Researchers sought to determine the presence and relative importance of “hidden information” and “hidden action” effects to explain the high rate of default amongst high-risk borrowers in South Africa. In the summer of 2003, the partner lender mailed a brochure to 57,533 former clients with a good repayment history offering a randomly-assigned interest rate, which was conditional on their previous designation as low, medium, or high-risk borrowers—high-risk borrowers were offered high rates, low-risk borrowers low rates. In all, 5028 clients accepted the offer, of which 4348 were approved for a loan.
While meeting with loan officers to determine the conditions of their loan, 41 percent of borrowers were randomly selected to receive an offer for a new interest rate (the contract rate) that was lower than the original offer rate they received in the brochure.
After the loan contracts were finalized, a random 47 percent of the borrowers who had received the lower contract rate were informed that they would receive that same low rate on all future loans for the next year as long as they repaid the initial loan on time. The guaranteed future rate was designed to give borrowers a greater incentive to repay their initial loan.
By randomizing the interest rate along three dimensions—(i) the initial offer rate featured in the mailer, (ii) the contract rate that was revealed only after the borrower agreed to the initial offer rate, and (iii) the future rate that extended preferential pricing on future loans to borrowers who remained in good standing—the researchers essentially created five different groups whose repayment rates could be compared to determine whether hidden information or hidden action effects have a larger impact on loan repayment.
- Group 1: High offer rate, high contract rate, no low future rate
- Group 2: High offer rate, low contract rate, guaranteed low future rate
- Group 3: High offer rate, low contract rate, no low future rate
- Group 4: Low offer rate, low contract rate, guaranteed low future rate
- Group 5: Low offer rate, low contract rate, no low future rate