at private cost
1 2 2e

and learns his

expected benet from approving the loan with probability e. With probability 1 e, the agent remains uninformed, declines the loan and earns outside wage b = 0. Thus, the agents expected utility is

uA = eb

1 2

e2

(1)

and the agents choice of eort is e d = b. Hence, when lending decisions are delegated, the agent chooses his privately optimal eort level e d and makes a decision without the principals interference.
14 Note that this implies that, as in the empirical lending environment I study, a supervisor can overrule a subordinate only on a positive, but not a negative recommendation. This is a departure from Aghion and Tirole (1997), who assume that an agent who remains uninformed solicits and follows the principals assessment.

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3.2.2

Lending decisions under supervision

How are incentives to collect information aected when lending decisions are made in a hierarchy? To match the experimental design and empirical lending environment, I next consider the case in which loans are screened sequentially by the principal and the agent. All loans are rst screened by the agent. With probability e, the agent is informed and can make a recommendation. With probability E , he faces a principal who is informed and makes a decision, yielding benet B to the agent. With probability 1 E , however, the agent faces a principal who is uninformed and therefore optimally follows (rubber-stamps) the agents suggestion, yielding benet b to the agent. With probability 1 e the agent remains uninformed and earns b = 0. Thus, the agents expected utility under supervision is

2 uA = e EB + (1 E )b 1 2e

(2)

When a loan is recommended by the agent for approval it is reviewed by the principal. As in the experiment and the empirical lending environment, the principal reviews only loans not previously screened out by the agent (that is, the mass of loans e).15 With probability E the principal learns his benet from making the loan, makes a lending decision and earns payo B . With probability 1 E , the principal learns nothing, optimally follows the agents suggested decision and earns B . Thus, the principals expected utility is
2 uP = e EB + (1 E )b 1 2E

(3)

As is intuitive, in this setting, principal and agent choose eort strategically. I consider a Perfect Bayesian Equilibrium of this game, which rules out the possibility that an agent exerts no screening eort and recommends all loans for approval. In this case, the rst order conditions that follow from (2) and (3) dene the principals and the agents reaction curves for information gathering and have a unique intersection.
Es = B b

(4) (5)

e s = E (B b) + b

These conditions make a number of intuitive predictions. First, the principal supervises more when her stake is high and the congruence parameter is low, so that she is likely disagree with the agents decision. Second, the agents initiative is decreasing in the principals monitoring eort E . This
15 This structure of decision making is rather common in retail lending and corresponds to the case where sales and approval channels are separate and loans declined at the branch level are not sent to the banks credit department for review.

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property of the model illustrates the disincentive eect of supervision. The intuition for this result is straightforward. Whenever there is scope for disagreement between the principal and the agent, an increase in the principals monitoring eort makes it more likely that the agents decision is overturned. This, in turn, reduces the agents expected return from exerting eort and collecting relevant borrower information. Third, when = 1, so that there is no scope for disagreement between principal and agent, the agent exerts optimal screening eort and the principals screening eort goes to zero such that she always trusts and rubber-stamps the agents decision. The model thus generates the following testable predictions, describing the eect of organizational structure on loan ocers incentives to acquire information. Proposition 1 (The Disincentive Eect of Supervision) The agent exerts less eort under supervision. This follows directly from a comparison of (2) and (6), which shows that E (B b) + b b and hence
e s ed for all E > 0 and < 1. Proof: see Appendix A.

Proposition 2 The agent invests greater eort in gathering information when her preferences are more closely aligned with those of the principal: e s / > 0. Proof: see Appendix A. Note that this basic framework also makes reduced-form predictions about the use of qualitative information communicated by reporting loan ocers. As the interests of principal and agent become more closely aligned, and approaches one, the principal reduces her monitoring eort (E/ < 0). This implies that an agents positive recommendations are less likely to be overturned and information collected by a reporting loan ocer is more likely to aect the banks ultimate lending decision. Finally, this also implies that an increase in the potential for conict between the dierent layers of the banks corporate hierarchy induces frictions that reduce the volume of lending as any loan recommended for approval is more likely to be turned down. As we shall see, results from the experiment provide evidence consistent with these two additional empirical predictions.

3.2.3

Communication

The model can also shed light on the eect of organizational structure on incentives to communicate information about a potential borrowers credit risk. To see this, I introduce the possibility that agents can disclose private (non-veriable) information to the principal, which reduces the principals marginal cost of investigation to cc (E )/E < c(E )/E for any level of monitoring eort E > 0. This leads to a shift in the principals reaction curve and increases the principals monitoring eort. In the experiment, I operationalize this idea by allowing loan ocers to send an internal, non-veriable, 12

risk rating to their manager. The availability of this additional information might be thought of as allowing the manager to target any additional screening eort towards a salient subset of information contained in a clients loan le. In this way, the experiment makes communication observable and allows me to test the following prediction. Proposition 3 (Communication) The agent discloses more information when incentives with the principal are more closely aligned. Proof: see Appendix A. The intuition for this result is straightforward. When the interests of principal and agent are misaligned, denoted by a low congruence parameter , an agent who shares private information increases the risk of being overruled by an informed principal. By contrast, when the interests of principal and agent are aligned, the agent benets from sharing information with the principal, as a principal with aligned interests (high ) is likely to implement the agents preferred decision.

3.2.4

Testable implications

The model gives rise to the following testable predictions. First, relative to the baseline case of decentralized decision-making, the observable eort of reporting loan ocers should decline under supervision. Second, in a hierarchy, the screening eort of loan ocers is increasing in the degree of incentive alignment with their senior managers. Third, loan ocers will disclose more private information about proposed loans when their incentives are more closely aligned with those of the loan approving managers. Finally, when congruence between loan ocers and risk managers is high, managers monitor less and are therefore more likely to follow the agents recommended decision. To test these predictions, the experimental treatments vary (i) the allocation of formal authority over the lending decision and (ii) the structure of performance pay inside the bank. In order to identify the sources of agency conict highlighted in the model, I vary the congruence parameter by altering the alignment of performance pay between loan ocers and senior managers. In the experiment, loan ocers and risk managers were awarded the conditional payments ai for loans that were approved and performed, bi for loans that were approved and subsequently became delinquent and a payment ci for loans that were declined. Hence, upon observing an informative signal about a borrowers creditworthiness, the decision rule for approving a loan is given by pi ai +(1 pi )bi ci ,16 where pi denotes the expected probability of performance. This simply states that a loan ocer will approve a loan if her expected benet from making the loan is greater than the outside payment
16 Throughout the paper, I assume that loan ocers prior about the average loan in the population is such that loan ocers and managers will always prefer inaction to approving a loan when no information about a borrowers creditworthiness is obtained from the screening process.

13

ci , which is made if the loan is declined. This decision rule denes a threshold probability for loan approval as a function of the incentive parameters for loan ocers p a (aa , ba , ca ) and senior managers p p (ap , bp , cp ), respectively. In the experiment, I alter the incentive payments faced by loan ocers and supervising risk-managers, such that interests between reporting loan ocers and loan approving managers are either aligned ( = 1) and p a = p p or divergent ( < 1) and p a < p p . Finding evidence consistent with the predictions of the model would, rst, provide support for the hypothesis that a banks ability to screen borrowers is constrained by the presence of agency conict inside the rm and, second, shed light on the interaction between performance pay and organizational structure in shaping rm performance. While any incentive contract observed in an empirical lending environment is likely to be endogenous to the rms performance (Bandiera et al. 2007, Prendergast 1999, Chiappori and Salani e 2003), the experimental design used here allows me to induce exogenous variation in the structure of decision-making, thus allowing for an identication of causal eects.

4
4.1

The Experiment
Basic Setup of the Intervention

In the experiment, 125 loan ocers, drawn from the sta of ve commercial banks evaluated loan applications from a database of 325 loans, assembled in cooperation with a large commercial lender. The exercise was carried out at two dedicated experimental labs in the western Indian city of Ahmedabad between May and August 2010, and participants completed a total of 3, 042 lending decisions over the course of the experiment. Loan ocers invited to participate in the experiment were recruited in cooperation with the regional oces of ve commercial banks. Individuals identied by these partner institutions were contacted by a member of the local lab sta and invited to attend an introductory presentation to familiarize themselves with the exercise and experimental protocol. Loan ocers who agreed to participate were then contacted on a weekly basis to arrive at the lab at a pre-arranged time to complete an experimental session. Summary statistics for the pool of participants appear in Table 1. When participating loan ocers arrived at the lab, they were randomly assigned to one of three experimental treatments, under which they evaluated a set of six loan applications per session. Randomization was carried out at the loan ocer and session level to ensure a sequence of treatments orthogonal to loan ocer characteristics, treatment type and composition of the participant pool. The loan les assigned to each loan ocer were randomly and independently drawn from the database of

