How Borrowers Respond to Dynamic Incentives? An Exploration of Repayment Decisions on Digital Credit

We examine how borrowers in digital credit markets respond to dynamic incentives. To this end, we leverage quasi-experimental variation in progressive lending policies to identify causal effects on repayment behavior. Our empirical strategy uncovers systematic heterogeneity in borrower responses across different stages of the borrower–lender relationship. We find that first-time borrowers who receive exogenously larger initial loans are significantly more likely to default—consistent with elevated moral hazard and increased repayment burden effects. In contrast, repeat borrowers who receive larger loan increments relative to their prior borrowing cycle exhibit substantially lower default rates. These contrasting patterns are consistent with a theoretical framework where experienced borrowers interpret loan size increases as credible signals of future credit expansion, thereby reinforcing their incentive to maintain repayment discipline. Supporting this mechanism, we document robust evidence of strategic repayment behavior, particularly among borrowers who advance rapidly through successive loan cycles. Collectively, our findings highlight the critical role of relationship dynamics in shaping borrower behavior and underscore the importance of tailoring progressive lending policies to a borrower’s experience level in order to enhance repayment outcomes across a diverse client base.

This paper was accepted by Bruno Biais, finance.

Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2021.02016.