Demand for rent-to-own contracts: a behavioral economic explanation

Journal of Economic Behavior & Organization Vol. 38 (1999) 199±216

Demand for rent-to-own contracts: a behavioral economic explanation Brian J. Zikmund-Fisher*, Andrew M. Parker Department of Social and Decision Sciences, Carnegie Mellon University, 5000 Forbes Avenue, Pittsburgh PA 15213, USA Received 23 February 1997; received in revised form 5 January 1998; accepted 9 April 1998

Abstract Rental purchase contracts for consumer durables, often described as `renting-to-own,' typically require total payments two to four times greater than retail prices. Under such conditions, why do lower income consumers ever select this option? Within several low-income samples we consider liquidity constraints, time preferences and risk attitudes as possible explanations for this demand. Use of these services appears to be a risk-averse response to the income and expense shocks faced by low-income households and a financial management tool to address myopic time preferences. # 1999 Elsevier Science B.V. All rights reserved. JEL classi®cation: D12 Keywords: Rent-to-own; Low-income; Consumers; Risk preferences; Time preferences

1. Introduction Many consumers, particularly those in low-income neighborhoods, purchase consumer durables using rental±purchase contracts, commonly referred to as `rent-to-own' (Freedman, 1993). These contracts involve making small, regular (usually weekly) payments to obtain electronics, furniture or appliances. For example, a customer might pay $9.95 a week for 72 weeks to obtain a VCR. Though simple to initiate, such rent-toown contracts generally involve making total payments two to four times greater than prevailing retail prices for consumer durable goods. However, despite this cost and the potential availability of substitutes (e.g. savings plans, consumer credit, or layaway * Corresponding author. E-mail: [email protected] 0167-2681/99/$ ± see front matter # 1999 Elsevier Science B.V. All rights reserved. PII: S 0 1 6 7 - 2 6 8 1 ( 9 9 ) 0 0 0 0 6 - 2

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plans), rental±purchase has been a growth industry, generating $3.98 billion in annual revenues by 1996 (Association of Progressive Rental Organizations, 1997). Given the exorbitant cost of using rental±purchase methods, what accounts for its popularity with certain consumer groups? What characteristics of the consumers and the service provided contribute to creating a market for rental±purchases within lower income neighborhoods? We collect evidence to support or dismiss the relative importance of four explanations for the observed demand: Households that use rental±purchase may face liquidity constraints in their economic environment; they may have high intertemporal discount rates; they may utilize a very myopic time horizon in their decision making; or they may demonstrate particularly risk-averse preferences. These four causal factors, either individually or combined, could lead low-income households to select rental±purchase despite its high cost. Our goal is therefore to analyze which factors significantly discriminate between rental±purchase users and non-users, using this information to identify necessary and sufficient factors for demand for rent-to-own services. In this paper, we demonstrate that measures of liquidity constraints do not distinguish rent-to-own users from non-users, but measures of time and risk preferences are significant factors in explaining rental±purchase demand, both past and present. 2. Background and research design 2.1. The anomaly of rent-to-own demand In principle, renting-to-own is a simple transaction with straightforward terms. The customer takes possession of a consumer durable item immediately and then makes small regular payments, usually weekly. Most rent-to-own contracts have a fixed duration, averaging 77 weeks (Cheskin+Masten, 1991).1 Electronic items such as television sets are the most common items, but most stores also offer furniture (sofas, dinette sets, complete bedroom sets) and appliances (dishwashers, washing machines, clothes dryers). The consumer has the item delivered to her home and may use the good as long as payments continue to be made. In addition, while these stores often request references to check income and residency, there is no formal credit check or deposit requirement. Thus, anyone with sufficient income, regardless of poor credit record or other financial problems, can utilize rent-to-own. If the customer makes all of the weekly payments and completes the contract, he or she then owns the good. If, however, the consumer misses a payment and does not start paying again quickly, the store picks up the good and he or she loses any ownership interest. Terminated rental±purchase agreements are thus equivalent to pure rentals from the customer's perspective. While rental±purchase contracts do have unique features, the anomaly of renting-toown demand lies in what low-income consumers must pay over the course of the contract to get these features. Table 1 compares an actual rental±purchase contract taken from a 1

Less often, rental±purchase contracts are week-to-week with an ownership option which becomes less expensive over time. This contract form makes the contract language closer to that of pure rentals and therefore may be a response to regulation efforts.

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Table 1 Rent-to-own compared to credit card costs Item: 31'' color television, major brand-name, stereo, new (Retail price: $599) Total payments Credit card (21 months @ $33.98/month) Rent-to-own contract (91 weeks @ $26.99/week)

$714 $2456

Implicit interest rate 19.8 APR 229.7 APRa

a

The rental±purchase industry argues calculation of implicit interest is inappropriate for these contracts, since many states do not classify them as credit sales and renting-to-own includes other services (e.g. repair). Source: Authors' survey of stores in Pittsburgh, PA, May, 1996.