14

historical loans, subject to the constraint that no ocer would be assigned the same le more than once. To add to the realism of the lending environment, loans shown to participants included loans that had performed, loans that had defaulted and loans that had been declined by the Lender.17 Participants knew that they were evaluating actual loans, but had no information on whether a loan had been previously made by the Lender. Each session of the experiment began with a standardized one-on-one presentation by the lab administrator, introducing the loan ocer to the assigned treatment. Each treatment varied two features of the decision-making process: the assignment of decision rights to either principal or agent and the performance pay faced by the two parties. The participants were briefed on these features according to a standardized protocol and completed a short quiz to verify their understanding of the treatment prior to beginning the exercise. Participants were then logged into a customized software interface (see Figure 6 for a screenshot), which displayed the randomly assigned sequence of loan les. The information for each loan consisted of the complete pre-sanction documentation, as available to the Lender at the time the original lending decision was taken. Participants were able to go back and forth between the dierent sections of the credit le and faced no time constraint in completing the exercise. After reviewing this information, loan ocers were then asked to assess the credit risk of each applicant along eighteen rating criteria, grouped into the categories personal risk, management risk, business risk and nancial risk. In the last step, participants then decided to approve or decline the loan.18 Throughout the experiment, a lab administrator was available to answer questions and ensure that there was no communication among the participants during the exercise.19 In a subset of experimental treatments, participants were randomly assigned to play the role of a supervisor. In this setting, a subordinate loan ocer (agent) was able screen out loans, which were then not reconsidered by the risk manager (principal), but did not have the authority to approve a loan. Thus, a supervisor was able overrule a subordinate on positive, but not on negative lending decisions. This corresponds to the common practice in the real lending environment I study where, for instance, loans declined at the branch level are not passed on to the banks credit department for a second assessment.
17 The ratio of performing, non-performing and declined loans was kept constant throughout the exercise at 4 performing, 1 non-performing and 1 declined loan per session. This ratio corresponds to the ratio for comparable loans at commercial banks in India and was not disclosed to the participants. In separate robustness checks, I test for learning during the exercise and check whether lending decisions approached the population ratio of good and bad les but nd no evidence that participants learned to infer the ratio of good to bad les over the course of the exercise. 18 The internal risk ratings assigned during the exercise were not binding, such that participants were free to approve or reject a loan irrespective of the assigned rating.This corresponds to the standard practice in the market I study, where loans to rms with a turnover of less than Rs 1,000,000 receive an internal credit rating, but the lending decision is not based on a formal credit scoring model. 19 All lab administrators were employees of Ahmedabad Oce of the Center for Micronance.

15

Throughout the experiment, participants faced meaningful monetary incentives based on their lending decisions and the outcome of the loans they approved. To ensure that monetary stakes were perceived as meaningful by the participants, the average payment was calibrated to approximately twice the hourly wage of the median loan ocer. Participants received a show-up fee of Rs 100 (approximately $2.15) and a performance bonus of up to Rs 300 (approximately $6.45) awarded at the end of each experimental session.20

4.2

Experimental Treatments

I implement three experimental treatments, summarized in Table A below. The treatments vary, rst, the assignment of formal authority over the lending decision to either a risk manager (principal) or loan ocer (agent) and, second, the alignment of monetary incentives between the two parties. To induce exogenous variation in the probability threshold for accepting a loan p i , the experimental treatments alter the structure of performance pay faced by loan ocers and risk-managers. I vary the p a . Each treatment specied three contingent payos for loan ocer and manager, conditional on the nal lending decision and the outcome of loans that were approved. These payos distinguished between a payment a for a loan that was approved and performed, a payment b, for a loan that was approved and became delinquent and a payment c, for a loan that was declined. To facilitate notation, I denote these payments by the triple (ai , bi , ci ). Throughout the experiment, loan ocers faced the incentive scheme (20, 0, 10), while risk managers faced either identical monetary incentives (20, 0, 10) or more high-powered performance pay, which carried a penalty for approving loans that subsequently became delinquent (50, 100, 10).21 The rst combination of incentive payments corresponds to the case of congruent interests and identical thresholds for approving a loan p a = p p , the second combination of incentive payments corresponds to the case of misaligned incentives and p a < p p . In this latter case, a loan-approving manager is more stongly incentivized on the quality of loans she originates than the reporting loan ocer, which implies a higher quality threshold for approving a loan. As in the empirical setting, loan ocers could be incentivized only based on outcomes that were observable to the bank. All incentive payments, as well as the show-up fee, were awarded by the lab administrator after the de-brieng which concluded each session of the experiment.22
lending decisions were made by a hierarchy, consisting of a loan ocer and a risk-manager, all performance pay was conditional on the lending decision of the manager, who held formal authority over the lending decision. This captures the fact that, as in the empirical setting, the bank only observes the outcome of loans that are approved. 21 As in the empirical setting, loan ocers could be incentivized only based on outcomes that were observable to the bank. Therefore, whenever a loan was declined at any level of the screening process, both parties received payo c. This meant that a loan ocer who suggested a loan for approval which was subsequently turned down by the manager was not rewarded for a correct recommendation, since the outcome of the loan was not observed by the bank. Similarly, if a loan was screened out by the agent, both parties received the payment c . 22 In the de-brieng participants also received feedback on the accuracy of their lending decisions and were shown a
20 Whenever

16

4.2.1

The Baseline Treatment

This treatment was assigned to 107 loan ocers, covered a total of 1,629 lending decisions and serves as the benchmark for all comparisons throughout the experiment. Under the Baseline Treatment, loan ocers were given complete autonomy over the lending decision. Participants were able to review all information contained in a prospective clients credit le, provided a qualitative assessment of the applicants credit risk and made a decision to approve or decline the loan.

4.2.2

The Supervisor Treatment

With this treatment, which was assigned to 102 participants and covered a total of 786 lending decisions, I test Proposition 1 of the model. The model predicts that, as a loan ocer loses inuence over the nal lending decision, incentives for the acquisition of information are blunted. Hence, for any value of the congruence parameter < 1, the agents eort under supervision will be lower than the agents eort in the Baseline case of decentralized decision making. In the Supervisor Treatment, formal authority was exogenously assigned to a senior manager. Participants assigned to this treatment were aware that their recommended lending decisions would be reviewed by a manager with the authority to overrule their recommendation. The decision making process under the Supervisor Treatment proceeded as follows. Loan ocers were presented with a sequence of randomly assigned loan les. They provided a qualitative risk assessment and were able to either decline a loan or forward it to the manager for approval. For any loan that arrived at the risk-managers desk with a loan ocers recommendation to approve, the risk manager had access to all hard information contained in the loan le, and was additionally able to review soft information in the form of the subordinate loan ocers qualitative assessment of the clients credit risk. As in the real lending environment I study, loans screened out by the banks front-line loan ocers were not reconsidered at higher levels of approval.

4.2.3

The Aligned Supervisor Treatment

This treatment is designed to test Proposition 2 of the model. The model shows that, the alignment of incentives between principal and agent increases the probability that a reporting loan ocers recommendation will be followed, thus mitigating the disincentive eect of supervision (e/ > 0). The Aligned Supervisor Treatment was assigned to 96 loan ocers and covered a total of 627 lending decisions. The protocol for this treatment was identical to the Supervisor Treatment, with the
scorecard comparing their decisions against the observed ex-post performance of each loan.

17

exception that the introductory brieng emphasized that loan ocers now faced a supervisor whose monetary incentives were aligned with their own. In practical terms, this meant that, in contrast to the previous treatment, the risk manager was not penalized for approving a loan that subsequently became delinquent.

Table A: Summary of Experimental Treatments

Treatment Baseline (No Supervisor) One stage of screening Loan ocer reviews loan, assigns risk rating, makes autonomous lending decision Supervisor Two stages of screening, divergent performance pay Loan ocer reviews loan, assigns risk rating Risk manager reviews escalated loans, makes nal decision Aligned Supervisor Two stages of screening, identical performance pay Loan ocer reviews loan, assigns risk rating Risk manager reviews escalated loans, makes nal decision Summary

4.3

Empirical Specication

In the subsequent empirical analysis, I focus on observable screening eort, lending decisions and the protability of lending under alternative structures of decision making. Throughout the analysis, I consider four primary outcomes of interest:

1. Screening Effort measured as loan ocers total evaluation time for each loan. 2. Lending Decisions measured as a dummy variable equal to one if a loan is approved. 3. Loan Performance measured as a dummy variable equal to one if a loan was in default. 4. Profitability measured as prot per loan, net of the lenders cost of capital.

18

Unless otherwise indicated, I estimate the following treatment eects specication for lending decisions made by loan ocer i on loan l

Yil = + 1 Supervisor + 2 Aligned + l + i + s + il Xil + il

(4.1)

where Yil is one of the four outcomes of interest, Supervisor is an indicator variable taking on a value of one if a loan was evaluated under supervision and Aligned is a dummy variable taking on a value of one if, conditional on a loan being evaluated in a hierarchy, performance pay between the information collecting loan ocer and the loan approving manager was aligned. I additionally control for loan ocer and supervisor xed eects, denoted by i and s , loan xed eects l and a vector of randomization conditions and additional controls Xil .23 The disturbance term il is clustered at the credit ocer and session level to capture common shocks and serial correlation in decisions taken by the same credit ocer within the same session of the experiment. In this specication, the treatment eect of supervision is estimated by the Supervisor Treatment 1 , while the treatment eect of supervision with identical performance pay is estimated and ts = 1 + 2 . Two statistical test are of interest. First, by the Aligned Supervisor Treatment and tas = testing the hypothesis ts = 0 provides evidence whether an increase in hierarchical distance leads to measurable dierence in outcomes. Second, testing ts = tas provides evidence on whether, conditional on loans being evaluated in a hierarchy, these eects are modied when monetary incentives between information-collecting loan ocers and loan-approving managers are more closely aligned. The basic identication assumption underlying these tests is the random assignment of loan ocers across treatments. To verify that this assumption is met, Table A1 reports tests of random assignment, comparing the means of pre-treatment characteristics across treatment groups. None of the means are signicantly dierent from the Baseline, indicating that the randomization was successful. An additional concern in the present experimental setting is the possibility that the estimation of causal eects may be confounded by the occurrence of learning during the exercise. To address this potential concern, Figure 2 plots the percentage of correct recommendations by the total number of experimental sessions completed by each credit ocer. The graph shows a that there is an upward trend in correct decisions over the rst few sessions, suggesting the presence of a moderate learning eect. To account for this pattern, I control for the number of sessions completed by each participant in additional robustness checks but nd that adding these controls does not alter the main results.
23 The treatments described in this paper were part of a series of experiments carried out at the same location. The vector of randomization conditions therefore controls non-parametrically for the ve randomization strata from which assigned treatments were drawn and an indicator variable for the experimental lab.

