Contract Design and Self-Control: Theory and Evidence

Stefano DellaVigna and Ulrike Malmendier

The Quarterly Journal of Economics, 2004, vol. 119, issue 2, 353-402

Abstract: How do rational firms respond to consumer biases? In this paper we analyze the profit-maximizing contract design of firms if consumers have time-inconsistent preferences and are partially naive about it. We consider markets for two types of goods: goods with immediate costs and delayed benefits (investment goods) such as health club attendance, and goods with immediate benefits and delayed costs (leisure goods) such as credit card-financed consumption. We establish three features of the profit-maximizing contract design with partially naive time-inconsistent consumers. First, firms price investment goods below marginal cost. Second, firms price leisure goods above marginal cost. Third, for all types of goods firms introduce switching costs and charge back-loaded fees. The contractual design targets consumer misperception of future consumption and underestimation of the renewal probability. The predictions of the theory match the empirical contract design in the credit card, gambling, health club, life insurance, mail order, mobile phone, and vacation time-sharing industries. We also show that time inconsistency has adverse effects on consumer welfare only if consumers are naive.

Date: 2004
References: Add references at CitEc
Citations: View citations in EconPapers (383)

Downloads: (external link)
http://hdl.handle.net/10.1162/0033553041382111 (application/pdf)
Access to full text is restricted to subscribers.

Related works:
Working Paper: Contract Design and Self Control: Theory and Evidence (2003)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:oup:qjecon:v:119:y:2004:i:2:p:353-402.

Ordering information: This journal article can be ordered from
https://academic.oup.com/journals

Access Statistics for this article

The Quarterly Journal of Economics is currently edited by Robert J. Barro, Lawrence F. Katz, Nathan Nunn, Andrei Shleifer and Stefanie Stantcheva

More articles in The Quarterly Journal of Economics from President and Fellows of Harvard College
Bibliographic data for series maintained by Oxford University Press ().