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

47 Pages Posted: 19 Oct 2020 Last revised: 9 Sep 2022

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 dealer compensation in the indirect auto lending market, where most lenders give dealers the discretion to mark up interest rates and the markup constitutes a dealer's compensation. To protect consumers from potential discrimination by this dealer discretion, several banks adopted a policy that removes dealer discretion and compensates dealers by a fixed percentage of the loan amount. We document that this policy decreased (increased) the interest rates for low-credit (high-credit) consumers; however, the market share of these banks also decreased (increased) in low-credit (high-credit) segments — a reversal of the usual demand curve. This reversal highlights a significant influence of auto dealers on consumer choices. Accordingly, we develop an empirical model that features dealer–consumer bargaining. Our estimation results show systematically different levels of bargaining power across consumer groups. We use the model to explore alternative compensation schemes that remove dealer discretion. We find that a lump-sum compensation scheme obtains the most market share. In addition, the optimized lump-sum scheme improves consumer welfare compared to the adopted policy. Our study highlights the importance of accounting for the incentives and bargaining power of middlepersons.

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 California 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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