national chain store to the cost of using a credit card to purchase the same item. When used as a purchase method, rent-to-own contracts are far more costly than purchasing outright, using store credit or even using high interest rate credit cards. The contract described in Table 1 is hardly unusual; general media articles (e.g. Consumer Reports, 1995; Freedman, 1993), consumer groups (Public Interest Research Groups, 1997) and our own informal survey of local rental purchase stores all indicate that the total cost to purchase a durable good using a rental±purchase contract is generally two to four times more than the retail purchase price. If one considers rental±purchase payments as a form of credit sale (which the industry vigorously argues is inappropriate), such payment schedules would imply interest costs in excess of 100 percent APR2 and often much higher. The primary response of the rental±purchase industry to claims of excessive cost is the argument that most customers do not use such contracts to purchase items but merely to rent them. If so, the flexibility, repair and delivery services provided might justify the weekly cost. To support this claim, the industry cites figures that only a minority of rentto-own contracts (35% in Association of Progressive Rentals, 1993; less than 25% in Association of Progressive Rental Organizations, 1997) are continued to ownership. However, our data and some of the industry's own surveys cast doubt on this argument. In our sample the majority of consumers who started rental±purchase contracts did complete the contract and end up owning the good. Of the 58 past rental±purchase users we surveyed who completed or terminated contracts,3 44 subjects (76%) reported having completed the contract terms and obtained ownership. This completion percentage did not vary substantially (72% in Study 1, 79% in Study 2), despite the fact that these surveys were administered in two different neighborhoods. Similarly, Cheskin ‡ Masten, surveying customers of industry leader Rent-A-Center, report 74 percent of past rent-toown users had previously rented to term on at least one item and 70 percent of rental± purchase users intend to rent to term when they begin.4 Clearly, many consumers do 2

See Walden (1990) for a discussion of the appropriate calculation of the implied interest costs. Rent-to-own contracts had been used by 61 (42%) out of the 144 subjects interviewed in Studies 1 and 2, described below. This percentage is virtually identical to the results of Cantrell and Godwin (1992), who found 40 percent usage of rent-to-own stores in their sample of low-income consumers. 4 The disparity between these figures and the contract completion rates appears to result from the use of different measures. Both our surveys and Cheskin ‡ Masten measured percentage of subjects completing contracts, not percentage of contracts completed. Many customers who terminate contracts may be repeat customers making a series of short-term rentals, which would deflate the percentage of contracts rented to term relative to percentage of customers completing contracts. 3

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indeed consider these contracts as a purchase method for consumer durables despite their high cost. The rent-to-own industry boomed in the 1980s and 1990s, with the market dominated by multi-outlet chains such as Rent-A-Center (Freedman, 1993). The industry grew from about 5,000 outlets in 1985 to over 7,500 stores in all 50 states (Winn, 1997), with approximately 9 million annual deliveries and 2.9 million households as customers (Association of Progressive Rentals, 1993). This pattern fits with the rapid growth over the last 10±15 years of all forms of `fringe banks' such as pawnshops and check-cashing outlets, which have replaced mainstream financial institutions for many consumers in lower income brackets (Caskey, 1994; Caskey and Zikmund, 1990). While some steps have been taken to document the supply of industries targeted at lowincome consumers, only a few studies have considered the demand for these services. Sociological studies by Caplovitz (1967), for example, documented the costly business practices of vendors serving Harlem housing projects in the early 1960s, but he categorizes the existence of demand rather than exploring its determinants. Caskey notes that pawnshops enjoy large numbers of repeat customers who return time and again despite the high cost, and rent-to-own stores appear to have similar patterns of repeat business.5 Swagler and Wheeler (1989) assessed past rental±purchase users' attitudes toward rent-to-own programs, finding that most past customers were not satisfied with their experience and a large sub-set of users had previously been denied credit. By contrast, Cheskin+Masten (1991) found 80 percent of their respondents satisfied with their rental±purchase experience. They also found that rent-to-own users cite the following as reasons to rent rather than to buy: immediate use of the good, convenient locations, no large initial deposit, the payment structure, and lack of a long-term obligation. However, only Cantrell and Godwin (1992) have tried to directly compare the characteristics of rent-to-own users and non-users. Their work identifies age, perception of the costs of renting-to-own and credit history as differentiating rental±purchase users from non-users, but their short survey only assessed a small number of potential factors. 2.2. Outline of the research design To explore in more detail the determinants of rent-to-own demand, we performed a series of interview surveys6 using individuals drawn from several low-income neighborhoods in Pittsburgh, Pennsylvania. We conducted 153 face-to-face interviews, each of approximately 1/2 hour duration. Subjects were paid a flat amount between $7± 10 for participating in the research, with the size of the stipend varying with the length of the interview required.

5 Cheskin+Masten (1991) found 72 percent of a sample of customers of Rent-A-Center, a major rent-to-own chain, had previously used renting-to-own, and Caskey (1994) finds a majority of pawnshop customers are repeat users. Similarly, 51 percent (19 out of 37) of past rental±purchase users we sampled in Study 2 indicated they would consider renting-to-own again despite the cost. 6 The full text of subjects' instructions and questions reported here are available from the authors as a separate Appendix. Additional information from this research, focusing on the psychological factors involved in consumers' decision to use rental±purchase, is reported in Parker and Zikmund-Fisher (1997).

