Fee-based Screening and Referral Programs: Evidence from Credit Card Contracts

Abstract

Banks use tools at their disposal to help direct consumers towards suitable financial products which can in turn enhance the bank’s profitability. We examine the role of two factors that are often jointly used in the financial services industry: contract menus and referral programs. We analyze panel data of over 16,000 credit card accounts and their contract choices between an upfront lump-sum fee without spending requirement, and a card with an annual fee which can be waived each year if a minimum amount is charged to the card. We study consumers’ contract choices, their subsequent card usage and retention as a function of referral status, contract choice, and monthly account usage. Firstly, we find that the bank’s contract menu generally screens customers into the appropriate contract - annual fee cardholders tend to spend more on average, and with lower variance, than lump sum fee cardholders. However, a fraction of annual fee cardholders does not spend enough on the credit card to have their annual fee waived, and subsequently have a high likelihood of cancelling their credit card due to dissatisfaction. We show that referral policies mitigate this issue by helping the bank achieve its objective of screening customers into their most likely appropriate contract. Altogether, our study shows the value of referral programs to both banks and consumers by enhancing the match quality between consumers and their contract choices. 

Keywords: credit card spending, referral status, contract choice, fee structures, retention

JEL Classification: D83, D91, G02, L84