CARIN, Patricia Lei R. INOCENCIO, Angelika B.

DASUGO, Czarina Ashley D. LASCANO, Jerome Ivan B.

Credit Ratings As Basis for Overall Employee Evaluation

I. Introduction

A. Background of the Study

Credit rating is not a popular concept in the Philippines. Credit ratings are used to
measure firm performance, credibility, and for employee evaluation especially in other countries
through looking at an individual’s credit history and credit scores. Firms are very careful with the
workers that they hire. Firms make sure that these workers are capable, and most of all credible.
How does a firm measure employee performance and credibility? Employee selection is one
important aspect in every firm, they devote their time in really studying employee applications to
make sure that they get the best ones since employee selection can be related to management
outcomes (Campbell, 2012). These firms want to make sure that the criterias really allow them to
pick the most qualified applicants. “Selecting the best workforce from a pool of applicants is an
essential function for a firm which hopes to survive competitive pressures” (Brown, 1982).
Given this, it can be seen how important credit ratings are for firms so they could evaluate an
applicant and an employee at the same time.

Abscbn news (2017) reported that the FICO company in the United States introduced the
use of credit ratings in the Philippines to help assess the credit scores of the Filipinos. Inline with
this, Republic Act 9510 or Credit Information System Act stated that the state has the need to
establish a comprehensive and centralized credit information system for the collection and
dissemination of fair and accurate information relevant to, or arising from, credit and credit -
related activities of all entities participating in financial system. In line with this, this paper will
study if these ratings are either necessary or just sufficient in employee evaluation. This paper
will look closely at the effectiveness and applications of credit ratings especially before and after
hiring. This paper will also evaluate if the said system can be applied in the Philippine setting
given its effectiveness and usage in other countries.

B. Definition of Terms

Credit Score - “A credit score is a single number that is designed to represent the level of credit
risk a particular individual represents to a lender.” Even if this is based on credit reports, this
states the result that is used specifically for consumer lending (Weaver, 2014).

Credit History - records that contain an individual’s access to different types of credit such as
credit cards, car loans, and mortgages which are recorded by any credit reporting agency
(Weaver, 2014)

Employee Evaluation - the process of evaluating if an applicant is reliable, credible, and an

efficient worker which would make the firm evaluate one’s performance

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Consumer Reporting Agencies (CRAs) - any person who evaluates consumer credit information
so that third party entities and firms can benefit from the said report

Fair Credit Reporting Act (FCRA) - a federal law in the United States which promotes the
transparency, fairness and privacy of the consumers information.

C. Statistics

The Credit Card Association of the Philippines (CCAP) stated that they expect the
number of credit card holders to double over the years. Back in 2015, they reported that they
issued 6.9 million credit cards to 3 million people. Total sales in malls are reported to be 65%
cash and 35% credit (Barlongo, 2015).

86% of US organization use background investigations to ensure that employees are well
selected and did not engage in any bad behavior that may be a threat to the company at present
and in the future (Aamodt, 2015).

“About 34% of employers use credit checks on some job applicants and 13% conduct
credit checks on all applicants, according to the SHRM's survey. Only 14% cite a credit check as
the most important factor in a hiring decision, compared to 87% who said previous work
experience is most important.” (Ellis, 2013).

There is a 2.2% error in the credit reports and according to Consumer Data Industry
Association, 98% of the reports are accurate (Ellis, 2013).

II. Survey of Literature

A. Preliminary and Seminal Papers

Catch-22 Trap on Employment

Traub (2013) administered a survey on credit card debt of low and middle-income
households in the United States in 2012. Among their unemployed survey respondents,
employment credit checks were common and there are people who have been rejected in their
application to companies because of these credit checks. The same study also found that poor
credit is associated with unemployment, unpaid medical bills, among others. This suggest that
the credit reports of these potential employees are just reflective of their economic stress, and not
reflective of an individual’s suitability assuming they get hired. Initially, credit reports were
developed for lenders to evaluate whether a potential borrower would be considered a good
credit risk. This is done by looking at an individual’s history of paying his/her debts. The
borrowers eventually decide whether these potential borrowers be granted a loan, and on what
terms should their loans be granted. These said credit reports include not only an individual’s
personal details, but it also includes information on mortgage debt, student loans, car payments
and credit card accounts. This information on credit card accounts even include the balances of