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Study 1 collected data on subjects' past use of rent-to-own contracts, demographics, financial services used, perception of renting-to-own and other purchase methods, and preferences for installment contract form (payment size and duration). The 61 interviewees were parents, family members, and neighbors of children attending a summer camp jointly administered by a neighborhood organization and the YMCA. To identify factors not sufficiently explored in our first study, we then conducted eight extended interviews with volunteers drawn from a church in a second low-income neighborhood, asking open-ended questions to clarify exactly which dimensions consumers felt were relevant to their purchase decisions. A common theme in these interviews was a focus on non-monetary characteristics of different purchase methods,7 implying that consumer behavior ought to be predictable based on dimensions such as flexibility rather than the purely monetary contract terms.8 To address these issues more formally, we designed our second major survey (Study 2) to collect not only expanded background information about everyday economic behaviors (e.g. savings habits, credit record, and financial resources) but also additional questions designed to identify which non-price elements of rental±purchase contracts or subjects' financial situation might particularly affect their willingness to use rental±purchase. As discussed below, we also broadened our measures of rent-to-own demand to better assess subjects' current propensity to use such services. The data for this study consisted of 84 interviews administered at a family support center in a third low-income neighborhood. 2.3. A targeted sample Very little information exists to get a picture of what a `typical' rent-to-own customer is like. The best public data come from the Cheskin ‡ Masten survey of over 1600 Rent-ACenter customers selected from across the country, which only asked a limited number of background questions. This research found that the largest common factor was low income, with 72 percent of customers reporting an annual household income of less than $25,000. Women were somewhat more likely to use rental±purchase (57 to 43%), as were younger consumers (median age: 30±34). Table 2 displays some comparable demographic characteristics of our samples, separating those individuals with rental±purchase experience from those without. The demographics are broadly commensurate between the sub-samples in terms of age, gender, education, and access to credit cards and loans, though our samples do show a slightly lower household income for those subjects who have rented-to-own in the past. In terms of knowledge of the rental±purchase industry, virtually all of the individuals we interviewed were already familiar with renting-to-own as a purchase method, having either used it themselves in the past or learned about it through a family member or friend. However, given the limited information available for comparison, it is difficult to 7

For example, one subject avoided all forms of credit because he hated `to be haunted by bills,' while another subject particularly liked Christmas Clubs because it made the money `harder for [her] to get to.' 8 In fact, our interview respondents appeared to be selecting which purchase method to use far in advance. As evidence of this behavior, Cheskin+Masten (1991) found 64 percent of Rent-A-Center customers did not shop at another store before beginning a renting-to-own contract. See also Andreasen (1975) for more on lack of search by low-income consumers.

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Table 2 Demographic statistics Past rental±purchase usage

Female (%) Median age Median monthly income Median years of education % With loans % With credit card % Who have applied for rent-to-own contracts in the past % Who would recommend considering rent-to-own at present

Study 1 (n ˆ 61)

Study 2 (n ˆ 84)

No

Yes

No

Yes

53 35 $1000±$1500 13 22 26

28 33 $750±$1000 14 28 16

67 33 $1000±$1250 14 30 36

68 32 $750±$1000 13.5 32 35

41 ±

44 43

assess the degree to which our subjects represent the entire range of rent-to-own customers. The research reported here represents a focused study of consumer behavior and preferences within selected lower income neighborhoods.9 We chose this research method for several reasons. First, our fundamental research goal is to identify what factors distinguish rent-to-own users from non-users within low-income neighborhoods in which rental±purchases are common. A broad sample would tend to pick up crossneighborhood differences more than individual level factors. Second, the kind of in-depth financial and personal information required for this research necessitated the use of a face-to-face interview protocol. Subjects were often uneasy regarding how we planned to use their responses, and we took many steps to make clear that we represented no company or government agency. By working through community organizations and churches, we established an on-going relationship and validated our credentials as academic researchers. As a result, our subjects were willing to discuss their own financial situation in more detail than is commonly possible through larger, more impersonal surveys. We believe that the additional information and insights provided by this kind of detailed approach helps make up for any uncertainties in the representativeness of the sample. 3. Explaining rent-to-own demand Table 3 lists the four potential explanations for consumers' demand for rental±purchase services that we evaluate in this paper and the variables used to assess them. 9 The population of each of the communities selected contained substantial percentages of urban poor: In 1989 median household income in the two neighborhoods was $10,004 and $14,902, respectively, and between 34 and 38 percent of households in each community fell below the poverty level. Reported neighborhood unemployment rates as of the 1990 census ranged from 16.6 to 23.9 percent (University Center for Social and Urban Research, 1993).

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Table 3 Possible explanations for rental±purchase demand Explanation 1 Explanation 2 Explanation 3

Explanation 4

Low-income households face liquidity constraints, caused by insufficient credit access, which limit them to rent-to-own stores. Variables: income, ccard, loan, credrcrd Consumers demanding rental±purchase services have high intertemporal discount rates, making the extended payment terms of such contracts particularly attractive compared to outright purchase. Variables: payment; also tested directly in Study 1. Low-income consumers use renting-to-own as a self-management tool. These contracts provide financial structure to address myopic preferences for immediate reward, forcing money to be allocated to long-term goals rather than piecemeal to short-term needs. Variables: savehard, lottery, savefriend, savepot Low-income consumers place a high value on the escapability of rental±purchase contracts, given highly variable and unpredictable income flows and spending requirements. Variables: payins, escapability, incstable, incanticip

