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«Jorunn Lie Bjelland and Erlend Stene Supervisor Ellen Katrine Nyhus This Master’s Thesis is carried out as a part of the education at the ...»

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Can nudging reduce default rates?

A field experiment testing the effect of nudging on young adults’ propensity

to default on cell phone bills.

Jorunn Lie Bjelland

and

Erlend Stene

Supervisor

Ellen Katrine Nyhus

This Master’s Thesis is carried out as a part of the education at the

University of Agder and is therefore approved as a part of this

education. However, this does not imply that the University answers

for the methods that are used or the conclusions that are drawn.

University of Agder, 2013 Faculty of Economics and Social Sciences Department of Economics and Business Administration / Kristiansand School of Management Abstract Can altering the context in which people make their decisions be an effective method for reducing default rates? This thesis reports the results of an experiment that tested the effect of so- called «nudging» on young adults’ decision-making process concerning bill payments. Based on theories of judgment and decision-making, text messages were sent out to 2500 randomized treatment and control subjects aged 18-30, pulled from One Call’s (Network Norway AS) customer base. Incoming payments were then recorded to determine whether the messages had influenced customers’ decision to pay their bill within due. The results provide evidence that nudging may positively influence people’s decisions, and subsequently reduce default rates, if the nudge is executed correctly.

The aim of this study has been to test existing theories and models in this field of research in a new context, thereby contributing to further development and hopefully active use of nudging as a positive alternative to regulations. This could benefit each individual being nudged, and ultimately bring out positive larger scale societal changes.

Our hope is that companies that deal with payment collection will benefit from this research.

Although former studies have shown the effect of nudging in different contexts, the results might not be directly transferrable to payment rates. We have therefore opted to empirically test the effect of nudging in a new context; on customers’ payment behavior.

Key words: Behavioral economics, nudging, personal finances, young adults, field experiment, default rate, bill payments, cell phone industry.

i Preface This Master’s Thesis is written as a final part of the Master`s Programme in Business Administration at University of Agder, Kristiansand School of Management. The thesis addresses the concept of nudging, a term belonging to the field of behavioral economics, which lies in the gap between economics and psychology. Behavioral economics has been a central part of several subjects during our Master’s degree, particularly in the course ORG-419: Judgment and Decision-making, which we both attended last fall. It is especially this course that sparked our interest for the field and a desire to further explore the concept of nudging.

Writing a thesis is a demanding process. Through the process we have been challenged both academically, personally and in terms of team work. Overcoming these challenges has made us better equipped to face the workplace we are at the verge of entering. In spite of the tight schedule, we recognized the need to take time to wonder and let the information sink in, to fully capture the essence of our project and how to express ourselves accurately in this thesis. We hope that this is reflected in the final thesis.

Conducting a field experiment in such a limited time period carried many risks. Had we fully grasped the extent of these risks and the challenges ahead before we started this project, it might have never happened. Luckily we were blissfully unaware of the frustration to come, and we are very pleased with the overall process.

We would like to use this opportunity to express our gratitude and appreciation to several people for their invaluable help and support. First and foremost; we thank our supervisor Professor Ellen Katrine Nyhus for her enthusiasm, constructive feedback and support throughout the process. Her knowledge of and dedication to this field of research has been a strong asset in the process.

Further, we thank Frode Elverum, Per Ola Stålberg and Bente Gjertsen at One Call (Network Norway AS) for believing on our project and making the necessary resources available for the implementation. We also thank Associate Professor Rotem Shneor and PhD Research Fellow Andrew Muteti Musau for valuable input and discussions, and Research Librarian Henry Langseth for technical support.

–  –  –

Jorunn Lie Bjelland and Erlend Stene iii Contents

Abstract

Preface

1. Introduction

2. Background and theoretical foundation

2.1 Background

2.2 Making the right decisions

2.3 Biases and heuristics

2.4 Choice architecture

2.5 Nudging – on how to improve decisions

2.5.1 Review of relevant experiments

2.5.2 The nudges used in our study

2.5.2.1 Nudging using a common reminder

2.5.2.2 Nudging based on the anchoring-effect

2.5.2.3 Nudging based on loss aversion

2.5.2.4 Nudging based on social norms

3. Methods

3.1 The research process





3.2 Problem definition

3.2.1 Hypotheses

3.3 Unit selection

3.4 Research design

3.5 Method for data collection

3.6 Procedure

3.8 Reliability and Validity

4. Data analysis

4.1 Results

4.2 Analysis

4.2.1 Descriptive statistics

4.2.2 Hypothesis testing

5. Conclusions

5.1 Discussion of findings

5.2 Limitations

5.3 Implications

5.3.1 Practical implications

5.3.2 Implications for research

5.4 Conclusion

References

Appendix: Data analysis (SPSS)

