Information Disclosure, Cognitive Biases and Payday Borrowing

TL;DR: In this paper, the authors study whether and what information can be disclosed to payday loan borrowers to lower their use of high-cost debt via a field experiment at a national chain of payday lenders.

Abstract: If people face cognitive limitations or biases that lead to financial mistakes, what are possible ways lawmakers can help? One approach is to remove the option of the bad decision; another approach is to increase financial education such that individuals can reason through choices when they arise. A third, less discussed, approach is to mandate disclosure of information in a form that enables people to overcome limitations or biases at the point of the decision. This third approach is the topic of this paper. We study whether and what information can be disclosed to payday loan borrowers to lower their use of high-cost debt via a field experiment at a national chain of payday lenders. We find that information that helps people think less narrowly (over time) about the cost of payday borrowing, and in particular information that reinforces the adding-up effect over pay cycles of the dollar fees incurred on a payday loan, reduces the take-up of payday loans by about 10 percent in a 4 month-window following exposure to the new information. Overall, our results suggest that consumer information regulations based on a deeper understanding of cognitive biases might be an effective policy tool when it comes to regulating payday borrowing, and possibly other financial and non-financial products.

Summary

Introduction

• 0 We study whether additional, psychology-guided information disclosure induces payday borrowers to lower their use of high-cost debt a field experiment at a national chain of payday lenders.the authors.
• Ohio recently enacted a law limiting implied APRs of payday lending to 28%.
• Fees associated with payday loans, might not have self-control problems, might not suffer from overly optimistic expectations about their ability to repay these loans, and instead might decide to borrow from payday lenders at high interest rates because they face a pressing need for cash at a moment when they lack access to other, cheaper, forms of financing.
• The authors design three information treatments that incorporate important behavioral principles from the psychology and economics literatures about the possible cognitive lapses payday borrowers might be making, and ways to de-bias for those lapses.
• In addition to the three information treatments, the authors also introduce a self control treatment via a savings planner; the goal of including a savings planner is to see whether giving people a tool to help them take active steps to get out of debt can reinforce the effectiveness of information conveyance.

Borrowing Process and Intervention

• A quick overview of the payday loan process is useful background information as a precursor to their intervention.
• This fee does not vary by the length of the loan or borrower risk.
• The loan process begins when the customer approaches a counter or window where a customer service representative (CSR) works and requests a new loan or a refinancing of an existing loan.
• First, as the customer hands the application and support materials to the CSR, the CSR asks the customer if she would like to participate in a short 4-question survey in exchange for a year's subscription to a magazine of her choice.
• The authors main intervention is to have the CSRs replace the usual cash envelopes with custom envelopes printed with information treatments, which the authors describe momentarily.

Treatments

• The authors use three different information treatments to be printed on the cash envelopes.
• These information treatments are presented as Figure 2.
• People might confuse the fee structure they face when taking out a payday loan for the APR.
• Like the Dollar Treatment presented above, this treatment gets borrowers to take a broader look at the payday borrowing decision, and may therefore also partly undo borrowers’ tendency to apply too narrow a decision frame.

Treatment Randomization & Participant Characteristics

• The authors design the experiment to be implemented at 100 stores of a large national payday lending chain.
• Because it would be very difficult for CSRs to accurately keep track of which treatment each customer receives in a hectic store setting, the authors choose to randomize treatments at the store-day level.
• Within the states with multiple districts, the authors pick districts randomly but restrict each state to a maximum of two districts.
• All but one district of interventions took place before the first week of July.
• Table 1 present summary statistics of the administrative data, which show that 72% of borrowers are paid on a similar cycle (bi-weekly or semi-monthly) and that customers borrowed on average 9 times in the prior year, averaging $372 in loan amount.

