Interlinkage, Limited Liability, and Strategic Interaction

June 1999 - When will a landlord prefer to supply both land and credit to a tenant rather than allow the lender to borrow from a separate moneylender? The paper shows that if tenancy contracts are obtained prior to contracting with the moneylender, and the tenant has limited liability, interlinked d...

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Bibliographic Details
Main Author: Basu, Kaushik
Other Authors: Bell, Clive, Bose, Pinaki
Format: eBook
Language:English
Published: Washington, D.C The World Bank 1999
Subjects:
Online Access:
Collection: World Bank E-Library Archive - Collection details see MPG.ReNa
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653 |a Macroeconomics and Economic Growth 
653 |a Financial Literacy 
653 |a Finance 
653 |a Discount 
653 |a Credit Contract 
653 |a Option 
653 |a Moral Hazard 
653 |a Unlimited Liability 
653 |a Social Protections and Labor 
653 |a Instrument 
653 |a Discount Rates 
653 |a Contract Law 
653 |a Law and Development 
653 |a Contractual Obligations 
653 |a Amount Of Cred Borrower 
653 |a Debt Markets 
653 |a Default 
653 |a Finance and Financial Sector Development 
653 |a Moneylender 
653 |a Risk Neutral 
653 |a Economic Theory and Research 
653 |a Loan 
653 |a Labor Policies 
653 |a Contracts 
653 |a Limited Liability 
653 |a Instruments 
653 |a Risk Aversion 
653 |a Loan Contracts 
700 1 |a Bell, Clive 
700 1 |a Basu, Kaushik 
700 1 |a Bose, Pinaki 
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520 |a June 1999 - When will a landlord prefer to supply both land and credit to a tenant rather than allow the lender to borrow from a separate moneylender? The paper shows that if tenancy contracts are obtained prior to contracting with the moneylender, and the tenant has limited liability, interlinked deals will predominate over the alternative situation where the landlord and the moneylender act as noncooperative principals. Basu, Bell, and Bose analyze the example of a landlord, a moneylender, and a tenant (the landlord having access to finance on the same terms as the moneylender). It is natural to assume that the landlord has first claim on the tenant's output (as a rule, if they live in the same village, he may have some say in when the crop is harvested). The moneylender is more of an outsider, not well placed to exercise such a claim. A landless, assetless tenant will typically not get a loan unless he has a tenancy. Without interlinkage, the landlord is likely to move first.  
520 |a But uniform payoffs for the first mover are not essential for allocative efficiency if he is the only principal with a continuously variable instrument of control. So, the main result is sensitive to changes in the order of play but not to changes in the priority of claims. This paper - a product of the Office of the Senior Vice President and Chief Economist, Development Economics - is part of a larger effort in the Bank to understand the institutional structure of rural markets and its welfare implications. The authors may be contacted at kbasu@worldbank.org, clive.bell@urz.uni-heidelberg.de, or psbose@cc.memphis.edu 
520 |a In the noncooperative sequential game where the landlord is the first mover and also enjoys seniority of claims if the tenant defaults, interlinkage is superior, even if contracts are nonlinear - a result unchanged with the incorporation of moral hazard. The main result is that if a passive principal - one whose decisions are limited to exercising his property rights to determine his share of returns - is the first mover, allocative efficiency is impaired unless his equilibrium payoffs are uniform across states of nature. The limited liability of the tenant creates the strict superiority of interlinkage by making uniform rents nonoptimal when, with noncollusive principals, the landlord (the passive principal) is the first mover. A change in seniority of claims from the first to the second mover (the moneylender) further strengthens this result.