3.1. Externally imposed liquidity constraints Explanation 1 for rental±purchase demand asserts that insufficient income interacts with liquidity constraints to prevent low-income households from utilizing other, lessexpensive purchase methods. These households, excluded from borrowing because their lack of financial resources is perceived as making them a poor credit risk, are constrained to use rental±purchase because its small per-payment cost is all they can manage. Even if consumers do have sufficient income against which to borrow, they may not be able to obtain sufficient credit resources to manage their income flows effectively. In particular, the usury ceilings on interest rates imposed by most states limit the ability of lenders to service small loans to individuals with high default risks, and thus a valued service may be unavailable to this population. If, as we postulate in Explanation 1, such liquidity constraints are significant, they imply that demand for rental±purchase services occurs only as a result of another market failure, the lack of small consumer loans due to usury law restrictions. Even high-cost credit is likely to be less expensive than a rental± purchase contract as a method for obtaining consumer durables. To assess the influence of externally imposed constraints on the ability of low-income consumers to utilize other purchase methods instead of renting-to-own, we collected information on the following demographic and background variables: (a) age, sex and level of education of the respondent (educyr), (b) monthly household income (income), (c) whether the respondent had any type of major credit card (ccard) or financial loan (loan), and (d) a self-reported rating of the quality of the respondent's current credit record (credrcrd). If Explanation 1 (liquidity constraints) is valid, those consumers sampled with access to credit and/or higher incomes should be less likely to demand rental±purchase services. 3.2. High inter-temporal discounting Explanation 2 suggests that consumers with high inter-temporal discounting (see Loewenstein and Prelec, 1992; Loewenstein and Thaler, 1989) would prefer to rent-toown instead of saving or using layaway plans because rental±purchase contracts defer

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payments into the future. While credit plans do dominate renting-to-own because of their smaller per period payments, rental±purchase may be the most viable alternative for consumers with high rates of inter-temporal tradeoff when credit card usage is impracticable due to liquidity constraints (Explanation 1, above) or risk aversion (Explanation 4, below). Nevertheless, the total payments made in rent-to-own contracts are so large that discount rates based on risk-adjusted market returns are insufficient to justify choosing renting-to-own; discounting of future values beyond that implied by market tradeoffs appears necessary. Consumers may perceive the small payment sizes of renting-to-own to be economically and psychologically inconsequential (e.g. Markowitz, 1952). Such discounting-based explanations for seemingly anomalous spending behavior by low-income consumers are not new. Hausman's (1979) classic study identified substantial differences between the rates of inter-temporal tradeoff of low-income households and those of households in middle-to-upper-income brackets. That research found that lowincome consumers selected less energy-efficient appliances than more affluent consumers, implying that, for the less well-off, future energy savings were less valuable relative to a lower purchase price in the present. Consistent with Explanation 2 for rental± purchase demand, these consumers' tradeoffs between current and future payments, however, vastly exceeded market rates of interest. We use two different approaches to test this explanation. In Study 1, we test directly for a relationship between past rent-to-own usage and subjects' preferences over a set of purchase contracts varying in payment size and contract duration. In Study 2, we asked a single question having subjects rank five different installment payment plans for purchasing a $500 TV set, with the payment size varying between $5/week and $100/ week. Subjects' preferred payment size (denoted as payment) was then used as an explanatory variable to predict rental±purchase demand. 3.3. Self-management of myopic time preferences Whether or not low-income consumers have the generally high rates of inter-temporal discounting hypothesized above, they may have short-sighted preferences for immediate reward, leading to difficulty controlling monetary outflows. Lower income households often face considerable uncertainty about their financial futures (Andreasen, 1975), and their spending requirements often fluctuate substantially. As a result, these consumers may face particular difficulty making day-to-day choices consistent with the optimal long-term path, especially decisions about how or when to accumulate liquid savings. While all people tend to sacrifice larger future gains for smaller, immediate rewards (Ainslie, 1975), lower income households may find it especially easy for disposable income to be spent piecemeal towards short-term needs, instead of towards longer term projects. Explanation 3 is that consumers desire the structured payment plan of rent-toown contracts to provide `self-management' (Schelling, 1984; see also Elster, 1979; Thaler and Shefrin, 1981), thus counterbalancing their own myopic preferences over time. Low-income consumers may choose rental±purchase on these grounds despite its high cost, with the contract effectively acting as a budgeting tool.

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In our second study, we developed several variables which address this desire for financial structure. Subjects reported their perceived difficulty in saving (denoted savehard), ranking how easy it would be for them `to save a large amount, say $800' on a 5-point scale,10 where 1 ˆ `very easy' and 5 ˆ `almost impossible.' We also asked respondents about the methods they had used in the past or would use to save up such amounts. Subjects were asked to respond as to whether they would either give money to a trusted friend or relative to keep (denoted savefriend) or keep a pot of money around the house as a savings bank (denoted savepot). We expected that individuals who need to have external financial structures to manage their money11 would be more likely to respond positively to savefriend and have high values of savehard.12 In addition, we also asked subjects about their frequency of playing the lottery. Many urban poor, particularly African-Americans, appear to use gambling on number games (Light, 1977) and official lotteries (Clotfelter and Cook, 1989) on a regular basis to `invest' a stream of small payments into a large lump-sum. The winning payoff is valued beyond its dollar amount by these individuals and households because they find other savings methods difficult or impossible to maintain. We anticipated that subjects using the lottery frequently might therefore be more likely to use rental±purchase in a similar way. Our subjects were asked how often they played the lottery, and we use a binary variable (denoted lottery) to identify subjects using the lottery on a regular basis, defined as at least `every week or two.' 3.4. Risk-aversion and escapabilty Low-income households may also use the unique features of renting-to-own to directly address the risk in their financial situation noted by Andreasen. Given that such households do not have the stabilizing financial resources to ride out financial shocks, we assert in Explanation 4 that the post-purchase flexibility offered by the free termination option of renting-to-own is so valuable that risk-averse low-income consumers are willing to pay extreme premiums for this feature. Even if the probability of such shocks is objectively low, the high negative value implied by credit default or termination fees on low-income consumers may make bearing of such risks undesirable. If so, consumer demand for rental±purchase may stem from its unique combining of a completely escapable contract with installment payments and immediate usage. The risk aversion implied by such a choice is, however, of a degree beyond that generally assumed in rational economic models of individual choice. We would therefore expect rental± purchase customers to have preferences for contract flexibility bordering on the 10 All scale variables were analyzed initially under the assumption that the underlying relationships with rentto-own demand were linear, allowing for cardinal analysis. When, upon inspection, this assumption appeared to be inappropriate, we note alternative analyses. 11 As an example of this profile, one of our subjects told us she often gives money to her grandmother to hold on to and hides any savings she has in the house to keep herself from spending it. In fact, she reported, ``sometimes I hid it away so well that I couldn't find it, which was great!'' 12 Keeping savings money around the house (savepot) is difficult to interpret, since it could indicate evidence for either of two opposite characteristics: good self-management abilities in saving which might imply a lower likelihood to rent-to-own or crude financial management skills which would suggest a need for the structure of rental±purchase contracts.