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an individual, credit limits, records of bankruptcy and monthly payments. The access to these
credit reports are possible because there are some companies that supply these namely Equifax,
Experian and Transunion which are commonly known as CRAs. These can be accessed by
employers legally under the terms of the Fair Credit Reporting Act or FCRA. Such law requires
the employers to get consent from the individual that they want information of. Although the
process of obtaining this kind of information is difficult, is it still possible, and definitely, the
applicants would be more than willing to grant their employers the consent because this is asked
by the firm they are vying for. The study found that one in ten participants in their survey who
are unemployed were informed that they were not hired because of the information present in
their credit reports. Consequently, among the job applicants with “blemished” history, one in
seven have been informed that they were not hired because of their existing credit.

The study by Traub (2013) concluded that the use of credit reports in employment puts
these job seekers and applicants in a “catch-22 trap”. Individuals find it difficult to pay their bills
on credit because they are unable to land on a job; and since they are unable to land on a job,
they can’t pay the bills they have on credit. The catch-22 trap is indeed evident especially to
those who struggle with poor credit ratings. There is little evidence in proving that these credit
reports reveal valid and relevant information that will affect an employee’s performance, and the
credit history of an individual obstructs access to employment.

Equal Credit Opportunity Act

The Federal Deposit Insurance Corporation (FDIC) defines the Equal Credit Opportunity
Act (ECOA) as the act that prohibits any kind of discrimination related to a credit transaction.
The ECOA prohibits discrimination based on race, religion, national origin, sex, marital status
and age. According to a paper published by Burns (1979), the goal of this Act is to eradicate
discrimination in credit markets, but also to facilitate a better way for credit markets to be
inclusive. The paper analyzes the use of an effects test and its relation to credit scoring, and
eventually on employment. Determining the results of an effects test and its relation to credit
scoring, according to the paper, can provide a useful starting point in analyzing credit scoring
and its implications on the screening process. When the ECOA was made effective, other
substitutes of decision procedures were practiced, rather than what was done prior to the Act,
when discrimination was explicitly evident.

B. Follow-up Studies and Empirical Papers

Credit Check Bans

A research study conducted by Ballance, Clifford & Shoag (2016) states that in the last
ten years, most states in the United States have already banned using credit checks in influencing
hiring decisions of employers, which is a screening tool already used by many. Their study made
us of datasets acquired from Equifax, a consumer reporting agency (CRA) that gives information
on employer credit checks. They also acquired data from the Longitudinal Employer–Household
Dynamics (LEHD) Origin-Destination Employment Statistics or commonly known as LODES in
determining the areas the employees reside in. Using employment outcomes and changes in the

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commuting patterns of the workers, Balance, Clifford & Shoag (2016) found that these credit
check bans have increased the employment of residents in areas that have a low average of risk
score. They have also determined that due to these credit bans, employers demand for more
signals on other determinants of an applicant’s performance including educational background
and experience.

Is Credit Status a Good Signal of Productivity?

The use of credit status, credit ratings and credit reports in the process of hiring job
seekers is a practice that has been scrutinized for the longest time. According to a study by
Weaver (2014), there are employers that screen new hires by examining their credit reports. This
type of practice has sparked criticism and debate. The people who are against this kind of
practice asserts that this practice amounts to discrimination. These people argue that personal
credit status is not related to job performance, and that this practice is likely to disproportionately
harm workers due to low income and great incidence of poor credit in some areas. On the other
hand, the people who support this practice asserts that this mechanism allows employers to
assure the quality of the employees they are getting. People who support the practice state that
this will make sure that the character of an employee is well-evaluated and that fraud is unlikely
to happen. Since this practice has been rampant, there are not much data that evaluate the
relationship between credit status and productivity. This study relies on the data obtained from
the National Longitudinal Survey of Youth from 1979 or, hereinafter, NLSY79. NLSY79
contains a dataset that reflects credit-relevant variables such as data on net worth, data on
rejections of credit applications, credit card debts and other indicators. This study makes use of
firm-learning. Among the models used in this study is the employee’s log productivity as a
function of the variables that the employer sees which is given as:

