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The Effect of Credit on Spending Decisions: The Role of the Credit Limit and Credibility Author(s): Dilip Soman and Amar Cheema Reviewed work(s): Source: Marketing Science, Vol. 21, No. 1 (Winter, 2002), pp. 32-53 Published by: INFORMS Stable URL: http://www.jstor.org/stable/1558056 . Accessed: 26/03/2012 06:53 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp JSTOR is a not-for-profit
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  The Effect of Credit on Spending Decisions: The Role of the Credit Limit and CredibilityAuthor(s): Dilip Soman and Amar CheemaReviewed work(s):Source: Marketing Science, Vol. 21, No. 1 (Winter, 2002), pp. 32-53Published by: INFORMS Stable URL: http://www.jstor.org/stable/1558056. Accessed: 26/03/2012 06:53 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jspJSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new formsof scholarship. For more information about JSTOR, please contact support@jstor.org.  INFORMS is collaborating with JSTOR to digitize, preserve and extend access to  Marketing Science. http://www.jstor.org  The Effect of Credit on Spending Decisions: The Role of the Credit Limit and Credibility DilipSoman*AmarCheema HongKong University ofScienceandTechnology,Clear WaterBay,Kowloon,Hong KongUniversityofColoradoatBoulder,Boulder,CO 80309mksoman@ust.hk*cheemaa@uscu.colorado.edu Abstract Theobjectiveofthepresentresearch is tostudyconsumerdecisionsto utilizealine of credit. Thelife-cyclehypothesisfrom economicsarguesthatconsumers shouldintertempor-allyreallocatetheirincomesover their lifestream tomaxi-mize lifetimeutility.Oneformofintertemporalallocationisto usepastincome(inthe formofsavings)inthe future.Asecond form is the use of future incomeinthepresent.Thiscanonlybe doneifconsumers have access toatemporarypoolofmoneythattheycandraw from andreplenishinthefuture-afunctionperformedbyconsumer credit.However,our research reinforcespriorfindingsthatconsumers areunabletocorrectlyvalue their futureincomes,and thattheylack thecognitive capabilitytosolve theintertemporal op-timizationproblem required bythelife-cycle hypothesis.In-stead,wearguethatconsumers use information such as thecredit limit asasignaloftheir futureearnings potential.Specifically,ifconsumershaveaccess tolargeamounts ofcredit,theyarelikelyto infer that their lifetimeincomewillbehighandhence theirwillingnesstouse credit(andtheirspending)will alsobehigh. Conversely,consumers who aregrantedloweramounts of credit arelikelyto infer that theirlifetimeincomewillbelowand hencetheirspendingwillbe lower.However,basedonresearchinthe areaof consumerskep-ticism andinferencemaking,wealsoarguefor amoderat-ingroleof thecredibilityassociated withthecreditlimit.Specifically,wearguethattheabove effectofcredit avail-abilitywould beparticularly strongforconsumers who be-lievethatthecredit limitcredibly signalstheirfutureearn-ings potential(i.e.,anaiveconsumer whohas limitedexperiencewithconsumercredit).However,asconsumersgain experiencewithcredit,theystartdiscountingcreditavailabilityasapredictoroftheir futureandstartquestion-ingthevalidityoftheprocessused toset thecreditlimit.Hence,withexperiencetheeffect of credit limitonthewill-ingnesstouse creditshould beattenuated.We testthesepredictionsinfiveseparatestudies.Inthefirstexperimentalstudy,wemanipulatecredit limit andcredibilityandposesubjectswith ahypotheticalpurchaseopportunity.Consistent withourprediction,credit limit im-pactedthepropensitytospend,butonlywhenthe credi-bilitywashigh.Inthesecondexperimental study,werep- MARKETINGSCIENCE ?2002INFORMS Vol.21,No.1,Winter2002,pp.32-53licatethesefindingsevenwhensubjectsweregiveninformation about theirexpectedfuturesalaries,andalsoshowthat the credit limitinfluencestheirexpectationof fu-tureearningspotential.Inthethirdstudy,we show thatthemereavailability(andincrease)of currentliquiditycannotexplainourfindings.In the fourthstudy,we conductasur-veyof consumersinwhich wemeasureanumber ofde-mographiccharacteristics and also ask them for theirpro-pensitytospendinagivenpurchasesituation.Inthefifthstudywe use theSurveyof ConsumerFinances(SCF)da-taset,a triennialsurveyofU.S. familiesthatisdesignedtoprovidedetailed information on theuseoffinancialservices,spendingbehaviors,and selecteddemographiccharacteris-tics.Results from bothstudies4and5providefurthersup-portfor ourproposedframework-credit limitsinfluencespendingtoagreaterextent for consumers withlowercred-ibility:youngerconsumers