Corporate Finance Through Loyalty Programs

Abstract

Loyalty programs (LPs) are widely prevalent and typically analyzed in economic research for their role in boosting income. This paper uncovers a novel role of LPs as financing instruments. The rewards issued to and redeemed by consumers cause shifts in firms’ present and future cash flows, effectively creating a form of borrowing from consumers. We document three stylized facts about LPs in the airline and hotel industries: 1) LPs serve as significant financing sources, with co-branded credit card programs contributing a large portion; 2) rewards are issued through broad consumption but are redeemed predominantly for consumption related to the issuing firm; 3) LPs generate countercyclical cash flows. We then build a dynamic model of LPs as financing instruments. The model features convenient rewards, which consumers can freely redeem. As a result, the funds raised through LPs emerge endogenously in equilibrium as a result of the interplay between reward issuance and redemption. The model suggests that 1) firms supplying high-value, low-frequency services can leverage LPs more effectively for financing; 2) LP financing has special cyclical natures that are attractive to highly cyclical firms; 3) firms should aim to decouple reward issuance from their business; 4) firms should limit consumers’ discretion to purchase or transfer rewards.