III. Financial Literacy of Payday Borrowers: Some Survey Evidence

• In October 2008, the authors conducted a short phone survey of all consenting participants.
• The phone survey was conducted by PB Research, a firm with experience handling their demographic of customers.
• That does not mean, however, that individuals fully digest and comprehend the implication of this fee structure.
• About half of the phone survey participants said they did not know what APR is on the typical payday loan in their area and about 40 percent said they did not know what the fees are for borrowing $300 for 3 months.
• In contrast, most (about 90 percent) provided an answer to question (iii) (how long it takes the average person to pay back in full).

IV. Empirical Specification

• The authors main dependent variable is a dummy variable for whether or not an individual borrows in a given pay cycle (Indicator for Loan).
• Given that over seventy percent of borrowers are bi-weekly or semi-monthly, it must be that a good portion of individuals are not just reporting back their pay cycle.
• The authors include as controls both store*year fixed effects to account for regional fluctuations in borrowing activity and day-of-the-week fixed effects to account for the possibility that different days of borrowing may imply more-or-less constrained borrowing.
• Because the authors rely on individual data but randomize at the store level, they need to account for the correlation of outcomes across individuals within the same store (Moulton, 1990).
• Estimate a Tobit model to handle the truncation.

Main Results

• For these specifications, the authors use the “balanced” panel described above and estimate treatment effects across all post-intervention pay cycles.
• The F-test for joint significance of the treatments has a p-value of 0.084 when testing the information treatments and the saving planner treatments and a p-value of 0.053 when testing just the three information treatments.
• On the one hand, it is possible that the effect of the information is short-lived.
• The authors separately study how the treatments effect borrowing one cycle post-intervention (t=intervention cycle +1), 2 cycles post-intervention (t=intervention cycle+2), and 3 or more cycles post-intervention (t>intervention cycle+2; that is until the last period included in the administrative data).
• The authors obtained information on number of competing stores by zip code from the directories of payday stores that are maintained by the bank regulator in each State (some of which they could directly download from the web, others they had to call the States to obtain).

Heterogeneity of Effects across Groups of Borrowers

• The authors ask whether information disclosure differentially impacts individuals according to the information they provided on the in-store survey.
• Third, the authors have a discrete measure of whether the payday loan funds are for gratification items (gifts, apparel, electronics, eating out or vacations), as identified in Parker (1999) and Souleles (1999).
• For this last dimension though, perhaps due to poor wording of the question, the majority of individuals responded exactly the length of the loan term; thus, the best the authors can do is to categorize those who expect a longer than one pay cycle payback time (measured as >1.33*cycle to handle weekends) into the category of “long expected payback time” individuals.
• 18 The literature vigorously criticizes split analyses and, in particular, dichotomizing continuous variables because of the loss of power and possible bias (Maxwell and Delaney, 1993; Irwin and McClelland, 2001).
• The general message is of a larger point estimate and more precise response to the Dollar Information treatment among individuals with higher self-reported self-control levels, or those not using the loan for gratification purposes.

VI. Conclusion

• Even though the payday product appears quite transparent (especially when compared to other consumer financial products), their results suggest that information disclosure that is inspired by, and responds to, cognitive biases or limitations that surround the payday borrowing decision has a significant effect on individuals’ decisions of whether or not they end up taking out a payday loan.
• An Explanation for Preference Reversals between Joint and Separate Evaluations of Alternatives, also known as The Evaluability Hypothesis.
• Lusardi, A., Mitchell, O., Saving and the Effectiveness of Financial Education.
• The Real Costs of Credit Access: Evidence from the Payday Lending Market.