19

Data and Descriptive Evidence

My empirical analysis draws on data from two main sources. The primary dataset consists of the experimental data and contains detailed information on each participants lending decisions, risk ratings and personal characteristics. Each observed lending decision is then matched with rm and loan-level data, extracted from the proprietary database of the Lender. The resulting dataset covers 3,042 lending decisions made by 125 loan ocers on a sample of 325 loans (drawn from a database of approximately 1,000 borrower proles). The dataset includes 1,629 observations where the lending decision was delegated to a loan ocer and 1,413 observations where the nal lending decision was centralized at the level of a senior risk manager.

5.1

Participants and Experimental Data

Table 1 presents summary statistics for the pool of participants and lending decisions made over the course of the experiment. As the gures indicate, this was a sample of highly experienced loan ocers. On average, participants had more than 20 years of work experience in banking, with at least one year in retail or small enterprise lending. Loan ocers were drawn from all levels of their respective banks corporate hierarchy and ranged from trainees to senior managers with substantial experience in entrepreneurial nance. Nearly half of the participants (49%) had previously served as a branch manager or in a comparable management role at the banks regional oce. The level of education in the sample was high, with nearly all participants having completed at least a post-secondary qualication and 23% holding the equivalent of a masters degree in accounting, business or nance.24 Table A.3 explores the representativeness of the participant pool and shows that the demographics of loan ocers who participated in the present study are, in fact, remarkably similar to those of the employee population of a large commercial bank. The remainder of Table 1 (Panel B) reports descriptive evidence on the participants lending decisions during the experiment. Lending decisions are recorded as a dummy variable equal to one if a loan is approved and zero otherwise. The accuracy of lending decisions is measured by comparing each decision to the ex-post performance of the loan as recorded in the proprietary database of the Lender (described in greater detail the next section). Participating loan ocers completed an average of 14 experimental sessions in which they evaluated 74 loans. Overall, loan ocers were conservative in their lending decisions. In a sample that included 30% of loans classied as delinquent, only 66% of all loans
24 Since one of the experimental labs was linked to the corporate training center of a large commercial bank, there was also variation in the regional origin of the participants. The majority of participants were bank employees from the state of Gujarat (76%), overall participants in the sample came from 14 dierent Indian states and Union Territories.

20

evaluated during the experiment were approved.25 The data further highlight that even for a group of highly experienced loan ocers, distinguishing between good and bad borrowers was a challenging task in this observably high-risk market segment. While loan ocers correctly identied and approved 72.81% of all ex-post performing loans, only 52.33% of all non-performing loans were screened out. This suggests that a non-trivial share of defaults in the sample may be due to non-idiosyncratic reasons or factors outside the scope of the data available to the Lender at the time the loan was approved. The experimental data further recorded the loan ocers qualitative assessment of credit risk for each loan. Whenever a loan was evaluated in the exercise, loan ocers were asked to provide a subjective assessment of the applicants credit risk along by completing a standardized credit rating form consisting of 18 standard questions which allowed the loan ocer to assign a credit score from 1 (low risk) to 5(high risk). These credit scoring questions were adapted from the internal format used by a leading commercial bank and grouped into the sub-categories personal risk, business risk, management risk and nancial risk. All risk ratings are qualitative in the sense that they do not correspond to a veriable number (such as audited nancials), and cannot be easily quantied, but may dier in their degree of veriability.26 For the purpose of the subsequent statistical analysis, I dene the overall rating as the sum of all individual ratings for l evaluated by loan ocer i. Each of the four sub-category ratings is dened as the arithmetic mean of all individual ratings belonging to the respective sub-category for each loan. To simplify the interpretation of the empirical results presented in the next section, all risk rating variables used in the regression analysis are standardized to have mean zero and standard deviation one. Table 1, Panel C presents descriptive evidence on risk ratings. Two patterns stand out. rst, the ratings are consistently higher for the sample of ex-post performing than for the sample of ex-post defaulting loans, which provides suggestive evidence that the qualitative risk ratings do have informative content. Second, the variance of qualitative risk ratings is higher for comparatively less veriable risk-rating categories, perhaps indicating that less veriable information is inherently noisier and therefore more dicult to communicate. Whenever lending decisions in the experiment were made in the context of a hierarchy, all risk ratings assigned by the reporting loan ocer were reported to the supervising risk manager. Thus, the loan ocers qualitative risk ratings provide with a precise measure of qualitative or soft information communicated inside the hypothetical bank under alternative experimental treatments. It should
also Banerjee, Cole, and Duo (2009) for evidence on incentives and lending behavior in Indian banks. other words, there are dierences in the degree to which a given category of risk ratings can be backed up by hard information. For instance, while both a loan ocers subjective assessment of a clients personal risk and nancial risk have no direct hard information equivalent, the loan ocers impression of a clients personal risk is likely to involve a greater degree of subjectivity than an assessment of nancial risk which can be backed up by the clients audited nancials. See (Liberti and Mian 2009) and (Hertzberg et al. 2010) for related denitions of qualitative information.
26 In 25 See

21

be noted that there is a nuanced dierence between the denitions of qualitative information in the related literature (Liberti and Mian 2009, Hertzberg, Liberti, and Paravisini 2010) and the idea as it is operationalized here. Related work on the use of soft information in lending generally assumes that the agent has privileged access to information that is inaccessible to the principal, such as a personal interview with the client. The experimental design departs from this assumption in that both parties have access to the same hard information. Therefore, in the context of my experiment, the signal transmitted to the principal constitutes qualitative information in the sense that it cannot be readily veried, but is more accurately interpreted as an additional non-veriable signal akin to a second opinion on a loan.27

5.2

Loan Database

Throughout the experiment, lending decisions were based on a dataset of 325 historical loans, assembled from the proprietary database of a large commercial lender. Each credit le contains the complete personal and nancial information available to the Lender at the time the loan was approved and is matched with one year of monthly repayment history from the collections database of the Lender.28 The information in each loan le was grouped into the following primary categories, corresponding to the sections of the Banks standard application: (1) basic client information including a detailed description of the clients business, (2) documents and verication (3) balance sheet and (4) income statement. In addition, participants in the experiment had access to three types of background checks for each applicant: (5) a site visit report on the applicants business, a (6) site visit report on the applicants residence and (7) a credit bureau report, which was available for a subsample of 40% of all applicants and summarizes the clients total outstanding balance as well as the number of current and overdue accounts. To ensure consistency in the class of loans included in the sample, I focus on unsecured retail loans to self-employed individuals with a ticket size between Rs 100,000 (approximately $2,000) and Rs 500,000 (approximately $11,000),29 and a tenure of 12 to 36 months, drawn randomly from the universe of loans processed by the banks branches in six regions. To rule out potential bias arising from vintage eects, I consider only loans originated in 2008 Q1 or 2008 Q2. In addition, I restrict the sample to new borrowers on whose repayment capacity the lender has no prior information.
screening processes of this type are, for example, commonly used in mortgage underwriting. were collected and de-identied at the lenders headquarters. Each le underwent an additional round of screening prior to its inclusion in the exercise to ensure that no condential information could be inferred from the content of the le. 29 Loans of this ticket size account for less than 15% of the Lenders total unsecured retail lending. I focus on these comparatively larger ticket size loans because these loans play a more important role in nancing entrepreneurship and are better documented than smaller ticket personal loans.
28 Data 27 Sequential

22

Using standard denitions of credit delinquency, I distinguish between performing and non-performing loans. I classify delinquent loans as loans on which monthly installments remain outstanding for 60+ days. After this period, the client receives a written notice and visit from a branch level collections ocer. If a loan remains outstanding for more than 90 days, it is classied as NPA. Among loans that are in default, dened as 60+ days overdue, delinquency typically occurred early in the contract, with the median defaulting loan remaining current for only four months. Using a conservative estimate of the Banks cost of capital, the median prot for a performing loan in the sample is approximately Rs 25,576 ($ 550). Figure 1 plots the distribution of loan-level prot for the sample of loans. The gure illustrates that, from the lenders perspective, the loss from approving a bad loan, generally implying a loss in excess of the principal, is much greater than the opportunity cost of foregoing a protable lending opportunity. In addition to non-performing loans, the database contains a subsample of loans that were originally rejected by the lender. Reasons for rejection included incomplete or inconsistent documentation, excessive debt burden or a known history of default. While the sample includes data on loans that were declined by the lender and classies them as loans that a loan ocer should reject based on available information, I do not observe the counterfactual performance of these loans had they been made by the Bank. Decisions on rejected loans are therefore not taken into account in any of the subsequent estimations pertaining to loan or session level prot. Before turning to the main analysis, I explore to what extent loan ocers could infer a borrowers credit risk based on hard information alone, Table 2 reports mean comparisons of audited nancials for performing and non-performing loans. As is evident from these gures, there are several hard information characteristics that distinguish performing from non-performing loans. Borrowers who defaulted on their loans had substantially lower total annual income, earnings before interest and taxes EBIT and investment expenses as well as substantially lower ratios of monthly debt service to income and sales compared to businesses who remained current on their obligations. Somewhat counterintuitively, borrowers who repaid their loans also had a signicantly higher overall level of debt. This is explained by the fact that in the market I study, the observably highest risk borrowers are factually excluded from institutional credit and therefore have low average levels of pre-existing debt. Finally, a simple mean comparison suggests that the age of a rm is a useful predictor of default, with younger businesses being signicantly more likely to default. Taken together, these two pieces of evidence suggests that, while there are a number of hard information criteria that reliably distinguish between borrower types, qualitative information plays an important additional role in dierentiating between credit risks. 23

Empirical Results

The empirical analysis proceeds in two steps. I rst show how the structure of decision-making inside the bank aects incentives for the acquisition, communication and use of qualitative information. Second, I explore how the structure of decision making aects lending decisions and protability.

