Designing Dealer Compensation in the Auto Loan Market: Implications from a Policy Experiment

32 Pages Posted: 19 Oct 2020

See all articles by Zhenling Jiang

Zhenling Jiang

University of Pennsylvania - The Wharton School

Yanhao 'Max' Wei

University of Southern California - Marshall School of Business

Tat Chan

Washington University in St. Louis - John M. Olin Business School

Naser Hamdi

Equifax, Inc.

Date Written: September 29, 2020

Abstract

We study the design of dealer compensation policy in the indirect auto lending market, where most lenders give dealers the discretion to mark up interest rates. To protect consumers from potential discrimination by the dealer discretion, several banks switched to a new compensation scheme by fixing the markup as a percentage of the loan amount. We document that the market share of these banks responded positively (negatively) in the consumer segment where the policy increased (decreased) the interest rate — a reversal of the usual demand curve — which highlights the influence of dealers on the bank choice for financing loans. Accordingly, we develop and estimate an empirical model that allows for dealer–consumer bargaining, which depends on both the dealers' and the consumers' utility. Based on the estimation results, we explore alternative compensation policies that also eliminate dealers' discretion. We show that a lump-sum compensation that pays dealers a fixed dollar amount per loan dominates the current policy for the banks in terms of gaining market share. This is because dealers' equivalent markup rates would better align with their bargaining power. Our study highlights the importance of accounting for the interests and bargaining power of middlemen in designing a compensation scheme.

Keywords: auto loan, interest-rate markup, dealer compensation, consumer protection, Nash bargaining

Suggested Citation

Jiang, Zhenling and Wei, Yanhao and Chan, Tat and Hamdi, Naser, Designing Dealer Compensation in the Auto Loan Market: Implications from a Policy Experiment (September 29, 2020). Available at SSRN: https://ssrn.com/abstract=3702092 or http://dx.doi.org/10.2139/ssrn.3702092

Zhenling Jiang (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Yanhao Wei

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA 90089
United States

Tat Chan

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Naser Hamdi

Equifax, Inc. ( email )

Atlanta, GA
United States

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