andless-educatedconsumers.Across allstudiesweachievedtriangulationby usinga va-rietyofapproaches(surveysandexperiments),subjectstypes(youngstudents and olderconsumers),nature ofpre-dictorvariables(manipulatedandmeasured),dependentmeasures(purchaselikelihood,credit cardbalance,newcharges),andmethods ofanalysis(ANOVAandregression),andconsistentlyfound thatincreasingcredit limitson acreditcardincreasesspending,especiallywhenthecredi-bilityof the limitishigh.Thispaper joinsagrowing bodyofliteratureinmarket-ingandbehavioraldecisiontheorythatgoesbeyondthe tra-ditionaldomainsofinquiry (e.g., productchoice,effects ofmarketingmixvariables)andfocusesonconsumerdecisionsrelatingto theappropriateuseofincome tofinance con-sumption.Ourframeworkdiffers frompriorresearch ontheeffect ofpaymentmechanisms onspendingintwosignifi-cantways.First,weareinterestedinthe effectsof the avail-abilityofcredit onspending,andnotnecessarilyintheef-fect ofthetransactionformat thatisassociatedwitheachpaymentmechanism.Second,whilepriorresearchhas stud-iedthepoint-of-purchaseandhistoric(i.e.,prepurchase)ef-fects ofcredit,thepresentresearchisconcerned withtheavailabilityofcreditinthefuture.Specifically,ourframe-workisinvariantto thecurrent andpriorusageof creditbytheconsumer.(ConsumerCredit;CreditCards;IntertemporalChoice;MentalAccounting; Self-Control)0732-2399/02/2101/0032/$05.001526-548XlectronicISSN  THEEFFECTOFCREDITON SPENDING DECISIONS:THE ROLEOFTHE CREDITLIMITANDCREDIBILITY Introduction Theprovisionofconsumerfinancinghas becomeapervasivetool formanymarketers worldwide(Glass-man1996).Simultaneously,consumer debthassoared torecord levelsand analarmingnumberofhouseholds arefindingthemselvesinfinancialdiffi-culties(Andelman1998,MonthlyReview2000).Giventhese trendsintheconsumermarketplace,asurpris-inglysparseamount ofresearchhasattemptedtostudyaconsumer'sdecisiontousecredit.Whyshouldconsumers use credit tofinancepur-chases? Thelife-cyclehypothesis(ModiglianiandBrumberg1954)positsthatconsumersattempttomaintaintheirlifestyleandconsumptionbasketsovertheir lifetimeeventhoughtheir incomeand wealthmayfluctuateover time.Specifically,olderconsumerscan borrowfromtheirpastsavingsandconsumeatlevelsbeyondtheircurrentincomes.Conversely,youngconsumerswhoexpectfutureincomesto behigherthantheirpresentincome can borrowfromtheirfuture income tosupporttheirpresentlife-style.Theseprocesseshavebeenreferredto as con-sumptionsmoothing(ShefrinandThaler1988).Theavailabilityofcreditfacilitatesconsumptionsmooth-ingandhence arationalconsumer canuse credittointertemporallymaximizelifetimeutility.However,aneconomicallyrationalintertemporalreallocation ofincomerequiresafairdegreeofcognitivecomplexityonthepartoftheconsumer,anassumptionthathasbeenshownto beunrealistic(cf.Johnsonet al.1987,Kotlikoff et al.1988).Giventhiscognitivehandicap,how doconsumersintertemporallyallocateincomes?Whatfactorsinfluencethisdecision?Inthepresentresearch,wefocus onthedecisiontoborrow fromfutureincome. Weagreewithpriorbe-havioralresearchthatconsumersareunable tocor-rectlyvalue theirpresentandfutureresources,andthattheylackthecognitivecapabilitytosolve the in-tertemporaloptimizationproblemrequiredbythelife-cyclehypothesis.Furthermore,wearguethatcon-sumersuseexternalinformationsuchas theavail-abilityofcredittoinfertheirfutureearnings.Specif-ically,ifconsumershaveeasyaccess tolargeamountsofcredit,theyarelikelytoinfer thattheirlifetimeincomeishighandhencetheirwillingnesstousecreditwillalsobehigh. Conversely,consumerswhoaregrantedloweramountsof creditarelikelytoinferthattheirlifetimeincomewillbelow,andhencebelesslikelytousecredit.However,wealsoarguefor amoderatingroleofthecredibilityassociatedwiththecredit limit.Spe-cifically,wearguethattheabove effectof creditavail-abilitywouldbeparticularlystrongforconsumerswhobelievethat thecreditlimitcrediblyrepresentstheirfutureearnings potential(suchasanaivecon-sumerwhohaslimitedexperiencewithconsumercredit).However,asconsumersgain experiencewithcredit,theystartdiscountingcreditavailabilityasapredictoroftheirfutureincome.Hence,withexperi-encetheeffectofcreditlimit onthewillingnesstouse creditisattenuated.Therestofthispaperisdividedintothreesections.First,wereviewrelevantresearch inthe area ofbe-havioraldecisiontheory,economics,andmarketingandarticulateourhypothesesabouttheeffectsofcreditlimitsandcredibilityonthepropensitytospend.Second,wedescribeaseriesofstudiesusingexperimentsaswell assurveydatato testourhy-pothesesandruleoutalternativeexplanations.Third,weconcludewith ageneraldiscussion andproposeavenues