6.1
6.1.1

Incentives Inside the Bank

Incentives to acquire information

In this section, I rst examine how the structure of the decision-making process within the bank aects incentives for the acquisition of borrower information. Proposition 1 in the model leads us to expect that greater hierarchical distance between the initial screener and the originator of a loan discourages screening eort among the banks downstream loan ocers. To test this hypothesis, I estimate the baseline specication using total evaluation time per loan as a proxy of screening eort as the dependent variable. Unless otherwise indicated, the omitted category in all regressions is the Baseline Treatment, in which lending decisions are delegated to the banks loan ocers. Table 4 presents the results. I rst present estimates from a specication without xed eects and then, in columns (2) to (4), successively add individual, time and loan xed eects. The treatment eect estimates show that screening eort declines relative to the Baseline Treatment whenever loan ocers do not have nal authority over the lending decision; the treatment eect of supervision is negative throughout and statistically signicant in three of the four reported specications. The magnitude of the disincentive eect of supervision is substantial. Taking the estimates at face value, the presence of a supervisor reduces screening eort by 6% to 7%, relative to the case in which loan ocers make autonomous lending decisions. These results are consistent with incentive theories of delegation, as developed in Aghion and Tirole (1997) and Stein (2002) and existing empirical studies that have taken these theories to the data in a banking context, such as Liberti (2003). Building on these ndings, I next explore whether and to what extent incentives for the collection of information are aected by the structure of performance pay inside the bank. Proposition 2 in the model suggests that an that an increase in the alignment of incentives between reporting loan ocers and loan approving managers can mitigate disincentives in the acquisition of information that arise from the shift towards a more hierarchical lending model. The intuition behind this prediction is straightforward. When a loan ocer faces a manager with more closely aligned monetary incentives, recommendations passed on by the loan ocer are more likely to be followed at higher levels of approval.

24

This, in turn, restores the loan ocers control over lending decisions, thus strengthening incentives for the collection of information about the credit risk of prospective borrowers. In the second row of Table 4, I report estimates of the eect of incentive alignment on the screening eort of the banks downstream loan ocers. The coecient estimates are positive and statistically signicant throughout and show that, when monetary incentives inside the bank are aligned, the screening eort of reporting loan ocers increases by up to 9% relative to the basic Supervisor Treatment. At the foot of Table 4, I additionally report joint F -Tests of the two supervision coecients. The results show that when the initial screener and the originator of the loan face identical performance pay eort is in fact not statistically dierent from eort under the Baseline Treatment (p-values > .10). Taken together, these results provide evidence of a strong and economically signicant disincentive eect of supervision, but also suggest that the careful design of monetary incentives can be a powerful tool to mitigate agency problems in credit markets that necessitate a more hierarchical lending model.30

6.1.2

Incentives to communicate : how reliable is qualitative information?

Does organizational design aect the quality of information that is transmitted inside the rm? Theory suggests moral hazard in communication as an important mechanism through which hierarchical distance may impede a banks ability to screen borrowers and provide credit in an informationally opaque market. In this section, I test this proposition directly, using qualitative risk ratings assigned to each loan that was evaluated in the experiment as an observable measure of communication. In the model, Proposition 3 illustrates under which circumstances a reporting loan ocer would want to restrict information disclosed to a supervisor. Whenever monetary incentives and therefore perceived payos from approving a marginal loan are misaligned, a loan ocer who discloses private information about a loan increases the risk of being overruled by an informed manager. Consequently, we would expect the degree of information disclosed by a reporting loan ocer to be increasing in the alignment of performance incentives with the loan-approving manager. Figures 4 and 5 provide prima facie evidence in favor of the hypothesis that the alignment of monetary incentives within the bank improves the reliability of communicated risk-assessments. The two gures plot the kernel densities of internal risk ratings for performing and non-performing loans, respectively, and show that when the screener and the originator of a loan face identical performance pay, the distribution of these distributions diers signicantly from the Baseline ; Internal risk ratings for non-performing loans have signicantly lower mean under aligned incentives. Similarly, the
30 It is, moreover, worth noting that these results speak against an explanation based on moral hazard in teams. If loan ocers were tempted to free-ride on the eort of a supervisor, one would not expect this eect to be diminished when incentives between loan ocers and managers are more closely aligned.

25

kernel density plots show that under aligned monetary incentives, loans which ultimately performed received signicantly higher risk ratings. A Kolmogorov-Smirnov test rules out the equality of these distributions at the 5% level, which suggests that the alignment of incentives at dierent levels of the decision-making process improves the banks ability to distinguish between credit risks. To test this proposition more formally, I estimate the informative content of internal risk ratings as a predictor of default. The outcome of interest in the regressions I estimate is a dummy variable taking on a value of one if a loan became delinquent (dened as being 60+ days overdue) and zero otherwise. On the right hand side, I add interactions between each treatment and the risk ratings. To facilitate the interpretation, all risk ratings are normalized to have mean zero and standard deviation one so that coecient estimates may be interpreted as the eect of a one standard deviation improvement in the reported risk rating on the probability of default. The results dierentiate between the overall risk rating and its four components, personal risk, management risk, business risk and nancial risk. Table 5 reports the results. In column (1), I rst estimate the eect of the reported overall risk ratings on the probability of default. In columns (2) to (5), I then consider each of the sub-categories of the qualitative risk rating in ascending order of veriability, beginning with personal risk, and ending with nancial risk. Interestingly, the estimates show that, overall, qualitative risk ratings are a strong predictor of default. In the Baseline Treatment (column 1), a one standard deviation improvement of the overall risk rating is associated with a 10% decline in the probability of default. In columns (2) to (5), I repeat the exercise for each sub-component of the qualitative risk rating. Because the correlation between the sub-components of the qualitative risk-rating is high, I do not control for the remaining components of the risk-index in these regressions. The point estimates range from 6% to 10% decrease in the probability of default for a one standard deviation improvement in the respective risk rating and are signicant at the 1% level throughout. In Table 5, rows four and ve, I next turn to the interaction eects between the internal risk-rating and the the two supervision treatments. The coecient estimates indicate that internal risk ratings are in fact not signicantly less informative when loans are evaluated in a hierarchy. While the coecients on three of the four sub-category interactions are positive, suggesting that signals become somewhat more noisy when transmitted across the tiers of a corporate hierarchy, the interaction terms with the Supervisor Treatment do not attain statistical signicance. This suggests that the mere presence of a supervisor does not reduce the informative content of internal risk-ratings. It is worth noting that this nding is not necessarily inconsistent with related ndings in the literature (Liberti and Mian 2009), which suggest that the use of soft information declines with hierarchical distance. In fact, additional results presented below provide evidence consistent with this prediction. 26

Interestingly, the treatment interactions reported in Table 5 further demonstrate that there are nonetheless substantial ineciencies in the communication of non-veriable information, which are eectively mitigated by the alignment of performance based incentives within the bank. The estimates show that, when information-collecting loan ocers and loan-approving managers face identical performance pay, internal risk-ratings become signicantly more informative as a predictor of default. Under aligned monetary incentives, a one standard deviation increase in the risk rating transmitted by a loan ocer is associated with an additional 6% decline in the probability that a loan will become delinquent. Note that there are two possible sources of this eect: First, the greater accuracy of risk ratings under aligned incentives may reect an improvement in the availability of relevant information as a result of higher screening eort (documented in the previous section). Second, in line with the predictions of the model, the alignment of incentives inside the bank reduces the probability that a loan ocer will be overruled, so that the alignment of monetary incentives reduces the scope for moral hazard in communication. Finally, the results suggest that there is some variation in the ease with which dierent types of qualitative information are communicated. While the results in Table 5, column 2, illustrate that incentive alignment generally improves the reliability of risk ratings, this is not true for personal risk, arguably the least veriable component of the overall risk rating. The improvement in the predictive power of qualitative risk ratings, when measured as the probability of default conditional on internal risk ratings, is greatest in the case of nancial risk, the most veriable of the qualitative risk ratings.

6.1.3

Does qualitative information aect lending?

The results so far demonstrate that an increase in hierarchical distance between the initial screener and the originator of a loan leads to signicant disincentives for the acquisition and communication of qualitative information. This has potentially important implications for the banks ability to screen borrowers (given that qualitative assessments of credit risk measured here by internal risk ratings assigned to each loan are an informative predictor of default) and raises the natural question to what extent the the structure of decision making aects the banks ability to incorporate qualitative information into the lending decision. To explore this question, I estimate the eect of qualitative risk ratings on the probability that a loan is approved. The dependent variable in the regression I estimate is a dummy equal to one if a loan was approved and zero otherwise. In addition to the treatment indicators, the specication includes interactions between the treatment indicators and the risk ratings. Recall that in the experiment, loans screened out by a reporting loan ocer were not reconsidered at higher levels of approval. I therefore 27

restrict the sample of loans considered here to loans forwarded to a supervisor with a recommendation to approve and estimate the correlation of the qualitative risk ratings with the nal lending decision. Table 6 reports the results. The estimates in column 1 show that qualitative information collected by subordinate loan ocers does not aect lending decisions in a hierarchy. As the coecient estimates in the rst line of columns (2) to (5) show, this is also true for each of the sub-components of the qualitative risk rating. However, once again this picture is changed when incentives inside the banks corporate hierarchy are aligned. Under aligned incentives, a one standard deviation improvement in the management risk and management risk ratings reported by the loan ocer improves the probability that a loan will be made by 5% and 6%, respectively. Interestingly, lending decisions are unaected by the least veriable category of qualitative information personal risk and nancial risk, the most veriable of the qualitative information ratings. In the case of personal risk, this may be because even under aligned incentives, this type of qualitative information is too noisy to be translated into an accurate lending decision. In the case of nancial risk, on the other hand, loan approving managers may prefer to rely on a clients actual nancials, rather than a subordinate loan ocers assessment. Taken together, the ndings presented in this section provide compelling evidence that the shift to a hierarchical lending model has a signicant negative impact on loan ocers incentives to acquire information as well as the banks ability to incorporate qualitative information into the nal lending decision. However, the results also highlight the importance of interactions between the structure of decision making and the alignment of monetary incentives inside the rm: when incentives between information collecting loan ocers and loan approving managers are aligned, screening eort relative to the Baseline Treatment is unaected, qualitative information retains its informative content and managers make lending decisions based on information communicated by their subordinate loan ocers.

