2/18/2009
Costless Disclosure of Product Quality by Sellers
Strategic Disclosure:
Some Results from Economic Theory
Andrew Daughety
Department of Economics and Law School
Vanderbilt University
Conference on
Transparency and Accountability:
The Role of Information Disclosure
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February 6, 2009
- Only one apple is in the box; willingness-to-pay as indicated.
- The seller knows which type of apple is for sale, the buyer does not.
- Costless for the seller to open the box.
Costless Disclosure of Product Quality by Sellers:
The Unraveling Result
Costless Disclosure of Product Quality by Sellers:
The Unraveling Result
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A seller with the “high” type of apple will want to open the box,
so as not to be lumped (“pooled”) with the low type.
A skeptical consumer will assume the worst if the box remains
unopened. This extends to the case of many quality levels.
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Thus: voluntary disclosure occurs, no need for disclosure rules,
even in the case of a monopoly supplier.
(Grossman, JLE 1981; Milgrom, BellJE1981)
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2/18/2009
Costless Disclosure of Product Quality by Sellers:
The Unraveling Result – Underlying Assumptions
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- Veracity and verifiability
- Costless disclosure
- No
N economic
i activity
ti it needed
d d tto produce
d
or learn quality
- Buyer sophistication
- Single seller
- Selective Disclosure
- Problems with Transparency
Vertical Quality: Examples and Assumptions
Some examples of (vertical) quality:
• durability (e.g., mean time to failure)
• safety (e.g., likelihood of harm)
• consumer satisfaction
ti f ti (e.g.,
(
likelihood
lik lih d off satisfaction)
ti f ti )
• efficiency in use (e.g., appliance energy demands)
Usual case: consumers prefer more to less, full-information firm
profits increasing in quality.
Veracity and Verifiability
• claims,, even if vague,
g , are truthful;;
• quality is verifiable by third party (contractible).
Both assumptions supported by ex ante or ex post enforcement.
Costly Disclosure of Quality
Costly Disclosure of Quality (II)
Production cost of quality constant, but requires pre-sale cost to
provide credible quality disclosure (e.g., audit cost).
Lowest
Highest
What if production (or other) costs increase with quality?
- Now rational buyers know that the quality being sold affects more
than (simply) demand.
-Thus
Thus, firm pricing can signal information about quality; signaling
must be costly to be credible.
Lowest
Pay audit cost, voluntary disclosure
No voluntary disclosure;
pooling.
“Marginal type of seller”:
Difference in profits between:
• profit if type could costlessly disclose
• average profit of non-disclosing types
just equal to disclosure cost.
If only value of disclosure is to help higher types charge higher
prices, disclosure is viewed as “excessive.”
(Viscusi, BellJE 1978; Jovanovic, BellJE1983; Verrecchia, JAcctgE 1983)
Highest
Pay audit cost, voluntary disclosure
No voluntary disclosure; distortionary
signaling via other channels.
Marginal type of seller
Now, with multiple (costly) channels of communicating quality
(disclosure, price, warranty, etc.) buyer always learns information.
Furthermore, now disclosure is generally “insufficient.”
- Mandatory disclosure can benefit consumers, but not efficient.
(Daughety and Reinganum, RAND 2008)
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2/18/2009
Acquisition of Information About Quality Prior to Sale
What if the seller must learn the quality of the good?
• quality testing;
• information acquisition from experts.
Further assume that buyers may not know if sellers have learned quality
Further,
quality.
Primary results, assuming veracity and verifiability of quality claims:
• Under costless disclosure, if learning is costless and disclosure is
voluntary, then the seller will choose to learn and will disclose.
• If mandatory, the seller will choose to not learn (and not disclose)
whenever it is more profitable to have uninformed buyers.
• If testing can improve quality, then voluntary disclosure leads to
excessive testing; mandatory disclosure to socially optimal amount.
Basic implication: mandatory disclosure, if needed, is likely to require
mandatory testing and/or significant liability for selective release.
Strategic Competitors
What happens if there are competitors?
Recent theory has focused on two-seller models.
• If sellers know each other
other’ss quality type,
type costless disclosure is
incomplete, though (as earlier) still “excessive.”
• If disclosure is costly, there is less disclosure with two sellers than
with one.
• A recent empirical study of competition among HMOs indicates
that increased competition is correlated with reduced disclosure.
Disclosure may intensify competition, and firms try to avoid this.
This gives an important new role for mandatory disclosure: it may
increase competition, lowering prices.
(Hotz and Xiao, WP 2005; Jin, RAND 2005; Levin, et. al. JIndE forth.; Board, JIndE forth.)
(Matthews and Postlewaite, RAND 1985; Shavell, RAND 1994; Shin, ECMA 2003)
Buyer Sophistication
Most analyses have assumed sophisticated (skeptical) buyers.
• This might be a realistic assumption for corporate buyers, regulators.
• It may be a stretch for consumers.
• Consumers may
y have difficulty:
y
1) processing complex information (limited understanding);
2) forming beliefs in lieu of disclosure;
or 3) anticipating alternatives/consequences for what the seller is
providing.
In cases (1) and (2), if a fraction of the buyers are not “sophisticated”
then even if disclosure is costless, it may not occur. Then mandatory
disclosure helps those buyers who can understand disclosed
information, at the expense of the seller.
Case (3) might be addressed via informational campaigns or by
mandating provision of information on alternatives by sellers.
(Milgrom & Roberts, RAND 1986; Fishman & Hagerty, JLEO 2003;
Daughety & Reinganum, JITE 2008)
Partial Disclosure – Selective Release of Information
If the buyer knows that there are multiple pieces of information about the
product, then strong skepticism again implies that any unrevealed
information will be assumed to be worse than that reported. This
forces the seller to reveals the best attributes possible.
possible
• If the seller can only credibly report on a limited set of items, the
best ones will be selected.
More importantly, this can mean that if only limited disclosure of a series
of tests is possible, then limiting discretion as to which tests can be
reported can improve the information that is provided.
• That
Th is,
i providing
idi uniform
if
reporting
i requirements
i
can be
b socially
i ll
desirable.
This relied on the buyer knowing what the missing reports could have
said. This may be unrealistic.
(Milgrom, BellJ 1981; Fishman and Hagerty, QJE 1990)
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2/18/2009
Some Problems with Disclosure/Transparency
If disclosure costs are high, since signaling via other channels is
distortionary, then both sellers and buyers may be better off with
no testing.
There can be unintended responses to disclosure.
Of course, there is a difference between some inscrutability and no oversight.
Privacy considerations
• Price discrimination via later use or sale of information revealed
via purchase.
• Broader privacy considerations (e.g., health choices, reading
choices, investment choices, travel choices, contributions).
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