The Economics of Debt Collection: Enforcement of Consumer Credit Contracts

In the U.S., third-party debt collection agencies employ more than 140,000 people and recover more than $50 billion each year, mostly from consumers. Informational, legal, and other factors suggest that original creditors should have an advantage in collecting debts owed to them. Then, why does the debt collection industry exist and why is it so large? Explanations based on economies of scale or specialization cannot address many of the observed stylized facts. The authors develop an application of common agency theory that better explains those facts. The model explains how reliance on an unconcentrated industry of third-party debt collection agencies can implement an equilibrium with more intense collections activity than creditors would implement by themselves. The authors derive empirical implications for the nature of the debt collection market and the structure of the debt collection industry. A welfare analysis shows that, under certain conditions, an equilibrium in which creditors rely on third-party debt collectors can generate more credit supply and aggregate borrower surplus than an equilibrium where lenders collect debts owed to them on their own. There are, however, situations where the opposite is true. The model also suggests a number of policy instruments that may improve the functioning of the collections market.