this model reflects the difference between employer expectations and true productivity, net the
effect of the experience profile represented by . The model also reflects the
noisy signal an employer sees that will reflect an employee’s true productivity, which is also
subject to errors. Another model present in the study is the impact of employer learning on
wages, which is also presented in a firm-learning model. The market is able to learn about an
employee’s productivity the same time the employer does, and this can be implemented
strategically. The model estimates:

where w is log wages; C is an indicator for negative future credit status; A is a measure of the
cognitive ability of an individual (which is the individual’s score on the Armed Forces
Qualification Test or AFQT); E is experience and X is the vector containing other relevant
variables, of which includes gender, marital rice, the interaction of education and experience
among others. Weaver (2014) finds that the character-related portion of credit status is not a
significant predictor of worker productivity. Results of this analysis done in the study indicate

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that credit status does not contain any meaningful signal about the components that describe
employee productivity.

C. Extensions and Applications

Initially credit scores are provided to help lenders retrospect the capacity of borrowers to
pay future debts however nowadays, employers would commonly rely on an applicant’s credit
history as well before making any decisions regarding employment. Credit reports provide an
individual’s personal information, as well as any financial related actions which dictates any
trend as to how this individual covers their debt. Credit reports also show all data that may have
any effect on a potential borrower’s capacity to pay future liabilities (Adebayo & Hurley, 2016).
These credit reports are not readily accessible to employers this is why they may opt to legally
access these reports from any consumer reporting agencies (CRAs) under the terms of the Fair
Credit Reporting Act (FCRA). The FCRA authorizes any CRA to provide credit reports to
individuals whom, within good faith, will use the information solely for employment purposes.
This statute is otherwise known as the Permissible Purposes of Consumer Reports, as specified
under the US Code (15 U.S.C. § 1681b). Under the same act, employers are required to obtain a
written permission from individuals they have requested credit reports for. This statute also
requires employers to notify these individuals before taking any specific actions with regards to
their employment status if any of these decisions have been affected by any information
specified in the credit report. Together with this notification, the employer must attach a copy of
the report and a handwritten description of the consumer’s rights. Applicants are given ample
amount of time to point out and settle any errors with regards to their credit report. Usually only
after 3-5 business days can employers decide and take necessary actions, basing all these from
the applicant or employee’s credit report. Employers must again notify applicants of their action.
According to an article done by Traub (2013), although there has already been an increasing
number of laws being passed to limit instances wherein employers can discriminate against
applicants by solely relying on their credit history, federal law allows employers to use credit
history as a basis to deny applicants of employment. The author added that the consumer
protections identified in the FRCA are necessary but are insufficient to prevent your credit
checks from being barriers to employment since employers can reject any applicant who
declined a credit check.

According to Aamodt (2015), there seems to be five main reasons as to why employers
base their decisions regarding an applicant’s employability. The first reason is that it is required
by an external agency such as bonding companies, or a state government. The second reason is
because employers’ want to avoid, if not, reduce legal liabilities brought about by negligent
hiring. The third reason is that employers assume that employees who are struggling financially
are more likely to commit theft or to accept bribes. The fourth reason is that the employers
believe that a bad credit history reflects the insolence and irresponsibility of applicants thus,

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deemed unfit for the job. And for the fifth reason, an employee that is financially struggling will
perform poorly at work and would most likely take leaves of absence due to stress and errands to
run to deal with their financial problems. These reasons are adjudged discriminatory because
according to Weaver (2014), the personal credit of employees and their work performance have
no correlation. Furthermore, Weaver mentioned how minority workers would be greatly affected
by this practice since they have greater incidence of poor credit while not earning as much as
other workers.

III. Conclusion and Recommendations

A. Research Gap

Though ideally expected that the credit ratings are known to measure the credibility and
level of risk of the debtor presented to a creditor, these ratings or scores that are now being used
to determine other factors such as firm’s performance and individual’s capability has to be
addressed in further research. In this study, the researchers investigated the relationship of credit
ratings to the overall employee evaluation. Most of the studies are reported and presented in
other countries especially the United States. Given that United States introduced credit ratings in
the Philippines, the researchers were not able to evaluate its implementation in the Philippines
due to the restrictions of data availability.

