Self Control and Liquidity: How to Design a Commitment Contract

Abstract

If individuals have self-control problems that lead them to spend money when they had previously planned to save it, they may take up financial commitment devices that restrict their future ability to access their funds. We experimentally investigate how the demand for commitment contracts is affected by contract design features. In our experiments, each subject is endowed with a sum of money and asked to divide that money between a liquid account, which permits unrestricted withdrawals at any time over the course of the months-long experiment, and one or more commitment accounts, which impose withdrawal penalties or restrictions. The design features of the liquid account are the same for all subjects, but the design features of the commitment account(s) are randomized across subjects. When the interest rates on the two types of accounts are the same, we find that allocations to a commitment account are higher when the account is less liquid. The commitment account that disallows early withdrawals altogether attracts the largest allocations. However, this relationship no longer holds when the commitment account interest rate is greater than the liquid account interest rate.

Time inconsistent preferences and the annuitization decision

“…People with low self-control put too much weight on the near future disregarding long-term costs and benefits. For example, DellaVigna and Malmendier (2006) find that most people plan to attend the gym on a regular basis when signing the membership contract, but actual attendance is much lower (for further evidence on self-control problems see DellaVigna, 2009;Beshears et al, 2011). One way to overcome these problems is to bind or precommit one's own behavior (see for example Strotz, 1955;Thaler and Shefrin, 1981;Laibson, 1997;Sorger, 2007).…”

“…1) By introducing a commitment device allowing people to bind or precommit their behavior (see Strotz, 1955). If people choose the lump sum because of self-control problems a precommitment device is a powerful tool to help people overcome this problem (see for example Thaler and Shefrin, 1981;Laibson, 1997;Beshears et al, 2011). 2) Making it mandatory to determine the payout scheme at the beginning of the contract when people are (still) young and not at retirement, is another way to increase real life annuitization rates.…”

Holding the Hunger Games Hostage at the Gym: An Evaluation of Temptation Bundling

“…Indeed, past research has demonstrated that people value mechanisms that prevent their future selves from making unwise decisions such as procrastinating (Ariely and Wertenbroch 2002), undersaving (Ashraf et al 2006, Beshears et al 2011, smoking cigarettes (Giné et al 2010), failing to achieve workplace goals (Kaur et al 2010), and giving in to repeated temptations in the laboratory (Houser et al 2010). Study participants have expressed a willingness to use "commitment devices" such as placing money in restrictive accounts that prevent premature savings withdrawals (Ashraf et al 2006, Beshears et al 2011; self-imposing deadlines with associated late penalties to prevent procrastination on coursework (Ariely and Wertenbroch 2002); and placing money on the line for forfeiture if they fail to quit smoking, exercise, or lose weight (Halpern et al 2012, John et al 2012, Royer et al 2012, Volpp et al 2008.…”

“…Study participants have expressed a willingness to use "commitment devices" such as placing money in restrictive accounts that prevent premature savings withdrawals (Ashraf et al 2006, Beshears et al 2011; self-imposing deadlines with associated late penalties to prevent procrastination on coursework (Ariely and Wertenbroch 2002); and placing money on the line for forfeiture if they fail to quit smoking, exercise, or lose weight (Halpern et al 2012, John et al 2012, Royer et al 2012, Volpp et al 2008.…”

“…We then presented them with an opportunity to pay for an exercise program: if they enrolled in the program, study staff would hold their iPod for one month in a monitored locker at the university gym, ensuring they never listened at home and had something to look forward to during exercise. Sixty-four percent of participants indicated that this program "sound[ed] appealing" to them when asked on a "yes/no" scale (t 211 = 19 43; p < 0 0001), demonstrating that temptation bundling devices are valued and adding to the mounting evidence of demand for commitment devices (Ariely and Wertenbroch 2002, Ashraf et al 2006, Beshears et al 2011, Giné et al 2010, Halpern et al 2012, Houser et al 2010, John et al 2012, Kaur et al 2010, Volpp et al 2008.…”