Information Misrepresentation: The Importance of Earnings Estimations in Student Loan Default Rates at For-Profit Universities

Abstract

Over recent years, high student loan default rates at for-profit universities have researchers questioning whether these schools induce risky loans by misinforming students of the benefits of attending. Prior research suggests that for-profit schools have default rates 5-6 percentage points higher than other institutions. Our study examines if this differential default rate among institutions is the result of low for-profit graduates’ earnings. We hypothesize that if students are rational and accurately project the costs and future benefits of attending an institution, they should not default on loan repayments. After controlling for graduate earnings and other factors theoretically associated with default, we find that four-year for-profit schools have significantly higher average default rates than public and private institutions. We interpret these unexplained differences in default rates among for-profit institutions as possible systematic deviations of their students’ earnings projections and suggest that these schools misinform borrowers of their future ability to repay. We find no evidence of bad loans at two-year and less than two-year for-profit institutions. In fulfillment of the requirements for the undergraduate certificate in finance, this paper conducts a detailed examination of the student loan market—specifically student loan default rates. It includes discussion and analysis of college investment, student debt, loan defaults, and credit risk. This study applies a theoretical model of student default to an empirical study at the institutional level. It was advised by Professor Jean Grossman.