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lexicographic (single-dimensional). In addition, we also expect that those consumers facing higher levels of uncertainty and variability in household income and spending will have a greater need for such flexibility, and hence be more likely to rent-to-own as well. Since uncertainty underlies both Explanations 3 and 4, it is also possible that both hypotheses may apply simultaneously. If so, rental±purchase agreements are a compromise between structure and flexibility in managing one's finances. On the one hand, by establishing regular weekly payments, renting-to-own induces customers to put money aside consistently for major purchases (see Explanation 3, above). Consumers may intuitively understand that, since the purchase cost decreases the longer they stay in the contract, they may be more likely to complete renting-to-own than they would be to succeed with other methods (e.g. saving). On the other hand, the ability to terminate the contract implies one can always escape the imposed structure if it becomes too burdensome, which could explain rent-to-own usage by those who also have access to traditional sources of credit. Study 2 contained two types of hypothetical questions designed to assess the importance of contract flexibility. First, subjects were asked to imagine purchasing a new $800 washing machine and dryer set using an installment contract at a local appliance store. We then offered subjects a `payment insurance' option, which allows the consumer to delay payments at any time of their choosing, subject to a small per-instance fee.13 This option allowed risk-averse buyers to acquire substantial flexibility in contract terms while still maintaining the installment purchase framework (as opposed to rental± purchases). Subjects chose whether to purchase such an option (denoted payins) in this context. Second, we described to subjects two hypothetical individuals purchasing furniture; one who chose sale items on a no-returns layaway contract and one who passed up the sale items to ensure she could cancel the layaway contract if needed. Subjects identifying themselves more with the second individual than the first (denoted escapability) are presumed to be more risk-averse, placing higher values on contract flexibility and escapability. If Explanation 4 is valid, demand for payment insurance and escapable contracts should correlate highly with demand for rental±purchase services. We also asked two related questions about subjects' financial situation. Subjects rated both the variability and uncertainty of their income flow on a 7-point scale. Stability or, alternately, variability (denoted incstable) was measured by asking subjects how much their income was stable or varied over a period of several months, while uncertainty (denoted incanticip) was measured by asking subjects, if their income did change, whether such changes could be anticipated or whether they came as a surprise. In each case, higher ratings denoted more stable or predictable income flows, and we hypothesized that subjects reporting higher ratings would therefore be less risk-averse and thus less likely to rent-to-own.

13 The terms of `payment insurance' were presented as follows: ``If you pay a higher price now to get `payment insurance,' you are protected against the effects of sudden unexpected financial problems. If for any reason you cannot make a monthly payment or two, the insurance company will cover your payments until you can start paying again. However, each time you do so, you have to pay a small penalty, plus the missed payment gets added on to the end of the contract. If you do not pay for several months, the payment insurance company has the right to take the good away to get its money back.''

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4. Evaluating the potential explanations 4.1. Dependent measures of rent-to-own demand To test the potential explanations for rent-to-own demand, we utilized two different measures of the propensity of an individual respondent to demand rental±purchase services. First, in both studies we asked subjects whether they had ever applied for or used rent-to-own contracts in the past. This binary variable, termed rentpast, is empirically the most reliable, since it reflects subjects' actual behavior rather than a response to a hypothetical question. However, subjects answering rentpast positively are of two types: (a) those who chose rent-to-own in the past and would use it again and (b) those who used it in the past but would select differently in the future. This heterogeneity makes the identifying key dimensions relevant to the rent-to-own decision difficult. In particular, the positive or negative experience with renting-to-own may well change consumers' financial behaviors and preferences over purchase methods. Hence, the factors which influenced past choices may no longer be present at the time of the survey, adding additional noise to the analysis. To broaden our assessment of rental±purchase usage and to address the concerns about rentpast, our second measure of rent-to-own demand, collected in Study 2, asked subjects whether they would recommend that a friend or relative consider using rent-to-own if he or she wanted or needed to get a large item. The `recommend that a friend or relative consider' language was phrased specifically to differentiate respondents' assessment of rental±purchase contracts from their personal financial situation. Note that subjects did not need to state that they expected to use rental±purchase in the future, merely that it was part of the relevant opportunity set for someone who is similar to them. This question was designed to assess subjects' evaluation of rental±purchase methods independent of age, income level, purchasing habits, or other confounding factors. The resulting binary variable (rentrec), although hypothetical in nature, approximates an underlying propensity to utilize rental±purchase contracts, whether or not the need to make such a purchase had actually arisen. The two dependent variables were positively and significantly related (2(1) ˆ 5.22, p < 0.03) but not identical, since they measure two different manifestations of the rental±purchase demand. 4.2. Understanding past rent-to-own usage Each of the two studies was designed to identify distinguishing factors of rent-to-own demand using a mixed sample of consumers from areas in which rental±purchase is common. Although administered in two different neighborhoods, the proportion of respondents who had used rental±purchase contracts in the past was consistent in our two studies, and virtually all of our subjects were familiar with renting-to-own beforehand. However, awareness of the true cost of using this purchase method did vary. In Study 1, we asked subjects to describe important characteristics of different payment methods, including rent-to-own. Forty-two percent of the subjects familiar with renting-to-own voluntarily described it as costing substantially more than buying an item outright. Interestingly, however, this opinion was completely unrelated to whether or not one had

