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Incentives of low‐quality sellers to disclose negative information
Abstract
The paper studies incentives of low‐quality sellers to disclose negative information about their products. We develop a model in which one's quality can be communicated via cheap‐talk messages only. This setting limits the ability of high‐quality sellers to separate, as any communication strategy they pursue can be costlessly imitated by low‐quality sellers. We study two factors that can incentivize low‐quality sellers to communicate their quality: buyers' loss aversion and competition. Quality disclosure reduces buyers' risk, thereby increasing their willingness to pay for the product. It also introduces product differentiation, softening the competition.
This paper examines how the two common product liability rules (strict liability versus comparative negligence) affect firms and consumers when firms can advertise product quality deceptively and consumers exert precaution efforts endogenously.
Purpose – This work aims to examine the quality disclosure strategy of sharing economy platforms with network externality, considering consumer risk aversion.
Design/methodology/approach – The game theory, sensitive analysis and numerical study are used herein. The equilibria are derived from the game theory. The quality disclosure strategy is analyzed by profit comparison. To further understand the characteristics of the optimal disclosure strategy, sensitive analysis
and numerical studies are conducted to detail the analytical results.
Findings – Regardless of market structure, the quality disclosure decision problem is a trade-off between information effect and cost effect. Consumer risk aversion is a factor that can incentivize low-quality platforms to disclose quality. Both consumer risk aversion and network externality influence the quality disclosure strategy through information effect. Interestingly, for different competition intensities, consumer risk aversion
and network externality could lead to positive or negative information effects of removing uncertainty. The authors show that under certain conditions, consumer risk aversion and network externality could induce more quality concealment.
Research limitations/implications – The quality is set exogenous herein, and the integrated process of quality investment and information disclosure is an interesting direction for future research.
Practical implications – This work provides managerial insights for sharing economy platforms regarding how to wisely consider consumer risk aversion and network externality when sharing quality information.
Originality/value – This work identifies two effects that determine quality disclosure strategy and specifies the role of each factor on quality disclosure.
We extend the deceptive advertising model of Piccolo et al. (RAND J Econ 46(3):611–624, 2015) to a framework in which consumers may be loss averse. There are two sellers, competing on prices and offering experience goods with some differences in quality. Prospective customers may be harmed by deceptive advertising: a marketing practice that can induce them to make bad purchases. We show that although deceptive advertising occurs depending on the degree of consumers’ loss aversion, this behavioral bias does not reflect on firms’ prices. Nevertheless, the presence of loss-averse consumers crucially changes the optimal deterrence rule that a Public Authority should adopt against false claims and misleading advertising. Unlike Piccolo et al. (2015), in this more general model, strong enforcements may improve the buyer welfare according to the degree of loss aversion.
In many applications, assumptions about the log-concavity of a probability distribution allow just enough special structure to yield a workable theory. This paper catalogs a series of theorems relating log-concavity and/or log-convexity of probability density functions, distribution functions, reliability functions, and their integrals. We list a large number of commonly-used probability distributions and report the log-concavity or log-convexity of their density functions and their integrals. We also discuss a variety of applications of log-concavity that have appeared in the literature.
The authors study the market for factual content and examine whether competition increases or decreases its provision. Factual content is supplied by commercial media firms, which observe a set of facts depicting the state of the world and selectively decide how to report them. Consumers value content that matches their opinion, which incentivizes media firms to slant their reports by omitting certain facts. Novel features in the authors' model include consumers' ability to anticipate the media's incentives for slant and the requirement that all media stances must be supported by facts. Furthermore, consumers find reports with more facts to be more convincing. Despite consumers' ability to detect slant and their demand for factual support, the research shows that competition results in consumers reading fewer facts and being unable to update their prior beliefs about the state of the world. The authors also find that a monopoly medium may be more polarizing than competitive media and that polarized reporting can be less biased.
Many emerging technologies exhibit path-dependent demands driven by positive network feedback. Such network effects profoundly impact marketing strategists' thinking in today's network economy. However, the significant network externalities expected by many people often fail to materialize in the emerging technology market. We analyze this phenomenon in the context of a technology distribution channel. By studying cheap-talk strategies under information asymmetry, we show that incentive-compatible contracts are essential for achieving credible information transmission. In our model, the better-informed technology vendor has an incentive to inflate the retailer's ex ante belief of network externalities when a wholesale price contract is adopted. When properly termed revenue-sharing contracts are implemented, there are information-efficient cheap-talk equilibria where truthful information transmission is mutually beneficial. When the vendor's information is imperfect, even revenue-sharing contracts cannot guarantee credible information transmission if there is significant prior belief disparity between the vendor and the retailer. This study demonstrates how information-inefficient equilibria (e.g., information blockage) arise because of the conflict of interest or the conflict of opinion among channel members. It also explores the role of cheap talk in facilitating channel coordination.
In many applications,assumptions about the log-concavity of a probability distribution allow just enough special structure to yield a workable theory.This paper catalogs a series of theorems relating log-concavity and/or log-convexity of probability density functions,distribution functions,reliability functions,and their integrals. We list a large number of commonly-used probability distributions and report the log-concavity or log-convexity of their density functions and their integrals. We also discuss a variety of applications of log-concavity that have appeared in the literature. (The current draft corrects a typo in Table 3.)