6.2

The Protability of Lending

What is the impact of these observed distortions on outcomes and performance, such as the banks ability to provide credit and the protability of lending? To explore this question I look rst at the change of lending volume under alternative structures of decision making and then provide direct evidence on the quality of lending decisions and protability under alternative organizational regimes.

6.2.1

The supply of credit

In this subsection, I rst examine how the structure of decision making aects the supply of credit. Results appear in Table 7. The estimates show that the shift to a hierarchical lending model leads to

28

an unambiguous decline in the volume of lending. Relative to the Baseline Treatment, a given loan is 7% less likely to be originated when decisions are made by a hierarchy (column 3). In columns (1) and (2), I decompose this eect into the decisions of risk-managers and their subordinate loan ocers. It is evident from these estimates that the reduction in lending volume is driven by the decisions of the risk manager. Managers are 15% more likely to screen out a loan than loan ocers who are given autonomy over the lending decision. Notably, the estimates also show that loan ocers are signicantly more likely to approve a loan when they are facing a risk manager. There are two possible sources of this eect. First, knowing that a loan will undergo a second screening may lead a reporting loan ocer to (optimally) reduce screening eort. Second, as shown in the previous section, the presence of a supervisor reduces loan ocers incentives to acquire information. Hence, a reporting loan ocer may be less likely to detect bad news about a potential borrowers credit history and recommend more loans of lower average quality. Column (5) further shows that the shift towards more conservative lending decisions also carries over to the ticket size of approved loans. On average, the ticket size of loans originated by a hierarchy is $516 or 18% lower than the mean loan size in the Baseline comparison group.

6.2.2

The quality of lending decisions

To examine whether this shift towards more conservative lending is associated with an improvement in the quality of lending decisions, Table 8, adds interaction terms between each treatment and an indicator for loans that subsequently became delinquent to the basic specication. As in the earlier analysis, delinquency is dened as a dummy variable taking on a value of one for loans that remained 60+ days overdue. To dierentiate between the quality of decisions at the two levels of the decision process, column (1) examines the lending decisions of the subordinate loan ocer, column (2) looks at the lending decisions of the approving manager and column (3) considers the nal lending decision. The results indicate that subordinate loan ocers are more likely to approve loans, irrespective of loan quality, when they face supervision. However, the quality of a subordinate loan ocers decisions improves signicantly when monetary incentives between loan ocers and risk managers are aligned. The interaction coecient in column (1) shows that a subordinate loan ocer facing a supervisor whose monetary incentives are aligned with his own is 13% less likely to recommend a loan that subsequently becomes delinquent. This highlights that the alignment of incentives aects the behavior of a reporting agent holding the monetary incentives of the reporting loan ocer constant. The presence of a supervisor (column 2, row four). improves the quality of project selection, irrespective of the alignment of monetary incentives. When loans are evaluated by a hierarchy, screening at the 29

supervisor level reduces the probability that a non-performing loan is approved by 16%. Notably this result is unaected by the alignment of incentives between loan ocer and risk-manager.

6.2.3

Loan-level prot

Table 9, provides direct estimates of the eect of decision structure on protability from the viewpoint of the lender. In column (1), I initially focus on prots per loan as the outcome of interest and thus restrict the sample to the 1,475 loans that were approved over the course of the experiment. As one might expect, the addition of a supervisor adds value in the context of the informationally opaque market that forms the backdrop for the experiment. The coecient estimates show that prots per loan increase by $266 or 8% when loans are screened sequentially by a loan ocer and a risk manager, compared to the Baseline Treatment. Thus, in this setting, the benet of additional screening outweighs the disincentive eects introduced by the transfer of formal authority from the banks front line employees to a risk manager. However, prots per loan in a increase by an additional $250 or 12% of the median loan size, relative to the Baseline Treatment, when monetary incentives between the information collecting loan ocer and the loan approving manager are aligned. This nding is consistent with the notion that the protability of the banks lending is constrained by agency conict inside the rm, such as moral hazard in the acquisition and transmission of qualitative information. However, it should be noted that the nding that incentive alignment increases prot does not allow me to rule out alternative channels of causation, such as dierences in project selection under alternative treatments that arise from factors unrelated to the availability and transmission of qualitative information. However, together with the ndings on the incentive eects of supervision in the previous section, the results support a strong presumption in favor of the hypothesis that the alignment of monetary incentives aects prot through improvements in the availability and use of qualitative information. In Table 9, column (2), I use Return on Assets, dened here as the banks loan level net prot divided by the ticket size of the loan, as an alternative measure of prot. The point estimate suggests that protability per loan increases by approximately 8% in a hierarchy, relative to the Baseline 2 = 0.059) and Treatment. The coecient estimate for the case of aligned incentives is positive ( qualitatively similar to the estimate in column (1), but does not attain statistical signicance. Since the banks xed cost of underwriting is a function of the number of evaluated loans, prot per evaluated loan arguably provides a more meaningful measure of the banks net prot. Therefore, in column (3), I repeat the exercise using the full sample of screened loans including loans that were rejected so that the coecient estimates can be interpreted as the banks net prot per evaluated loan. 30

The results are qualitatively similar to those in the previous regressions but highlight the fact that the alignment of incentives inside the bank has a signicant eect on the quality of project selection and net prots from the perspective of the bank. Here, the coecient estimates suggests that while the introduction of a hierarchy has a weakly positive eect on the protability of the banks lending, prots per screened loan increase by more than $200 or 28% relative to the median. Finally, columns (4) and (5) carry out a robustness check and provide upper and lower bounds for the protability estimates. Recall that the sample of loans includes loans that were previously made by the Lender, such that their performance is observed, as well as loans that were originally declined by the lender. In column (4) I include loans whose outcome is not observed and assume that they performed at the 5th percentile of the protability distribution, implying default. In column (5), I repeat this exercise and assume that these loans performed at the 95th percentile of the prot distribution. The results show that, the upper and lower bound estimates for the eect of hierarchical screening on protability are lower, and not statistically signicant when these loans are included. By contrast, the eect of incentive alignment on the protability of lending is virtually unaected and remains statistically signicant, suggesting that incentive alignment inside the rm leads to a signicant improvement of the banks ability to detect and screen out these loans.

Conclusion

This paper presents evidence from a framed eld experiment in the Indian market for small enterprise loans to investigate the eect of organizational design on incentives inside the bank. The results oer new insights on the nature and importance of agency problems arising from the organizational design of a banks lending. I provide compelling evidence that information and agency problems constrain a lenders ability to screen borrowers in an informationally challenging environment, such as the emerging credit market studied here. However, I also show that simple incentive contracts using performance pay to align the interests of the initial screener and the originator of a loan are eective in attenuating moral hazard, facilitating the ow of information and improving the protability of lending. While the experiment is tailored to the context of the Indian market for entrepreneurial nance, the present paper makes three contributions that can shed light on the link between organizational structure and bank lending more broadly. The rst contribution of this paper is to provide a better understanding of factors inherent in a banks organizational structure that may limit its ability to screen borrowers and provide credit. Using a direct measure of loan ocers screening eort, I show that monitoring creates signicant disincentives for the collection and transmission of relevant borrower

31

information among the banks front-line loan ocers. Similarly, qualitative information loses the ability to aect lending decisions as it is passed across the tiers of the banks corporate hierarchy. The second substantive contribution of this paper is to measure the eect of organizational design on outcomes, including the quality of lending decisions and loan-level prot. The analysis highlights that organizational design can aect performance through two channels: the shift towards a more hierarchical lending model improves the probability that bad news about a borrowers creditworthiness are discovered, but may induce disincentives for the collection and transmission of relevant borrower information. I show that, in the salient context of the emerging credit market studied here, the benet of additional screening signicantly outweighs the agency costs of supervision. Loans evaluated by a hierarchy are substantially less likely to default and are 12-24% more protable than loans originated under delegation. While lending decisions become more conservative, the banks overall prot increases. The third contribution of this paper is to explore potential mechanisms that can mitigate information and incentive problems in the supply of credit. My results provide prima facie evidence that relatively simple incentive contracts using performance pay to align the interests of employees with dierent levels of authority can mitigate information and agency problems within the bank. These ndings have important implications for the design of lending models in emerging markets, where the provision of entrepreneurial nance promises high returns to capital, but commercial lenders often shy away from dicult credits that rely heavily on the use of qualitative information. The results presented in this paper suggest that the centralization of formal authority over the lending decision a common feature of lending models among commercial banks in emerging markets entails a signicant disincentive eect on the collection and use of qualitative information, and a signicant contraction in the provision of credit. Understanding which features of a banks organizational structure can mitigate these incentive and information problems holds the promise of improving the provision of credit to small enterprises and has important implications for aggregate welfare and growth. In conclusion, I note some promising avenues for future research. First, the ndings presented in this paper shed new light on the sources and the potential welfare costs of agency conict arising from the organizational design of a banks lending. Addressing these questions experimentally allows for a causal interpretation of eects but entails some natural limitations to generalization. Therefore, an important direction of future empirical work is to provide additional evidence on the role of organizational design in shaping incentives inside the rm in a wider range of lending environments and institutional settings. Second, this paper has considered a relatively simple combination of monetary incentives and organizational forms. Further work is needed to address how more complex lending models and structures of performance pay aect the provision of entrepreneurial nance in an emerging market. 32

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Appendix A
A.1 Theory Appendix Proof of Proposition 1

Proof. The agents eort under supervision is Eb( 1) + b. Noting that 1 and substituting E , 2 e s = ( 1) Bb + b. Hence, under aligned incentives, = 1 and e = b. Under misaligned incentives, 2 < 1 and es e = (1 ) Bb < 0.