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Table 4 Patterns of installment contract choices in Study 1 Preference pattern observed Shorter term /larger payment (A) Study 1 Subjects applying for renting-to-own in the past: Number of subjects (%) Subjects without rent-to-own experience: Number of subjects (%)

Mixed pattern (B)

Longer term/smaller paymenta (C)

16 (64)

4 (16)

5 (20)

18 (50)

13 (36)

5 (14)

a

Notes: Expected pattern under discounting Explanation 2.

actually applied for rental±purchase in the past (2(1) ˆ 0.003, n.s.), implying that customer confusion or lack of knowledge is unlikely to be the main reason why lowincome consumers use these types of contracts. Study 1 included a major section designed specifically to test the high discounting hypothesis (2). We presented subjects with a set of nine binary choices between different installment payment plans to purchase an electronic good (TV or camcorder). For example, one question asked subjects to choose between paying $4.50/week for 100 weeks and paying $22.50/week for 20 weeks to purchase a $450 camcorder. Manipulations included size of payment, length of contract, and value of the item. For one sub-set of the questions seen by each subject, total payments were fixed and identical for each of the two options considered. For two other sub-sets of questions, one of the two contracts in each question had either the payment size increased or term lengthened by 50 percent, thus requiring 50 percent greater total payments than the alternative. Payment sizes varied from $4.50 up to $33.75 per week, with contract lengths ranging from 20 to 150 weeks. If our subjects had particularly high inter-temporal discount rates, they should have chosen longer term contracts even when so doing imposed significant penalties in terms of total cost. Table 4 categorizes respondents by their revealed preference patterns14 and presents sample questions of the type used. The results cast serious doubt on the validity of the high discount rate hypothesis as predictive of past rent-to-own usage. First, most subjects demonstrated a strong preference for shorter contracts, in complete contrast with the predicted pattern. Second, dividing the sample by rentpast made no difference; past rentto-own users were no more likely to demonstrate the expected preference for longer contracts than non-users. As shown in Table 4, 64 percent of the subjects who had applied for rental±purchase contracts in the past could be classified as preferring shorter term/ larger payment size contracts, as compared to 50 percent of non-users. Overall, the modal pattern was to always choose the shorter contract, with correspondingly larger payments, 14

Subjects were classified as preferring longer term contracts, having a mixed preference pattern, or preferring shorter term contracts in Study 1 if they chose the longer term/smaller payment size contract at least seven times, between three and six times, or two or fewer times, respectively, out of nine total questions.

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even when doing so required 50 percent greater total payments. Since many of the shorter contracts required both larger immediate payments and larger total expenditures, choosing them over longer term contracts violates economic rationality given any positive discount rate. Examination of the role of liquidity constraints from the Study 1 data also yielded little insight. A logistic regression predicting rentpast from respondents' monthly income, credit card access, loan status, years of education, age and sex15 was not significant overall (2(6) ˆ 6.13) and yielded no significant coefficients. As a result, we expanded our question set in Study 2 to collect additional information relevant to self-management and risk-preference explanations, all of which was subsequently analyzed using a multivariate logistic regression framework. Table 5, column 1 shows the outcome of logistic regressions of rentpast on all of the explanatory variables noted in Table 3. Since this regression is noticeably overfit, as indicated by the non-significant overall 2 value for a regression with a pseudo-R2 16 of 0.32, column 2 reports the regression results after removing variables with little predictive power.17 This regression is significant overall (2(7) ˆ 21.16, p < 0.01), using Wald tests of the hypothesis that all the slope coefficients are equal to zero. While we include the age, gender, income and credit access variables previously examined in Study 1, none of these variables are significant. The remaining liquidity constraints variable, credrcrd (self-rating of the quality of one's credit record), which was only collected in Study 2, appears to be more correlated with rentpast but also remains non-significant. The results on our measure of payment size preferences, payment, are also non-significant, mirroring the negative result of our direct test of the discounting explanation (2) from Study 1 described above. Hence, we conclude that while liquidity constraints may affect some consumers' choices of how to purchase consumer durables, neither access to credit or liquidity nor inter-temporal discount rates appear to be driving past rental±purchase usage. The measures of risk-averse and self-management preferences, however, do show some ability to distinguish between those low-income consumers who have used rental± purchase services in the past from those who did not. Difficulty in saving (savehard) is significantly related with rentpast, and the coefficient on lottery shows a nearly 15 16

The self-report variable on the quality of subjects' credit record (credrcrd) was only collected for Study 2. Maddala (1983) proposes measuring goodness-of-fit of logit models with: pseudo-R2 ˆ

1 ÿ …L! =L †2=n …L! =Lmax †2=n

where L! is the likelihood of a constant-only regression, L is the likelihood of the fitted regression model, Lmax ˆ 1 for logit models, and n is the sample size. In this context, pseudo-R2 represents the percent improvement in the likelihood function as compared to its maximum possible value, corrected for the sample size. 17 We removed variables singly, beginning with the least significant. We continued this process until removal would have decreased the pseudo-R2 by greater than 0.005, checking to ensure that no removed variables should re-enter the regression. While this criterion is admittedly ad hoc, it proved effective in distinguishing those variables with stable explanatory power across different models from those with little or highly variable impact.

