Financial literacy and shrouded credit card rewards

• Published in: Journal of financial services marketing 2013-09, Vol.18 (3), p.177-187
• Main Authors: Ricaldi, Laura, Finke, Michael S, Huston, Sandra J
• Format: Article
• Language: English
• Subjects: Consumer credit; Credit card industry; Decision making; Economics and Finance; Finance; Financial literacy; Financial Services; Households; Loyalty programs; Marketing; Original Article; Studies; Surcharges
• ISSN: 1363-0539; 1479-1846
• DOI: 10.1057/fsm.2013.11

Credit card companies charge an interchange fee for each transaction, and almost half of this fee is returned to consumers in the form of a reward or perk program. Among credit card users who do not use cards for borrowing (convenience users), rewards are a means to negotiate the implicit price of the interchange fee. Any consumer whose time cost is less than the value of rebates should rationally choose a reward card. Half of convenience users do not own a reward card. We hypothesize that credit card companies segment customers by marketing non-salient credit card characteristics to appeal to naïve consumers while offering lower-price cards (net the rebate) to compete for more sophisticated consumers as suggested in Gabaix and Laibson (2006). Consumer sophistication is measured using a 20-question financial literacy instrument in a large national data set. When household characteristics such as education, income and wealth are controlled in a multivariate analysis, respondents in the highest financial literacy quintile were twice as likely to own a rewards card. The relation between literacy and reward cards provides evidence that credit card rebates resemble other markets where hidden product attributes create a welfare transfer from naïve to sophisticated consumers.