Moral Hazard, Collusion and Group Lending Jean-Jacques La¤ont1 and

While group lending has attracted a lot of attention, the impact of collusion on the performance of group lending contracts has remained unclear, particularly in moral haz-ard environments. This paper uses a simple model, with risk-neutral agents and limited liability, to clarify this issue and distinguish entrepreneursinformation sharing from col-lusion. Lending e ¢ ciency is enhanced when entrepreneurs mutually observe their e¤orts but reduced when they can collude: lenders thus do not bene\u85t from collusion; rather, information-sharing among the entrepreneurs improves lending even if the entrepreneurs collude but lenders can do even better and actually achieve the \u85rst best if the entre-preneurs observe each others e¤orts and do not collude. When entrepreneurs observe each others e¤orts and collude perfectly simple group lending contracts, based only on realized outputs, are optimal and outperform individual contracts. More sophisticated contracts which use revelation mechanisms to elicit e¤ort levels are thus not useful. This result remains true when agents have only noisy signals of each others e¤orts; however, the e¤ectiveness of group lending contracts increases with the informativeness of the signals. Finally, group lending contracts can help provide monitoring incentives when monitoring the other entrepreneurs e¤ort entails a cost, but become ine¤ective when the cost of monitoring is too high, so that the bank must resort to individual contracts