Communication and hidden action : evidence from a person-to-person lending experiment

We report the results of a laboratory experiment which examines the impact of precontractualcommunication in person-to-person lending. We show that potential hiddenaction undermines the positive effect of communication on repayment behavior and creditprovision. When strategic defaults by borrowers are revealed to lenders, pre-contractualcommunication reduces strategic default and increases credit provision. When strategicdefaults are hidden behind a veil of uncertainty, we find a substantially weaker impact ofcommunication. Borrowers are more likely to renege on repayment promises when theycan hide opportunistic behavior from lenders. These findings have important implicationsfor the design of lending relationships and procedures: Pre-contractual communicationand post-contractual monitoring go hand in hand