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Table 5 Coefficients from logit regressions on rentpast (Study 2, n ˆ 83a) Explanatory variables

(1)

Purchases payment insurance (payins) Selects returnable goods (escapabilty) Stability of monthly income: 1±7 (incstable) Can anticipate income changes: 1±7 (incanticip) Difficulty saving large sums: 1±5 (savehard) Uses the lottery frequently (lottery) Gives money to relative to keep (savefriend) Keeps money in a pot in the house (savepot) Optimal payment size for $500 TV (payment) Monthly income: $k (income) Self-report of credit record: 1±5 (credrcrd) Has a major credit card (ccard) Has any loans (loan) Years of education (educyr) Gender: female ˆ 1 (sex) Age of subject (age) Constant Wald overall 2 pseudo-R2 Ln Likelihoodb

0.61 1.25 ÿ0.14 0.34 0.58* 1.74 ÿ0.17 ÿ0.31 0.007 ÿ0.23 ÿ0.20 0.40 ÿ0.07 0.02 0.17 0.007 ÿ4.36 22.66 0.320 ÿ45.71

(2) (1.10) (1.93) (ÿ0.88) (1.70) (2.10) (1.85) (ÿ0.29) (ÿ0.47) (0.75) (ÿ0.60) (ÿ0.88) (0.59) (ÿ0.11) (0.12) (0.29) (0.28) (ÿ1.16)

0.68 1.09 ÿ0.13 0.39*c 0.59* 1.61 ± ± ± ± ÿ0.22 ± ± ± ± ± ÿ3.94* 21.16* 0.301 ÿ46.46

(1.34) (1.84) (ÿ0.85) (2.05) (2.65) (1.78) ± ± ± ± (ÿ1.11) ± ± ± ± ± (ÿ2.26)

Notes: Asymptotic z-statistics in parentheses; * p < 0.05 N ˆ 83, not 84, because 1 subject refused to answer payment. b For comparison, log-likelihood of a constant-only regression on rentpast is ÿ57.04. c Significant coefficient has opposite sign than predicted. a

significant effect as well, supporting the self-management explanation (3) for past choices to use rental±purchase. While not individually significant, payment insurance (payins), desire for escapable contracts (escapability), and stability of monthly income (incstable) all appear to be relevant predictors of past rent-to-own use, supporting the risk aversion explanation (4) as well. The only anomalous finding is the positive effect of incanticip on rentpast. This result is particularly puzzling given that, as we show below, the same variable has the significant negative relationship we both predicted and found with current rental± purchase demand, as measured by rentrec. Upon further examination of the data, however, the effect appears to be a function of the distinction between measures of past and present behavior. If we factor out the small group of respondents who rented-to-own in the past but now would not recommend it, the coefficient on incanticip reverses to match the anticipated negative relationship. 4.3. Predicting current rental±purchase demand To assess the validity of the proposed explanations in predicting current preferences and attitudes towards renting-to-own, we repeated the logistic regression analyses using

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Table 6 Coefficients from logit regressions on rentrec (Study 2, n ˆ 83a) Explanatory variables Purchases payment insurance (payins) Selects returnable goods (escapabilty) Stability of monthly income: 1±7 (incstable) Can anticipate income changes: 1±7 (incanticip) Difficulty saving large sums: 1±5 (savehard) Uses the lottery frequently (lottery) Gives money to relative to keep (savefriend) Keeps money in a pot in the house (savepot) Optimal payment size for $500 TV (payment) Monthly income: $k (income) Self-report of credit record: 1±5 (credrcrd) Has a major credit card (ccard) Has any loans (loan) Years of education (educyr) Gender: female ˆ 1 (sex) Age of subject (age) Constant Wald overall 2 pseudo-R2 Ln Likelihoodb

(1)

(2) *

2.74 ÿ0.49 ÿ0.23 ÿ0.51* 0.41 2.12* 2.14* 1.30 ÿ0.03* 0.40 ÿ0.04 ÿ0.04 0.25 ÿ0.40 1.41 ÿ0.05 6.49 47.00* 0.580 ÿ33.30

(3.34) (ÿ0.63) (ÿ1.05) (ÿ2.03) (1.25) (2.10) (2.75) (1.60) (ÿ2.38) (0.75) (ÿ0.13) (ÿ0.04) (0.35) (ÿ1.48) (1.77) (ÿ1.30) (1.31)

2.73* ± ÿ0.17 ÿ0.57* 0.32 2.26* 2.05* 1.33 ÿ0.03* ± ± ± ± ÿ0.33 1.38 ÿ0.04 5.71 46.10* 0.572 ÿ33.75

(3.37) ± (ÿ0.86) (ÿ2.32) (1.16) (2.21) (2.70) (1.65) (ÿ2.29) ± ± ± ± (ÿ1.40) (1.78) (ÿ1.23) (1.40)