A1: Results from T-tests; comparing the effect of each nudge against the control group of the month. 77 A2: Results from T-tests; comparing the effect of each nudge between February and March............... 80 List of figures Figure 3.1: A summary of the scientific method ………………………………………………………….36 Figure 3.2: The content of a problem definition ………………………………………………………..…37 Figure 3.3: Overview of factors that affect propensity to default payments ……………………………...41 Figure 3.4: Overview of the experiment …………………………………………………………………..42 Figure 4.1: Default rates in February, 2013 ………………………………………………………………56 Figure 4.2: Default rates in March, 2013 …………………………………………………………………58 List of tables Table 2.1: Behavioral characteristics of young adults who find themselves in financial difficulties …....11 Table 2.2: Recap of selected relevant experiments ………………………………………………………21 Table 4.1: Original data ………………………………………………………………………………..…52 Table 4.2: Summary of measures, February 2013 ………………………………………………………..55 Table 4.3: Percentage difference in each treatment group measured against the control group, February 2013 …………………………………………………………………………………56 Table 4.4: Summary of measures, March 2013 ………………………………………………………......57 Table 4.5: Percentage difference in each treatment group measured against the control group, March 2013 ……………………………………………………………………………………58 Table 4.6: Results from t-test between treatment groups and control group, February 2013 ………….....61 Table 4.7: Results from t-test between treatment groups and control group, March 2013 …………….…62 Table 4.8: Results from t-test between February and March for each treatment group, 2013 …………....63

1. Introduction The purpose of this study is to investigate whether changing the context in which people make their decisions may have an effect on, and subsequently reduce, people’s propensity to default payments. The study is motivated by an increasing concern for the rising debt levels in Norway, especially for young adults.

Current Western societies are often labeled as being excessively regulated. Some say that the law already interferes with individuals’ freedom of choice, micromanaging the private sphere. As formal laws have limited bounds concerning the regulation of private life, researchers recognize a need for alternative ways to encourage people to make better choices for themselves, ultimately benefitting society as a whole. We see the potential in nudging as a positive alternative to more intervening forms of regulations, so long that it is used exclusively for positive purposes.

According to classical economic theory, all participants in the marketplace are assumed to be rational actors. By studying the effects of nudging, we investigate the implications of modifying this standard economic assumption, examining the possibility that actors in the economy deviate from the rational standard. «Nudging» is a relatively new term, first coined by Thaler and Sunstein in 2008. But the interest for research on this phenomenon has rapidly gained momentum; David Cameron and Barack Obama are big advocates of nudge theory, and it is catching on in companies all over the world.

The media fronts a growing concern for the state of young adults in Norway regarding their personal finances. Norwegian collection agencies and other institutions express a well-grounded concern for the increasing number of young adults that find themselves in financial difficulties due to defaulted payments and debt problems. We wanted to explore whether nudging might help change this negative development in personal finances for young adults. The primary reason for examining the effects of nudging on young adults’ propensity to default on bill payments is that we have not been able to uncover any previous studies performed concerning this particular issue.

As cell phone bills are highlighted in the media as bills that are typically defaulted on, we have focused our thesis on these particular payments.

–  –  –

Can nudging young adults reduce their propensity to default on cell phone bills?

We start this thesis with an overview of the current state of personal finances of young adults in Norway, and the theoretical foundation that sparked our interest to further investigate the effects of nudging. We then move on to a review of relevant experiments, examining what studies in the field already have discovered, and possible weaknesses in the performed research. In the next chapter we address the specific type of methods used to perform this study, introduce the experiment and the procedure for its implementation. We then present the results of our study.

Based on these findings, we argue that nudging may significantly lower default rates. The thesis closes with a discussion of our findings, the limitations and implications of the study, and conclusions that can be drawn on the basis of our experiment.

–  –  –

2.1 Background Recent studies and statistics have shown a significant increase in the amount of outstanding credit debt in Norway, particularly owed by young adults, raising valid cause for concern. Outstanding credit debt includes money owed to credit card companies, sums owed or defaulted on uncollateralized loans, and money owed to collection agencies. By the end of 2011, young adults in Norway between the age of 19 and 26 owed NOK 1,1 billion to the aforementioned institutions (Stenseng, 2012). This is an increase of NOK 200 million from the year before (Stenseng, 2012).

Brusdal and Berg (2011) recently published a report on young adults in Norway and their creditfinanced consumption. The report was developed based on statistics from collecting- and credit agencies, and caused governmental concern and initiative to investigate these issues further. The report documented a sharp increase in the number of young adults who default on credit loans and bill payments. In 2011, one in four who defaulted payments to the extent of forced debt collection, was between 18-25 years old (Brusdal & Berg, 2011). Further, the number of young adults that were registered with reduced credit scores had increased by 50% since 2005 (Brusdal & Berg, 2011).

The report states that young adults is not the age group with the largest default problems. Adults ranging from 40 to 44 years of age is actually the age group with the most severe financial problems (Brusdal & Berg, 2011). Young adults is, however, the age group that accounts for the sharpest increase in default rates and more frequently end up having debt problems. We have chosen to focus on young adults due to the severity of this development, and also because of the detrimental effects that having poor credit rates may have later in life. Young adults with poor credit ratings will have a difficult time getting approved for mortgages, and the credit debt they build up in the initial phases of adult life may have crippling effects on their personal finances later on.

Brusdal and Berg’s report discusses a variety of partially interconnected reasons for why so many young adults accumulate staggering amounts of credit debt and default on their bill payments.



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