B. Conclusion and Recommendation

The study was able to determine the relationship of credit ratings to employee evaluation
using previous studies. Unfortunately, despite the deep evaluation of the relationship between the
credit ratings and overall employee evaluation, the researchers has not observed any significant
correlation due to the restrictions of accessing the data of credit ratings in the Philippines.
Moreso, evaluating an applicant through credit ratings is necessary but not sufficient for there is
no strong significant relationship between the worker’s credit status and the worker’s
productivity. Credit rating is a type of practice that amounts to discrimination for it hinders the
job seekers for employment because employers think that the applicants may commit theft or
have poor work performance. In addition, it is bad indicator of worker’s productivity given that
the employee may have a bad relationship with its past job which does not conclude that the
employee has a bad work performance. Hence, it only implies that the worker may have just
been experiencing economic stress. In fact, having bad ratings will only disincentivize workers
in looking for better job that would result to the difficulty of paying bills on credit because there
is insufficient income gained. Moreso, firms and companies may consider this as a basis of
evaluation provided the presence of past worker’s experiences and other factors that matter.
Despite the application of credit ratings in the Philippines, it is not a viable system to base the
overall employee evaluation. In addition, application of these credit scores may cause the
movement of unemployment rate in the country which may be a hindrance in the growth of the

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economy. Given this, the researchers suggest that further research can help investigate the
potential mechanisms that will lead to better management of employee selection.

Knowing that data are not accessible to the public, the researchers recommend the future
researchers to obtain data to make the study more accurate. Hence, Providing the data access to
the authorized lenders may cause discrimination among people so the researchers also
recommend the Philippine Identification System ID that is now proposed in the senate. To avoid
such discriminations, a certain id number with the corresponding credit ratings should be
presented instead.

IV. Bibliography

Aamodt, M. (2015). Using background checks in the employee selection process. In C. Hanvey
and K. Sady (Eds.) Practitioner’s Guide to Legal Issues in Organizations. New York:
Springer.

ABS-CBN News. (2017, October 11). US company to introduce 'credit scoring' in Philippines.
Retrieved from http://news.abs-cbn.com/business/10/12/17/us-company-to-introduce-credit-
scoring-in-philippines

Adebayo, J., & Hurley, M. (2016). Credit Scoring in the Era of Big Data. Yale Journal of Law
and Technology,18(1), 5th ser., 148-202.

Balance, J., Clifford, R., & Shoag, D. (2016). " No More Credit Score" Employer Credit Check
Banks and Signal Substitution. Working Paper.

Barlongo, C. (2015, March 22). CCAP expects double-digit growth of credit-card holders in next

few years. Retrieved from https://businessmirror.com.ph/ccap-expects-double-digit-

growth-of-credit-card-holders-in-next-few-years/

Brown, C. (1982). Estimating the Determinants of Employee Performance. The Journal of

Human Resources, 17(2), 178-194. doi:10.2307/145468

Burns, S. E. (1979). Credit Scoring and the ECOA: Applying the Effects Test. YALE LJ, 88,
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Campbell, D. (2012). Employee Selection as a Control System. Journal of Accounting Research,

50(4), 931-966. Retrieved from
http://0-www.jstor.org.lib1000.dlsu.edu.ph/stable/41680534

Ellis, B. (2013, February 12). Millions of credit reports have errors. Retrieved from

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 https://money.cnn.com/2013/02/11/pf/credit-report-errors/index.html?iid=EL

Ellis, B. (2013, March 4). One in ten unemployed denied jobs due to credit checks. Retrieved
from https://money.cnn.com/2013/03/04/pf/employer-credit-checks/index.html

Federal Deposit Insurance Corporation. (2015). Equal Credit Opportunity Act (ECOA).
Retrieved from Federal Deposit Insurance Corporation:
https://www.fdic.gov/regulations/compliance/manual/5/v-7.1.pdf

Fair Credit Reporting Act of 2006, 15 U.S.C. § 1681b.

Traub, A. (2013). Credit reports and employment: findings from the 2012 national survey on
credit card debt of low-and middle-income households. Suffolk UL Rev., 46, 983.

U.S. Equal Employment Opportunity Commission (EEOC). (n.d.). Title VII of the Civil Rights
Act of 1964. Retrieved from U.S. Equal Employment Opportunity Commission (EEOC):
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Weaver, A. (2015). Is credit status a good signal of productivity?. ILR Review, 68(4), 742-770.