Notes: Asymptotic z-statistics in parentheses; *p < 0.05 N ˆ 83, not 84, because 1 subject refused to answer payment. b For comparison, log-likelihood of a constant-only regression on rentrec is ÿ56.80. a

rentrec, willingness to recommend that a friend or relative consider renting-to-own, as the dependent variable. The results from these regressions are reported in Table 6. In the reported analyses, the explanatory factors listed show a clear ability to distinguish between consumers who would presently demand rent-to-own services and those who would not. Both the full and reduced regressions are highly significant overall (2(16) ˆ 47.0, p < 0.0001; 2(11) ˆ 46.1, p < 0.0001) and have pseudo-R2 values of 0.58 and 0.57, respectively. In addition, it is also clear that the factors influencing rental± purchase demand in the present are related, but not identical, to those found correlated to past behavior. First, the continued insignificance of any of the income or credit access variables confirms the failure of Explanation 1 (liquidity constraints) as predictive of rental±purchase demand. In particular, present access to credit cards is completely non-predictive of rentrec, indicating that at least some consumers would choose to use rental±purchase even given access to revolving credit accounts. However, basic demographic variables do show some correlation: women, younger subjects, and less educated respondents all appear to be more likely to demand rental±purchase services. Second, Explanations 3 (myopic time preferences) and 4 (risk aversion and escapability) do receive clear support from the experimental data. The coefficients on payins and incanticip indicate that each is a significant predictor of rentrec, and the

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coefficient on incstable is in the predicted direction as well.18 These results support the hypothesis that risk aversion and desire for flexibility are key sources of current rental± purchase demand. In addition, the significant coefficients on lottery and savefriend provide similar support for the self-management explanation. Finally, the significant and negative coefficient on payment implies that Explanation 2 (high inter-temporal discount rates) is also valid in terms of predicting rentrec; consumers desiring contracts with small payment sizes are more willing to recommend renting-toown. This finding is very intriguing given the unambiguous negative findings for this explanation when tested directly against past rent-to-own use in both studies, and we see it as welcome evidence that consumer learning from experience does exist. Those consumers for whom the small payments and long contract terms of renting-to-own proved to be either excessively costly or burdensome have learned from their experience to avoid such contracts, and their current preferences as assessed in our surveys reflect this fact. This finding is yet another reason why policy makers must be aware that what leads consumers to choose to rent-to-own need not always be observable post hoc. 5. Discussion Although recent legal and legislative efforts to control the rent-to-own industry have focused on the high cost of these contracts, the research presented here suggests that cost is not the only issue relevant to low-income consumers, who may consciously select rental±purchase based on other criteria. Two new issues emerged from our results as central to the demand for rental±purchase agreements. Households are more likely to rent-to-own when they face uncertain or unstable levels of disposable income and if they face particular difficulty managing their finances over the longer term. Measures of both of risk preferences and myopic time preferences, as assessed in our surveys, were positive and significant predictors of demand for rental±purchase contracts despite this method's almost exorbitant cost. In each case, consumers appear to be valuing non-price dimensions, such as the combination of escapability and regular structured payments, to the exclusion of other issues such as cost. In fact, policies designed to address non-price issues, whether by making saving easier or providing other, cheaper purchase method alternatives such as `payment insurance,' may be as or even more effective at improving social welfare than arbitrary regulation of rental±purchase agreements and rates. In closing, we note that the forces which drive low-income consumers to use rental± purchase stores are the same problems which prevent wealth accumulation in general. For example, Rose (1990) documents the fact that AFDC and other welfare recipients cannot accumulate large savings without facing reductions or elimination of their benefits. Such 18 We should note that incstable, our measure of stability or variation in monthly income, was not significant in any of the regressions in Tables 5 and 6 when analyzed cardinally. However, while little effect was observed over most of that scale, respondents with fixed incomes (scores of 6 or 7 on the incstable scale) were much less likely to use or recommend renting-to-own than other subjects. If we create a binary variable (fixedinc) to identify these fixed income subjects and substitute it for incstable in the regressions, the coefficient on fixedinc is large enough to be included in both reduced regressions (asy-z ˆ ÿ1.65 with rentpast; asyÿz ˆ ÿ1.44 with rentrec).

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controls not only limit these households' ability to accumulate the kind of wealth needed to improve their long-term financial situation (e.g. through home ownership), but it provides a disincentive for saving at all. To quote one of our interview subjects on his public housing benefit: ``[The local housing authority] can check up to see if you have a substantial amount of money that you're putting in the bank and if you do, they raise your rent.'' This fear of losing benefits, whether welfare checks or reduced cost housing, may lead individuals to use more expensive rental±purchase agreements instead of saving, despite the cost of such a decision. That decision only leads to greater financial constraints and further difficulty in saving, fueling a self-sustaining feedback loop of poverty.

Acknowledgements We gratefully acknowledge the financial support of the Small Grants Program of the Behavioral Economics Roundtable of the Russell Sage Foundation. We would also like to acknowledge our debt to George Loewenstein, Linda Babcock, Wesley Cohen, John Caskey, Franklin Fisher, Rachel Croson, Mark Miller, Naomi Zikmund-Fisher and four anonymous referees for their advice and editorial assistance, and WaÈndi Bruine de Bruin, Dawn Tamarkin, and Mahender Nathan for their research assistance. Sincere thanks are due to all of the following individuals and organizations for welcoming us into their communities and recruiting subjects for this research: Serena Washington and Dr. Gayle Griffin with Fort Pitt Elementary/Garfield YMCA Summer Camp; the Rev. Dr. Ralph Watkins and the congregants of Trinity African-American Methodist Episcopal Church; and Beverly Mullens and James Faulks of the Homewood±Brushton Family Support Center. An earlier version of this paper was presented at the Economic Science Association meeting, 17±20 October 1996 in Tucson, Arizona. We retain all responsibility for error.

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