CFI in Focus: Incentives and Debt Repayment in Consumer Bankruptcy

In our first study, “Reducing Strategic Default in a Financial Crisis,” we examine how increasing the penalty for default affects future default on consumer proposals, which are debt repayment plans available to distressed and insolvent debtors in Canada. We show that a higher default penalty reduces subsequent default, which suggests that not all defaults are the result of unfortunate events a borrower faces and that some defaults are what economists sometimes call “strategic.” The second study, “Debtor Income Manipulation in Consumer Credit Contracts,” examines how requiring debtors to make higher repayment to creditors based on their income can induce some borrowers to misreport their income. These behaviors are important to understand because similar incentives exist in many other settings. For example, the potential for strategic default appears in studies of various credit markets, such as mortgages, credit cards, and auto loans, but it is difficult to measure because strategic defaulters are not willing to reveal their motivation. Similarly, the incentive to misreport income may exist in other settings.