Grant-giving and the Collective Contract Idea

This paper puts to the test the conjecture that by offering collective con-tracts (contracts to groups of entrepreneurs rather than individual contracts), donor agencies can improve efficiency in discriminating between different types of candidate entrepreneurs and possibly increase the expected returns on their grant investments. Firstly considering exogenously fixed pairs of entrepreneurs, thus leaving aside the endogenous regrouping issue, we derive an efficient col-lective contracting form, which delivers at least as high expected profits (as the individual contracting system) so long as the correlation between the two dimensions of the adverse selection lies below a certain threshold value. We reveal the hidden mechanisms at play in the determination of the contractual terms. In most situations, however, this alternative mechanism is not robust to joint deviations by pairs of entrepreneurs, thus not collusion-proof. This leads us to question whether a collective contracting mechanism can effectively provoke candidate entrepreneurs to undergo a costly search and identification procedure and sort into homogeneous groups, and allocates funds efficiently. Indeed, we identify such a mechanism, yet from the donor’s perspective, a too costly search risks compromising its relative profitability.