Product Sales Incentive Spillovers to the Lending Market

Abstract

Automotive manufacturers are known to use deadline-based convex incentives to motivate dealerships to sell new cars. This paper shows that dealerships respond to these incentive targets by pushing customers from used to new cars as the end of the month approaches, and that subprime loans written to finance these end-of-the-month purchases default more often, particularly when written for financially constrained buyers. We also show that the new car buyers at the end of the month are more likely to default because they are sold less reliable models, and are less likely to be covered by insurance that protects them in the event of default. Although consumers undoubtedly bear costs from increased defaults, we find no evidence that the dealerships, or the lenders that purchase these loans, are hurt by the increase in defaults. Our results demonstrate how convex incentives in vertical contract structures can induce gaming behavior with spillover costs to third parties in the supply chain or retail channels.

Keywords: household finance, incentives, auto loans, subprime, agency problems

JEL Classification: D82, G29, G32, G34, L14, R30