The Economics of Debt Collection: Enforcement of Consumer Credit Contracts

Abstract

In the U.S., creditors often outsource the task of obtaining repayment from defaulting borrowers to third-party debt collection agencies. This paper argues that an important incentive for this is creditors’ concerns about their reputations. Using a model along the lines of the common agency framework, we show that, under certain conditions, debt collection agencies use harsher debt collection practices than original creditors would use on their own. This appears to be consistent with empirical evidence. The model also fits several other empirical facts about the structure of the debt collection industry and its evolution over time. We show that the existence of third-party debt collectors may improve consumer welfare if credit markets contain a sufficiently large share of opportunistic borrowers who would not repay their debts unless faced with “harsh” debt collection practices. In other cases, the presence of third-party debt collectors can result in lower consumer welfare. The model provides insight into which policy interventions may improve the functioning of the collections market.