A.2

Proof of Proposition 2

2 Proof. The agents optimal eort under supervision is e s = (1 ) Bb + b. Hence, e / 0 for all 1.

A.3

Proof of Proposition 3

Proof. The availability of an informative signal reduces the principals marginal cost of investigation from c(E )/E to cc (E )/E with cc (E )/E < c(E )/E for all E > 0. This implies an increase in the principals equilibrium eort E = c 1 ((1 )B ) and a decrease in the agents equilibrium eort 2 e = E b( 1) + b. Noting that uA (e ) = 1 2 (e ) , it follows that the agents utility from transmitting an informative signal is decreasing in the misalignment of incentives. Hence greater misalignment of incentives between principal and agent makes the agent less likely to disclose private information.

B
B.1

Experimental Instructions Instructions to Loan Ocer

Welcome to the lab and thank you for your participation in this exercise. Please listen carefully to the following instructions. Instructions change from session to session and therefore it is very important that you give us your full attention even if you have participated before. The integrity of the study requires that you do not talk to each other during the session, please do not use cell phones, and do not look at other persons screen. If you have any questions, please raise hand and it will be answered. Individuals who do not follow these will be asked to leave the lab. In this session you will be asked to view and review the pre-sanction information, give us your opinion on the quality of the application but you cannot make the nal decision. You can only make recommendation regarding the le and rate the le between 1 to 10, where 1 is for a very poor le and 10 is for a very good le. The nal decision will be made by the supervisor. We will compensate you with Rs 20 for every approved le that performs. We will compensate you Rs 10 for every rejected le. We will compensate you with Rs. 0 for every sanctioned le that defaults. There are a few questions on the slip of paper being distributed right now. Please answer the questions regarding todays incentive scheme as explained in this presentation. Before we start I will once again recap the incentive scheme for todays session: 1) You will get Rs 10 for each rejected le. 2) You will get Rs 20 for each sanctioned le that performs. 3) You will get Rs 0 for each sanctioned le that defaults. You will be charged Rs. 3 from your starting credit of Rs. 18 to view additional information. You may now start this session, when you have nished all six les in the session please come to me individually to receive your payout for today.

37

B.2

Instructions to Supervisor

Welcome to the lab and thank you for your participation in this exercise. Please listen carefully to the following instructions. Instructions change from session to session and therefore it is very important that you give us your full attention even if you have participated before. The integrity of the study requires that you do not talk to each other during the session, please do not use cell phones, and do not look at other persons screen. If you have any questions, please raise hand and it will be answered. Individuals who do not follow these will be asked to leave the lab. In this session you will be asked to view and review the pre-sanction information, give us your opinion on the quality of the application and make a decision on whether in your opinion this application should be approved or rejected. These les have been recommended by an ocer from your bank. He has given his rating, recommendation and decision regarding the les. You can either go with the recommendation of the loan ocer or make your own decision. You will be making the nal decision and the loan ocers payout will be made after your decision. We will compensate you with Rs 20 for every application that you accept that performs. We will compensate you Rs 10 for every rejected le. There will be no compensation or deduction for accepting a loan that defaults. There are a few questions on the slip of paper being distributed right now. Please answer the questions regarding todays incentive scheme as explained in this presentation. Before we start I will once again recap the incentive scheme for todays session: 1) You will get Rs 10 for each rejected le. 2) You will get Rs 20 for each sanctioned le that performs. 3) You will get Rs 0 for each sanctioned le that defaults. You will be charged Rs. 3 from your starting credit of Rs. 18 to view additional information. You may now start this session, when you have nished all six les in the session please come to me individually to receive your payout for today.

Representativeness of Loan Ocers

To present evidence on the representativeness of loan ocers participating in the experiment, Table A3 compares the participant pool to the employee population of a leading commercial bank. The bank dataset was obtained from one of the largest ve Indian commercial banks and covers all employees of the bank in the Indian state of Gujarat, where the experiment was set. In order to obtain a relevant comparison group, I report summary statistics on all bank employees serving in a role related to the sale or appraisal of retail and commercial loans. The comparison of key demographics for those two groups show that the participant pool and the statewide employee population of the bank are, in fact, remarkably similar in terms of gender composition, age and experience. Table A2 additionally reports recruitment and participation rates for the experiment. Overall 50% of invited loan ocers participated in the experiment. While there was some variation in the average age of participants, reecting in part the demographic structure of the participating banks, the mean and median rank of the participating loan ocers was very similar and close to that of the population of loan ocers covered by the bank dataset and summarized in Table A3.

38

Figures and Tables

Loan Database: Distribution of Loan Level Profit

.6 Density 0 6000 .2 .4

4000

2000 0 Profit per Loan (US$)

2000

4000

Figure 1: This gure shows the distribution of loan level prot for the database of loans underlying the experiment. This measure is approximated by the dierence between the net present value of payments on each loan and the principal amount of the loan and denominated here in US Dollars. The median loan size in this sample is US$482. The median loan size when non-performing loans are excluded from the sample is US$1081.

Learning: Correct Decisions by Experimental Sessions

.75 .6 0 Lending Decisions Correct (%) .65 .7

10 15 Total Sessions Completed

20

25

Figure 2: This gure examines the presence of learning eects in the experiment. The gure plots the percentage of correct lending decisions by the total number of experimental sessions completed by a loan ocer. A correct lending decision is dened as the approval, or recommendation for approval, of a loan that performed and the rejection of a loan that eventually defaulted or was initially declined by the lender.

39

Kernel Density: Evaluation Time

.8 0 4.5 .2 Kernel Density .4 .6

5.5 6 Log[Evaluation Time] Supervisor

6.5

Baseline

Aligned Supervisor

Figure 3: This gure plots the kernel density of log evaluation time by treatment. A KolmogorovSmirnov test for equality of distributions does not reject the equality of risk ratings under Aligned Supervisor Treatment and the Baseline, but rejects the equality of the Aligned Supervisor Treatment and the Baseline Treatment at the 10% level.

Risk Ratings: Performing Loans

.04 0 20 .01 Kernel Density .02 .03

40

60 Risk Rating, Performing Loans Supervisor

80

100

Baseline

Aligned Supervisor

Figure 4: This gure plots the kernel density of internal risk ratings for performing loans under
each experimental treatment. Kolmogorov-Smirnov tests for the equality of distributions rejects the equality of risk ratings under Supervisor Treatment and the Aligned Supervisor Treatment from the Baseline Treatment at the 5% level.

40

Risk Ratings: NonPerforming Loans

.04 0 20 .01 Kernel Density .02 .03

40

60 Risk Rating, NonPerforming Loans Supervisor

80

100

Baseline

Aligned Supervisor

Figure 5: This gure plots the kernel density of internal risk ratings for non-performing loans under
each experimental treatment. Kolmogorov-Smirnov tests for the equality of distributions reject the equality of risk ratings under Supervisor Treatment and the Aligned Supervisor Treatment from the Baseline Treatment at the 1% level.

41

Figure 6: Loan Rating Exercise, Login

Figure 7: Loan Rating Exercise, Evaluation

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Figure 8: Credit File, Sample

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Table 1: Summary Statistics, Loan Ocers

This table reports summary statistics for the pool of participants. Panel A summarizes the demographic characteristics of the participants. Age is the loan ocers age in years, Male is a dummy variable taking a value of 1 if the participant is male. Rank is the loan ocers level seniority level in the bank. Experience is the total number of years the participant has been employed with the bank. Branch Manager is a dummy indicating whether the participant has ever served as a branch manager. Panel B Evaluations reports on the participation and performance of the experimental subjects. Loans Evaluated is the number of unique loans evaluated by each participant over the course of his or her participation in the experiment. Loans approved is the share of armative lending decisions, Correct Decisions is the sum of Loans Correctly approved and Loans Correctly Rejected, divided by the total number of lending decisions made by the loan ocer. Prot per session is the banks net prot of all loans made by the loan ocer in an experimental session.
Panel A: Demographics Mean Median StdDev 10% 44.06 0.95 0.23 20.03 2.05 0.49 47.00 1.00 0.00 23.00 2.00 0.00 11.05 0.21 0.42 10.83 0.90 0.50 30.00 1.00 0.00 3.00 1.00 0.00

N Age Male Education [Masters] Experience [Years] Rank [1 Low 5 High] Branch Manager Experience [Yes/No] 125 125 125 125 125 125

Min 24 0 0 0 1 0

Max 64 1 1 40 5 1

25% 35.00 1.00 0.00 11.00 1.00 0.00

75% 52.00 1.00 0.00 29.00 3.00 1.00

90% 56.00 1.00 1.00 32.00 3.00 1.00

N Loans Evaluated Loans Approved Correct Decisions Loans Correctly Approved Loans Correctly Rejected Prot per Loan Screened in US$ 3,042 3,042 3,042 3,042 3,042 3,042

