This study examines the dynamic incentive paradox in microfinance, the tension whereby incentives that improve loan repayment discourage risky, high-return investments needed to escape poverty, and investigates whether an endogenously chosen contract rule can resolve it. We conducted a lab-in-the-field experiment with 60 active microfinance borrowers in Isfahan Province, Iran, across ten treatments varying liability structure, dynamic incentives, and peer mechanisms, yielding a panel dataset of 5,235 observations analyzed with borrower fixed-effects models. Consistent with the dynamic incentive paradox in this sample, dynamic incentives were associated with reductions in both risky-project selection and default rates, but the reduction in risk-taking consistently and substantially exceeded the reduction in default, pointing to a net cost to borrowers' earning capacity. This effect was strongest under peer monitoring and individual liability, and weaker when borrowers could communicate freely or endogenously choose group members. Prior to two of the ten treatments, borrower groups had the option of adopting an equal-sharing profit rule; groups that did so saw significantly higher risk-taking and cumulative earnings without a proportional rise in default, indicating that this self-selected rule functioned as an effective intra-group insurance mechanism even under dynamic-incentive pressure. Young women with a prior debt history were the most sensitive to the suppressive effects of dynamic incentives, while the magnitude of the paradox varied with socio-institutional context and borrower characteristics. These findings suggest that sustainable microfinance contract design may benefit from project failure insurance, multidimensional performance metrics, and demographically informed group structures, alongside greater borrower autonomy in setting profit-sharing rules.
Bagheri, F. , Moghadam, V. and Amiri, H. (2026). When Risk Reduction Limits Opportunities to Escape Poverty (Mechanism Design in Microfinance Using Experimental Economics). Iranian Journal of Economic Studies, (), -. doi: 10.22099/ijes.2026.56623.2138
MLA
Bagheri, F. , , Moghadam, V. , and Amiri, H. . "When Risk Reduction Limits Opportunities to Escape Poverty (Mechanism Design in Microfinance Using Experimental Economics)", Iranian Journal of Economic Studies, , , 2026, -. doi: 10.22099/ijes.2026.56623.2138
HARVARD
Bagheri, F., Moghadam, V., Amiri, H. (2026). 'When Risk Reduction Limits Opportunities to Escape Poverty (Mechanism Design in Microfinance Using Experimental Economics)', Iranian Journal of Economic Studies, (), pp. -. doi: 10.22099/ijes.2026.56623.2138
CHICAGO
F. Bagheri , V. Moghadam and H. Amiri, "When Risk Reduction Limits Opportunities to Escape Poverty (Mechanism Design in Microfinance Using Experimental Economics)," Iranian Journal of Economic Studies, (2026): -, doi: 10.22099/ijes.2026.56623.2138
VANCOUVER
Bagheri, F., Moghadam, V., Amiri, H. When Risk Reduction Limits Opportunities to Escape Poverty (Mechanism Design in Microfinance Using Experimental Economics). Iranian Journal of Economic Studies, 2026; (): -. doi: 10.22099/ijes.2026.56623.2138
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