Employer Credit Checks: Poverty Traps versus Matching Efficiency

Abstract

We develop a framework to understand pre-employment credit screening through adverse selection in labor and credit markets. Workers differ in an unobservable characteristic that induces a positive correlation between labor productivity and repayment rates in credit markets. Firms therefore prefer to hire workers with good credit because it correlates with high productivity. A poverty trap may arise, in which an unemployed worker with poor credit has a low job finding rate, but cannot improve her credit without a job. In our calibrated economy, this manifests as a large and persistent wage loss from default, equivalent to 2.3% per month over ten years. Banning employer credit checks eliminates the poverty trap, but pools job seekers and reduces matching efficiency: average unemployment duration rises by 13% for the most productive workers after employers are banned from using credit histories to screen potential hires.

The Unintended Consequences of Employer Credit Check Bans on Labor and Credit Markets

“…Our estimates are consistent with the predictions of a micro-founded model (Corbae & Glover (2017)). Vacancy postings fall after the introduction of the credit check ban for affected occupations, which is consistent with a reduction in labor demand due employers losing a cheap 22 The results for Blacks remain positive and become significant at the 10% level if we trim the bottom and top 1%.…”

“…Corbae and Glover (2017) show that such a trap may arise in a general equilibrium model. If the passage of these bans is correlated with our variables of interest, then our estimates cannot be interpreted as causal.…”

“…More directly related to our policy-based identification strategy, Corbae and Glover (2017) develop a screening model in which employers use credit reports in hiring because repayment rates are positively correlated with an unobservable component of worker productivity. 3 They show that banning employer credit checks may reduce vacancies, since employers cannot screen workers ex-ante.…”

The Unintended Consequences of Employer Credit Check Bans on Labor and Credit Markets

“…Our estimates are consistent with the theoretical implications of Corbae and Glover (2017), henceforth "CG." They build a general equilibrium model in which households make borrowing and default decisions, which affect their credit histories.…”

The Unintended Consequences of Employer Credit Check Bans for Labor Markets

“…Donaldson, Piacentino, and Thakor (Forthcoming) posit a theory in which debt overhang suppresses vacancies by raising workers' reservation wages. Most directly related to our policy-based identification strategy is Corbae and Glover (2018), who develop a screening model in which employers use credit reports in hiring because repayment rates are positively correlated with an unobservable component of worker productivity. credit reports is more relevant for routine jobs.…”