Min 3 0 0 0 0 -2429

Max 97 1 1 1 1 1762

Panel B: Evaluations Mean Median StdDev 10% 42 0.72 0.66 0.63 0.52 259 36 1 1 1 1 320 25.09 0.45 0.47 0.48 0.50 553 11 0 0 0 0 -478

25% 24 0 0 0 0 -55

75% 60 1 1 1 1 671

90% 78 1 1 1 1 885

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Table 2: Summary Statistics, Loans

This table reports summary statistics for the database of loans used in the experiment. Columns (1) to (3) show summary statistics for the sub-sample of performing loans and columns (4) to (6) show summary statistics for the sub-sample of non-performing loans. Columns (7) and (8) show dierences in means between the two groups and corresponding standard errors. Principal Amount is the total principal amount of the loan, Monthly Installment is the gross monthly installment on the loan including the clients payment towards principal and interest. Loan Tenure is the term of the loan in months. Total Income is the clients annual income from business and other sources before taxes and interest expenses. Business Expenses measures the clients annual business expenditure and includes current expenses and investments. EBIT are a clients monthly earnings from business activities before taxes and interest. Total Debt is the principal outstanding of all loans held by the client. Total Monthly Debt Service is the sum of the clients EMIs on all outstanding loans. Liabilities/Net Income is the ratio of total liabilities, including interest expenses, to net annual income. Liabilities/Sales is the ratio of total liabilities, including interest expenses, to net annual sales. EBIT/Monthly Debt Service is the ratio of EBIT to the monthly loan installment, including payments towards principal and interest.
Panel A Performing Loans Mean Median StdDev 5750.62 5364.81 2620.69 194.09 33.63 10.93 11501.43 15730.58 374.95 1899.98 9676.99 0.04 0.034 7.19 168.28 36.00 8.00 6437.77 1152.77 62.27 1019.31 5386.27 0.02 0.016 3.811 89.73 7.56 8.52 15892.27 49349.21 1097.05 3872.11 14206.70 0.10 0.051 26.70 Panel B Non-Performing Loans Mean Median StdDev 6456.59 6437.77 2718.48 163.29 37.07 8.20 7160.23 7739.71 273.37 1430.58 5704.47 0.06 0.060 4.69 149.27 36.00 7.50 4868.50 3387.64 120.17 1105.15 3862.66 0.03 0.032 2.24 83.39 8.40 5.41 9812.86 12473.67 407.34 1050.06 9004.86 0.07 0.070 3.98 Panel C Dierence in Means Dierence SE 705.97* [377.81] -30.80** 3.44** -2.73*** -4341.43** -7990.86** -101.58 -469.40* -3972.51*** 0.02* 0.024** -2.54** [13.78] [1.643] [0.994] [1781.04] [3434.88] [85.03] [281.21] [1621.59] [0.013] [0.011] [4.122]

Principal Amount in US$ Monthly Installment in US$ Loan Tenure [Months] Years in Business Total Income Total Debt in US$ Monthly Debt Service EBIT Business Expenditure Liabilities/Net Income Liabilities/Sales EBIT/Monthly Debt Service

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Table 3: Dierences in Means of Outcome Variables by Treatment

This table reports dierences in means between the decentralized baseline and each of the four hierarchical screening contracts, conditional on the randomization conditions. Loans Approved[Final] is the percentage of loans approved, Loans Approved [Loan Ocer] is the percentage of loans recommended for approval by the subordniate loan ocer, Ticket Size denotes the principal amount of approved loans. Prot per Loan is the lenders net prot per approved loan. Risk Rating is the qualitative risk rating assigned to the loan by the agent, standardized to a variable between 0 (high risk) and 100 (low risk). Robust standard errors for the dierence in means appear in parentheses. * denotes dierence statistically signicant at 10 %, ** 5 % and *** 1 %.

Treatment

Baseline Mean Di SE 0.66 0.73 3.991 0.482 0.14 61.92 63.28 59.35 [0.475] [0.443] [1.742] [2.082] [0.554] [14.27] [13.76] [14.88]

Treatment Supervisor Mean Di SE -0.135 -0.012 -0.387 0.178 0.026 4.31 3.635 6.193 [0.024]*** [0.023] [0.131]*** [0.13] [0.034] [0.748]*** [0.837]*** [1.692]***

Aligned Supervisor Mean Di SE -0.141 0.015 -0.57 0.012 -0.02 2.483 1.979 3.668 [0.021]*** [0.019] [0.111]*** [0.123] [0.032] [0.699]*** [0.830]** [1.309]***

Loans Approved [Final] Loans Approved [Loan Ocer] Ticket Size Approved in US$ Loan Level Prot in US$ Prot Margin Risk Rating Risk Rating, Good Loans Risk Rating, Bad Loans

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Table 4: Treatment Eects: Eort

This table shows treatment eects on the screening eort measured as the total time spent reviewing a loan le and the number of information credits spent to review individual sections of the loan le. The omitted category in each regression is the non-supervised baseline treatment. The dependent variable in all equations is the log of the loan ocers total evaluation time per credit le. In addition to the variables listed, I control for the ve randomization strata from which assigned treatments were drawn, an indicator for the experimental lab, and the ticket size of the loan in all specications that do not include loan xed eects. Standard errors are clustered at the individual and session level. * denotes statistical signicance at 10 %, ** 5 % and *** 1 %.

Dependent Variable

Log[Time] OLS (1)

Log[Time] OLS (2)

Log[Time] OLS (3)

Log[Time] OLS (4)

Baseline [Non-Supervised] Supervisor Aligned Supervisor -0.023 [0.043] 0.094 [0.051]* 1.97 [0.167] No No No No 2,097 0.099 -0.060 [0.035]* 0.093 [0.036]*** 0.70 [0.403] Yes Yes No No 2,097 0.480 -0.081 [0.038]** 0.092 [0.036]** 0.07 [0.798] Yes Yes Yes No 2,097 0.581 -0.068 [0.040]* 0.060 [0.034]* 0.03 [0.852] Yes Yes Yes Yes 2,158 0.652

F-Test, Supervisor+Aligned=0 P-Value Loan Ocer Fixed Eects Supervisor Fixed Eects Week Fixed Eects Loan Fixed Eects Number of Observations R-Squared

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Table 5: Treatment Eects: How Reliable is Qualitative Information?

This table explores the information content of qualitative internal risk ratings as a predictor of default. The omitted category in all regressions is the Baseline Treatment. The dependent variable in all regressions is a dummy variable indicating a le that defaulted or was screened out by the Lender ex-ante. The variable Risk Rating is the loan ocers qualitative risk assessment of a given loan, standardized to a variable with zero mean and standard deviation one. Each column considers a separate risk category. Column (1) considers the overall risk rating assigned by the agent. Columns (2) to (5) consider the sub-categories of the risk rating Personal Risk, Management Risk, Business Risk and Financial Risk in ascending order of veriability. In addition to the controls listed, I include dummies for the ve randomization strata from which assigned treatments were drawn and a lab dummy. Standard errors in brackets are clustered at the individual and session level. * denotes statistical signicance at 10 %, ** 5 % and *** 1 %.

Pr[Default=1] OLS (1) Overall Baseline [Non-Supervised] Rating Supervisor Aligned Supervisor Risk RatingSupervisor Risk Rating Aligned Supervisor Loan Ocer Fixed Eects Supervisor Fixed Eects Week Fixed Eects Loan Fixed Eects Number of Observations R-Squared -0.097 [0.015]*** -0.026 [0.015]* 0.001 [0.02] -0.004 [0.023] -0.056 [0.026]** Yes No Yes No 2,925 0.043

Pr[Default=1] OLS (2) Personal

Pr[Default=1] OLS (3) Management

Pr[Default=1] OLS (4) Business

Pr[Default=1] OLS (5) Financial

-0.074 [0.014]*** -0.027 [0.014]* -0.003 [0.01] 0.013 [0.021] -0.038 -0.025 Yes No Yes No 2,925 0.023

-0.095 [0.014]*** -0.026 [0.014]* 0.001 [0.02] 0.002 [0.022] -0.065 [0.025]*** Yes No Yes No 2,925 0.042

-0.093 [0.014]*** -0.025 [0.014]* 0.001 [0.02] -0.011 [0.023] -0.056 [0.026]** Yes No Yes No 2,925 0.047

-0.059 [0.014]*** -0.03 [0.014]** -0.003 [0.02] 0.02 [0.022] -0.071 [0.026]*** Yes No Yes No 2,925 0.024

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Table 6: Treatment Eects: Does Qualitative Information Aect Lending?