Figures

Figure 3: Savings Planner Treatment

Table 4: Dynamic Effects of Treatments and Savings Planner on Payday Borrowing Activity

Figure 1: Consent Form

Table 5: Effect of Information Treatments with Splits by Individual Heterogeneities

Figure 4: Phone Survey Financial Literacy Histograms

Table 1: Characteristics of Intervention Participants and Non-Participants

Table 2: Effect of Information Treatments and Savings Planner on Indicator for Taking out a Loan

Figure 2: Information Treatment Envelopes

Table 3: Effect of Information Treatments and Savings Planner on Amount Borrowed

Full text

0
Information Disclosure, Cognitive Biases and Payday Borrowing
Marianne Bertrand
(University Chicago Booth School of Business, NBER, CEPR and IZA)
Adair Morse
*
(University of Chicago Booth School of Business)
First Version: March 2009
This Version: July 2010
Abstract
We study whether additional, psychology-guided information disclosure induces payday
borrowers to lower their use of high-cost debt a field experiment at a national chain of payday
lenders. We find that information that helps people think less narrowly (over time) about the cost
of payday borrowing, and in particular information that reinforces the adding-up effect over pay
cycles of the dollar fees incurred on a payday loan in comparison to the fees on other financial
instruments, reduces the take-up of payday loans by about 11 percent in a 4 month-window
following exposure to the new information.
*
Both authors are from the Booth School of Business, University of Chicago, 5807 S. Woodlawn Avenue, Chicago,
IL 60637. Contact emails are marianne.bertrand@ChicagoBooth.edu and adair.morse@ChicagoBooth.edu. We
thank the Initiative on Global Markets at the University of Chicago, the National Poverty Center at the University of
Michigan, the Templeton Foundation, the William Ladany Memorial Faculty Research Fund, the Center for
Research on Security Prices, and the Stigler Center for financial support. We also would like to thank a number of
people for helpful comments, including John Caskey, Shawn Cole, Todd Gormley, Victoria Ivashina, AnnaMaria
Lusardi, Tavneet Suri, Jeremy Tobacman, Peter Tufano, John Zinman, and seminar or conference participants at
Booth School of Business, the CEPR-Gerzensee Asset Pricing Week, Copenhagen Business School, the University
of Illinois at Chicago, the European Finance Association Summer Meetings, the FDIC-JFSR Bank Research
Conference, the Federal Trade Commission, the Milton Freidman Conference on Finance and Development, the
National Poverty Center Spring 2009 Conference, the NBER Summer Institute in Corporate Finance, the NBER
Behavioral Finance Group, the NBER Household Finance Group, the Norwegian School of Management, the
Philadelphia Federal Reserve Conference on Recent Developments in Consumer Credit and Payments, the
Stockholm School of Economics and Wharton.

1
I. Introduction
In 2007, Americans paid an estimated
1
$8 billion in financial charges to borrow $50
billion from payday lenders. In a typical payday loan transaction, a borrower receives cash from
the payday lender in exchange for an authorization to draw the cash advance plus a fixed fee of
$15-$17 for every $100 of loan from the borrower’s bank account on the next pay check date.
2
Annualizing this fee reveals that payday loans are indeed expensive, with implied APRs (annual
percentage rates) usually well over 400%. Industry insiders contend that transaction costs are
high due to the short-term, high-risk nature of bridge loans. Consumer advocates argue that
payday lenders prey on those that are so financially illiterate or unsophisticated that they are
willing to take up such expensive loans. This predatory view has motivated some drastic state
and federal legislation. For example, Ohio recently enacted a law limiting implied APRs of
payday lending to 28%. At the federal level, the Military Lending Act that took effect in 2007
also caps annual interest rates at 36% for payday loans made to military personnel and their
family.
3
Empirical research has not been able to ascertain whether such a predatory view of
payday lending is warranted.
4
1
According to the Los Angeles Times, December 24, 2008.
Indeed, the simple fact that individuals take out payday loans,
even for relatively extended periods of time, certainly does not prove that these individuals are
being fooled or preyed upon by payday lenders. Individuals might be fully informed about the
2
Technically, payday loans operate on a fee system, not explicit interest rates, which is why usury laws do not apply.
However, because they are loans, the implied interest rate is the usual point of reference.
3
A 36% APR does not cover default for payday lenders; thus these legislations eliminate payday lending. As a point
of reference for the magnitude of payday interest rates, a recent compilation of data collected from 1400
microfinance institutions worldwide concludes that the median microfinance loan is less than 30% APR and ranges
only up to 85% APR (Rosenberg, Gonzalez, and Narain, 2009). Even with a self-reporting bias, this suggests that
payday loans are very expensive on a microfinance scale. Perhaps a more telling comparison would be other fee-
based finance, such as overdraft and ATM fees.
4
Morse (2007); Morgan and Stain (2007); Skiba and Tobacman (2007); Melzer (2008), Zinman (2009).