forfutureresearch. TheEffect ofPaymentMechanismsonSpending Someresearchinmarketinghasstudied theeffects ofusingvariouspaymentmechanisms onconsumers'spendingbehavior.Hirschman(1979)andFeinberg(1986)usedactualconsumertransactions tocomparethespendingofconsumers whopaidbycreditcardswiththosewhousedcash orchecks,andfoundthattheformerspendmore inotherwiseidenticalpur-chasingsituations.PrelecandSimester(2001)con-ductedanauction inwhichsubjectsbidfortickets toasportingeventthatwere tobepurchasedbythewinneron thefollowing daybyusingeithercashorcredit card(randomassignment).They replicatethefindingthatwillingness-to-payissignificantly greaterinthecreditcardconditionascomparedtothecash MARKETINGSCIENCE/Vol. 21, No. 1,Winter200233  SOMANAND CHEEMATheEffectfCredit nSpendingDecisions condition,andarguedthatliquidityconstraintscan-notcompletely explainthese effects.Allthese articlesshowedapoint-of-purchaseeffect-namely,theuseof aparticularpaymentmechanismat the timeofpurchasinginfluencesspendingbehavior.Inarecentpaper,Soman(2001)took adifferentapproachtostudyingtheeffectsofpaymentmecha-nisms.Hearguedthatpastpaymentsinfluencespendingdecisionsthroughtheirretrospectiveeval-uation(i.e.,the pain ofpast payments,PrelecandLoewenstein1998)but thatthepast usageof apar-ticularpaymentmechanismmoderatedthis effect. Inparticular,payments bycashandcheck arebothmemorable andpainful,while thosebychargecardsaremoreeasily forgottenandpainless,as aresultofwhichpeoplewhopredominantlyuse cards over-spendrelative to thosewhousecash orchecks(So-man2001).Thepresentresearchdiffers from thispriorre-search intwosignificantways.First,weareinterest-ed intheeffects oftheavailabilityofcreditonspend-ing,and notnecessarilyinthe effectof thetransactionformat thatisassociated witheachpaymentmecha-nism.Theresearchcitedabove wasmoreconcernedwith theeffectsofthenature of thetransaction format(e.g.,salience,convenience,whether itinvolved writ-ingdownthe finalprice)while theframeworkpro-posedinthispaperisexpectedto beinvariant totransactionformats.Second,whilethepriorresearchhasstudiedthepoint-of-purchaseandhistoric(i.e.,prepurchase)effects ofcredit,thepresentresearch isconcernedwiththeavailabilityofcredit inthefuture.Specifically,ourframeworkisinvariant tothecurrentandpriorusageofcreditbytheconsumer.Despitethesedifferences,oneresultfrom Soman(2001)isrelevantfor thepresentresearch.Inoneex-periment,hefinds thatthepropensitytospendin-creasesasafunction ofthecreditlimit,specificallythatas thecredit limitincreases,subjectsusingacreditcardreportahigherlikelihoodofmakingapurchaseceterisparibus.While henotesthat this re-sult isorthogonalto themainthesis ofhispaperandthatcreditlimitwasbeingmanipulatedonlyto testfor therobustness of hiseffects(Soman2001,p.464),we findasimilarsuggestionfrom thepopularpress(Keenan1998,Punch1992).Forinstance,therealiza-tion that totheextentyouraisethecreditline ontheaccount,youcankeepthecardholderin thefoldandget greaterusage (Punch1992,p.48)seems tobeacceptedintheindustry.Whydoesaccess togreat-eramounts ofconsumercreditdrive theconsumer tospendmore?Noacademicresearch inmarketinghasdocumentedthisphenomenon(exceptthe oneby-productofSoman's 2001article)andnonehasat-temptedtoexplain whyitoccurs,hencethepresentresearchisafirststepinthisdirection. TheIntertemporalAllocationofIncome Inthefaceofamismatchbetween theirincomestreamandtheirdesiredconsumptionstream,thelife-cyclehypothesis postulatesthatconsumersshouldallocatetheirlifetimeincome overtime inor-dertosmooththeirconsumption(AndoandModi-gliani1963,ModiglianiandBromberg1954;seealsoFriedman1957).Moreformally,thehypothesisstatesthat undercertainty,anindividualwillchoosehisconsumptionspendingover hislifetime(uptoaged)tomaximizeaconcaveutilityfunctionU [U =U(C1,C2,..,Cd)subjectto diA1 I C IR R -+ H1, j=1s=2 R1 whereCjrepresentsconsumptioninperiodj,R,=1/(1+rJ), r,is theinterestrate attimes,Alrepre-sentsinitialassets,andHIis thepresentvalue ofhu-manwealth atage1.Thisformulationspecifiesthatthecumulativediscountedconsumptionstreamoveranindividual'slifetime isexactly equaltothe sumofthecumulativediscountedincome streamand allas-sets.In severalempiricaltests,supporthasbeenfoundfor thesimplerimplicationsofthehypothesisthatthepropensitytospend(a)increasesas afunc-tionof initialassets,(b)decreasesas afunctionofexpectedlifetime,and(c)increases as afunction ofhumanwealth(cf.Courantet al.1986,Johnsonet al.1987,Kotlikoffetal.1988). MARKETING SCIENCE/Vol. 21, No. 1,Winter2002 4
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