This table explores the use of qualitative information in the lending decision. The omitted category in all regressions is the Baseline Treatment. The dependent variable in all regressions is a dummy variable equal to one if a loan was approved. The variable Risk Rating is the loan ocers qualitative risk assesment of a given loan, standardized to a variable with zero mean and standard deviation one. Each column considers a separate risk category. Column (1) considers the overall risk rating assigned by the agent. Columns (2) to (5) consider the sub-categories of the risk rating Personal Risk, Management Risk, Business Risk and Financial Risk in ascending order of veriability. In addition to the controls listed, I include dummies for the ve randomization strata from which assigned treatments were drawn and a lab dummy. Standard errors in brackets are clustered at the individual and session level. * denotes statistical signicance at 10 %, ** 5 % and *** 1 %.
Pr[Approved=1] Pr[Approved=1] Pr[Approved=1] Pr[Approved=1] Pr[Approved=1]

OLS (1) Overall Baseline [Non-Supervised] Rating -0.101 [0.19] 0.044 [0.03] Yes Yes Yes Yes 1,830 0.513

OLS (2) Personal

OLS (3) Management

OLS (4) Business

OLS (5) Financial

-0.127 [0.18] -0.023 [0.03] Yes Yes Yes Yes 1,830 0.505

-0.163 [0.17] 0.046 [0.027]* Yes Yes Yes Yes 1,830 0.513

0.317 [0.31] 0.062 [0.031]** Yes Yes Yes Yes 1,830 0.515

-0.132 [0.15] 0.024 [0.04] Yes Yes Yes Yes 1,830 0.511

Aligned Supervisor Rating Loan Ocer Fixed Eects Supervisor Fixed Eects Week Fixed Eects Loan Fixed Eects Number of Observations R-Squared

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Table 7: Treatment Eects: Lending Decisions

This table shows treatment eects on lending decisions. The omitted category in each regression is the non-supervised baseline treatment. In column (1), the dependent variable is a dummy indicating whether a loan was approved (escalated) by the agent. In column (2) the dependent variable is a dummy indicating whether a loan was approved by the principal. In column (3) the dependent variable is a dummy indicating the nal lending decision. The dependent variable in column (4) is the principal amount approved, denominated in US$ 1000 and equal to zero if a loan was declined. In column (5) the dependent variable is the loan amount approved, denominated in units of US$ 1000 and the sample is restricted to approved loans. In addition to the variables listed, I control for the ve randomization strata from which assigned treatments were drawn and an indicator for the experimental lab. Standard errors are clustered at the individual and session level. * denotes statistical signicance at 10 %, ** 5 % and *** 1 %.

Dependent Variable

Agent Pr[Approve=1] OLS (1)

Principal Pr[Approve=1] OLS (2)

Final Decision Pr[Approve=1] OLS (3)

Lending Volume USD[000] OLS (4)

Ticket Size USD[000] OLS (5)

Baseline [Non-Supervised] Supervisor Aligned Supervisor 0.071 [0.036]** 0.014 [0.031] Yes No Yes Yes 2,517 0.368 -0.158 [0.028]*** 0.020 [0.029] Yes Yes Yes Yes 1,830 0.480 -0.067 [0.036]* 0.031 [0.030] Yes Yes Yes Yes 2,517 0.409 -0.235 [0.181] 0.271 [0.152]* Yes Yes Yes Yes 2,108 0.543 -0.516 [0.120]*** 0.193 [0.134] Yes Yes Yes Yes 1,644 0.771

Loan Ocer Fixed Eects Supervisor Fixed Eects Week Fixed Eects Loan Fixed Eects Number of Observations R-Squared

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Table 8: Treatment Eects: Quality of Lending Decisions

This table shows treatment eects on the quality of approved loans. The omitted category in each regression is the non-supervised baseline treatment. In column (1), the dependent variable is a dummy indicating whether a loan was approved (escalated) by the agent. In column (2) the dependent variable is a dummy indicating whether a loan was approved by the principal. In column (3) the dependent variable is a dummy indicating the nal lending decision. The dependent variable in column (4) is the principal amount approved, denominated in US$ 1000 and equal to zero if a loan was declined. In column (5) the dependent variable is the loan amount approved, denominated in units of US$ 1000 and the sample is restricted to approved loans. In addition to the variables listed, I control for the ve randomization strata from which assigned treatments were drawn and an indicator for the experimental lab. Standard errors are clustered at the individual and session level. * denotes statistical signicance at 10 %, ** 5 % and *** 1 %.

Dependent Variable

Agent Pr[Approve=1] OLS (1)

Principal Pr[Approve=1] OLS (2)

Final Decision Pr[Approve=1] OLS (3)

Lending Volume USD[000] OLS (4)

Ticket Size USD[000] OLS (5)

Baseline [Non-Supervised] Supervisor Aligned Supervisor Bad LoanSupervisor Bad Loan Aligned Supervisor Bad Loan 0.070 [0.040]* 0.062 [0.033]* 0.014 [0.052] -0.131 [0.052]** -0.110 [0.029]*** 0.021 [0.029] -0.157 [0.039]*** -0.019 [0.058] -0.037 [0.041] 0.064 [0.034]* -0.067 [0.052] -0.094 [0.053]* -0.160 [0.200] 0.247 [0.194] -0.488 [0.264]* -0.315 [0.347] -0.067 [0.179] Yes No Yes Yes 2,517 0.370 Yes Yes Yes Yes 1,830 0.488 Yes Yes Yes Yes 2,517 0.412 Yes Yes Yes No 2,108 0.143 -0.098 [0.178] 0.049 [0.184] -0.196 [0.226] 0.008 [0.336] -0.162 [0.148] Yes Yes Yes No 1,475 0.164

Loan Ocer Fixed Eects Supervisor Fixed Eects Week Fixed Eects Loan Fixed Eects Number of Observations R-Squared

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Table 9: Treatment Eects: Loan Level Prot

This table shows treatment eects on the protability of lending. The omitted category in each regression is the nonsupervised baseline treatment. The dependent variable in column (1) is the Lenders prot per loan and the sample is restricted to loans that were approved. In column (2) the dependent variable is the lenders return on assets at the loan level, dened as the net prot over the principal amount for each loan and I consider only loans that were approved. In column (3) the dependent variable is prot per loan, denominated in US$ 1000 and equal to zero if a loan was declined. Columns (4) and (5) provide upper and lower bound estimates of the eect, replacing missing observations in the outcome variable for les rejected by the lender, replacing the outcome variable for these observations with the top and bottom decile of the prot distribution. In addition to the variables listed, I control for the ve randomization strata from which assigned treatments were drawn and an indicator for the experimental lab. Standard errors are clustered at the individual and session level. * denotes statistical signicance at 10 %, ** 5 % and *** 1 %.

Prot per Loan [US$ 000] OLS (1) Baseline [Non-Supervised] Supervisor 0.266 [0.152]* 0.250 [0.135]* Yes No Yes Yes 1,475 0.110

ROA per loan OLS (2)

Prot [US$ 000] OLS (3)

Prot Lower Bound OLS (4)

Prot Upper Bound OLS (5)

0.081 [0.040]** 0.059 [0.038] Yes Yes Yes Yes 1,475 0.104

0.132 [0.102] 0.228 [0.091]** Yes Yes Yes Yes 2,105 0.077

0.073 [0.092] 0.203 [0.078]*** Yes Yes Yes No 2,514 0.042

0.108 [0.090] 0.204 [0.085]** Yes Yes Yes No 2,514 0.067

Aligned Supervisor

Loan Ocer Fixed Eects Supervisor Fixed Eects Week Fixed Eects Loan Fixed Eects Number of Observations R-Squared

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Appendix Tables

Table A1: Test of Random Assignment

This table provides a test of random assignment. The table shows the mans of observable pre-treatment characteristics for the population of paerticipating loan ocers for the baseline and each treatment. Reported p-values (in brackets) correspond to a test for a dierence in means between the baseline and each treatment and are obtained from least squares regressions, controlling for treatment condition and an indicator variable for the experimental lab at which the experiment was carried out. Standard errors are clustered at the loan ocer level. * indicates a dierence in means signicant at the 10 %, ** 5 % and *** 1 % level.

Baseline (N=1,629) Mean SE Male Age Education [Masters Degree] Experience in Bank [Years] Rank [1-5] Branch Manager Experience Business Experience 0.94 46.18 0.31 21.30 2.02 0.56 0.69 [0.006] [0.289] [0.013] [0.296] [0.026] [0.014] [0.013]

Treatment Supervisor Basic (N=786) Mean p > |t | 0.961 42.73 0.291 18.54 2.13 0.488 0.627 [0.294] [0.242] [0.863] [0.189] [0.104] [0.990] [0.275]

Supervisor Aligned (N=627) Mean p > |t| 0.901 43.15 0.328 18.58 2.03 0.443 0.610 [0.380] [0.854] [0.566] [0.238] [0.285] [0.669] [0.145]

Table A2: Participation

This table reports participation rates in the experiment. The rst column shows the total number of loan ocers contacted by bank, the second column shows the percentage of loan ocers who participated in the experiment. Columns (3) and (4) summarize the average rank and years of experience of the participating loan ocers by bank.

Invited Bank of Baroda State Bank of India Punjab National Bank Bank of India Other Banks 127 76 31 11 10

Participated (%) 0.69 0.39 0.35 0.82 0.70

Mean Rank (1-5) 2.25 2.06 2.00 2.22 2.00

Mean Experience (Years) 13.71 14.77 23.93 30.84 18.25

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Table A3: Representativeness of Loan Ocers

This table examines the representativeness of loan ocers participating in the experiment by comparing the demographic characteristics of the participant pool with the employee population of a large commercial bank. The bank dataset covers all employees of one of the ve largest Indian commercial banks in the administrative region where the experiment was conducted. Summary statistics from the bank dataset refer to all of the banks credit ocers, branch managers and employees serving in a credit assessment role. Columns (1) to (3) report descriptive statistics for the participant pool. Columns (4) to (6) report the corresponding statistics from the bank dataset.

Experimental Participants (N=125) Mean Median StdDev Male Age Experience in Bank [Years] Rank [1-5] Branch Manager Experience 0.95 44.06 20.03 2.05 0.49 1.00 47.00 23.00 2.00 0.00 0.21 11.05 10.83 0.90 0.50

Bank Employee Dataset (N=5,111) Mean Median StdDev 0.93 46.60 22.99 2.31 0.62 1.00 51.00 27.00 2.00 1.00 0.24 10.20 10.96 0.92 0.48

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