2
fees associated with payday loans, might not have self-control problems, might not suffer from
overly optimistic expectations about their ability to repay these loans, and instead might decide
to borrow from payday lenders at high interest rates because they face a pressing need for cash at
a moment when they lack access to other, cheaper, forms of financing.
5
Under the view that the people borrowing from payday lenders are making an informed,
utility-maximizing choice given the constraints that they face, one would not expect additional
information disclosure about the payday product to alter their borrowing behavior. In contrast, if
all or a subset of payday borrowers are cognitively impaired, one might expect borrowing
behavior to respond to how the costs (and benefits) of the payday products are being disclosed.
Following this logic, we perform a randomized field trial to evaluate whether and how
various ways to present information about the costs of payday loans impact people’s decisions to
continue borrowing from payday lenders. We design three information treatments that
incorporate important behavioral principles from the psychology and economics literatures about
the possible cognitive lapses payday borrowers might be making, and ways to de-bias for those
lapses. The first treatment strengthens the already existing mandate on APR disclosure on
payday loan transactions by directly comparing the APR on a payday loan with the APR on
others financial instruments consumers are familiar with – car loan, credit card and subprime
mortgage APRs. The second treatment provides borrowers with information about the
accumulated fees (in $ terms) for having a $300 payday loan outstanding for 2 weeks, 1 month,
2 months, or 3 months (this figure is $270); this information is compared with information on the
equivalent fees for borrowing the same amount on a credit card. The last treatment presents
5
Rampini and Viswanathan (2009, forthcoming) provide a theoretical formalization of why firms or households of
low net worth may rationally insure less and be willing to pay very high rates to cover financing needs arising from
the durable goods they use in production (for example, borrowing however much is required to fix a broken car
when that car is the only way to get to work).

3
customers with information on the typical repayment profile for payday borrowers, reported in a
frequency format, e.g. the frequency distribution of time to repayment of a given loan. In
addition to the three information treatments, we also introduce a self control treatment via a
savings planner; the goal of including a savings planner is to see whether giving people a tool to
help them take active steps to get out of debt can reinforce the effectiveness of information
conveyance.
The implementation and evaluation of these various information treatments was made
possible because of the unique access we obtained to one the largest payday lending companies
in the U.S. Specifically, we were given access to all the customers that entered one of 77 stores
of the lender spanning eleven states over a period of two weeks. We randomized the information
treatments and planner treatment at the store-day level, thereby eliminating concerns about
heterogeneity in the payday borrowing population across stores or days of the week.
Approximately four months after the intervention, the lender provided us (after getting consent
from the borrowers themselves) with administrative data on all transactions the participating
borrowers engaged in with the lender before and after our intervention.
We find that individuals receiving the dollar adding-up treatment are 5.9 percentage
points less likely to borrow from the payday lender in the pay cycles that follow the intervention.
(This represents an 11 percent decline relative to the control group.) Individuals who receive any
of the three information treatments reduce borrowing amounts; in particular, Dollar, APR and
Refinancing Information treatments reduce borrowing on average by $55, $38, and $28
respectively in each pay cycle (representing declines of 23, 16 and 12 percent relative to the
control). We find no effect of the savings planner on borrowing behavior, and no evidence that
the savings planner reinforce the effectiveness of information disclosure. When studying

4
heterogeneity in treatment effect across borrower characteristics, we find that borrowers without
a college education and those with higher self-control (on two self-reported measures) respond
more strongly to the information disclosure.
Hence, in contrast with the view that all payday borrowing reflects informed and rational
behavior, our results suggest that information disclosure that is inspired by, and tries to respond
to, the specific cognitive biases and limitations that may surround the payday borrowing decision
has a non-trivial effect on some individuals’ decisions of whether or not to take on a payday loan.
Because our information treatments are mixtures of behavioral principles, we cannot isolate a
precise mechanism for the borrowers’ response. It appears though that getting consumers to think
more broadly about the decision to take up a payday loan, either by stressing how the fees
accompanying a given loan add up over time or, by presenting comparative cost information to
increase evaluability, or to a lesser degree, by disclosing information on the typical repayment
profile of payday borrowers results in a reduction in the amount of payday borrowing.
The rest of the paper proceeds as follows. Section II lays out our research design,
including a more detailed presentation of the experimental setting and experimental treatments.
Survey evidence of the financial literacy of payday borrowers is presented in Section III. Section
IV outlines our empirical methodology, and the results are presented in Section V. We conclude
(Section VI) with a discussion of the economic magnitude of our results, especially in light of the
intense policy debate surrounding the payday lending industry.
II. Research Design
Borrowing Process and Intervention
A quick overview of the payday loan process is useful background information as a
precursor to our intervention. When a customer enters a payday loan store desiring, on average,

Frequently asked questions

Q1. What are the contributions mentioned in the paper "Information disclosure, cognitive biases and payday borrowing" ?

The authors study whether additional, psychology-guided information disclosure induces payday borrowers to lower their use of high-cost debt a field experiment at a national chain of payday lenders. The authors find that information that helps people think less narrowly ( over time ) about the cost of payday borrowing, and in particular information that reinforces the adding-up effect over pay cycles of the dollar fees incurred on a payday loan in comparison to the fees on other financial instruments, reduces the take-up of payday loans by about 11 percent in a 4 month-window following exposure to the new information. 

Q2. What is the key strength of the research design?

A key strength of their research design is that the authors have access to administrative records onpayday borrowing activity, and hence do not have to rely on self-reported information. 

Q3. What is the effect of the Dollar treatment on the likelihood of reducing payday borrowing?

it appears that the Dollar treatment mixture of de-biasing the small dollar framing/adding up of costs over time and helping evaluability through comparison to other financial products was most effective at reducing payday borrowing. 

Q4. How many people are reporting back their pay cycle?

Given that over seventy percent of borrowers are bi-weekly or semi-monthly, it must be that a good portion of individuals are not just reporting back their pay cycle. 

Q5. What are the reasons to believe that a formal disclosure policy might be more effective than their experimental?

while the disclosure interventions the authors presented in this paper might be more“flashy” than what typically comes out of the regulatory process, there are also reasons to believe that a formal disclosure policy might be more effective than their experimental interventions. 

Q6. How long does it take to pay off a payday loan?

Although the coefficients are estimated with less precision, it seems that the Dollartreatment takes at least one cycle to take full effect, consistent with the view that it takes some time for people to adjust their budget and manage to pay off their payday loan in response to the information they have been exposed to on intervention day. 

Q7. How many weeks do borrowers report back their pay cycle?

The authors then use the time series of pay stub data to impute no payday borrowing in pay cycles where no transaction occurred, filling in 190,099 no payday borrowing cycles and14 In Figure 4, over 40% of respondents report the answer as being 2 weeks. 

Q8. How much does the dollar treatment reduce the likelihood of borrowing in a cycle?

As for the magnitude of the point estimate, a one-time intervention reduces the likelihoodof borrowing in any cycle post intervention (until October 1, 2008) by 0.059. 

Q9. What is the effect of a list of expenses on the planner?

It is theoretically possible that their decision to include some specific categories of daily and weekly expenses on the planner might in fact have reduced its effectiveness if the listing of such categories inhibited borrowers’ ability to retrieve other, non-listed categories from their memory (see e.g. Alba and Chattopadhyay, 1985).