The authors conducted a meta-analysis of study results on the price-perceived quality relationship published from 1989 to
2006. The findings show that the price effect on perceived quality has decreased. Furthermore, the price–quality relationship
is stronger in studies that use a within-subjects design, investigate higher priced products, and use samples from European
countries but weaker for services, durable goods, and respondents who are familiar with the product. A striking null result
indicates that the number of cues does not affect the price-perceived quality relationship significantly.
With cheap talk, more can be achieved by long conversations than by a single message-even when one side is strictly better informed than the other. ("Cheap talk" means plain conversation-unmediated, nonbinding, and payoff-irrelevant.) This work characterizes the equilibrium payoffs for all two-person games in which one side is better informed than the other and cheap talk is permitted. Copyright The Econometric Society 2003.
Four studies were conducted to assess the accuracy with which consumers perceive objective price-quality relationships. Results across four studies indicate that, overall, consumers perceive objective price-quality relationships with only a modest degree of accuracy. However, findings also suggest that the accuracy of consumers’ perceptions is moderated by product type; that is, price-quality perceptions are more accurate for nondurable products than for durable products. The authors conclude that consumers’ price-quality perceptions appear to be a function of general or product-type-specific schemas, rather than independent evaluations of price-quality relationships for individual product categories.
We examine the reference-dependent risk preferences of Ko″szegi and Rabin (2007), focusing on their choice-acclimating personal equilibria. Although their model has only a trivial intersection (expected utility) with other reference-dependent models, it has very strong connections with models that rely on different psychological intuitions. We prove that the intersection of rank-dependent utility and quadratic utility, two well-known generalizations of expected utility, is exactly monotone linear gain-loss choice-acclimating personal equilibria. We use these relationships to identify parameters of the model, discuss loss and risk aversion, and demonstrate new applications. (JEL D11, D81).
There is widespread evidence that some rms use false advertising to overstate the value of their products. We consider a model in which a policymaker is able to punish such false claims. We characterize an equilibrium where false advertising actively inuences rational buyers, and analyze the eects of policy under dierent welfare objectives. We establish precise conditions where policy optimally permits a positive level of false advertising, and show how these conditions vary intuitively with demand and market parameters. We also consider the implications for product investment and industry self-regulation, and connect our results to the literature on demand curvature.
This paper studies firms' incentives to disclose horizontal product attributes in a competitive environment. With competition, two elements play an important role: whether (i) firms can disclose only their own product characteristics or also those of their competitors, and whether (ii) competitors can react with their pricing decisions to the type of information disclosed. In all possible cases, full revelation is an equilibrium outcome. More importantly, it is generically the unique equilibrium outcome when (i) advertising is comparative and (ii) prices are also advertised, that is, announced simultaneously with the product information. When advertising is noncomparative or prices are not advertised, many nondisclosure equilibria exist.
There are two competing sellers of an experience good, one offers high quality, one low. The low-quality seller can engage in deceptive advertising, potentially fooling a buyer into thinking the product is better than it is. Although deceptive advertising might seem to harm the buyer, we show that he could be better off when the low-quality seller can engage in deceptive advertising than not. We characterize the optimal deterrence rule that a regulatory agency seeking to punish deceptive practices should adopt. We show that greater protection against deceptive practices does not necessarily improve the buyer welfare.
Four studies were conducted to assess the accuracy with which consumers perceive objective price-quality relationships. Results across four studies indicate that, overall, consumers perceive objective price-quality relationships with only a modest degree of accuracy. However, findings also suggest that the accuracy of consumers' perceptions is moderated by product type; that is, price-quality perceptions are more accurate for nondurable products than for durable products. The authors conclude that consumers' price-quality perceptions appear to be a function of general or product-type-specific schemas, rather than independent evaluations of price-quality relationships for individual product categories.
It was once said that there is nothing so useful as a theory that works. Understanding the role of risk in consumer behavior may provide the basis for combining consumer behavior theory with marketing management action.
Savvy consumers attribute a product’s market performance to its intrinsic quality as well as the seller’s marketing push. The authors study how sellers should optimize their marketing decisions in response. They find that a seller can benefit from “demarketing” its product, meaning visibly toning down its marketing efforts. Demarketing lowers expected sales ex ante but improves product quality image ex post, as consumers attribute good sales to superior quality and lackluster sales to insufficient marketing. The authors derive conditions under which demarketing can be a recommendable business strategy. A series of experiments confirm these predictions
I consider a cheap-talk model in which a firm has a chance to communicate its product quality to consumers. The model describes how advertising can be both informative to consumers and profitable for the firm through its content in a vertically differentiated market. I find that advertising content may be effective in inducing search even if incentives for misrepresentation exist. In particular, a firm with an undesirable low-quality product is able to attract consumers who would have not incurred a search cost had they known its true quality. In this case, a semiseparating equilibrium occurs where the lowest firm types pool upward in order to increase the expected product quality while simultaneously signaling that the product is affordable. Although consumers always benefit from truth in advertising, total welfare may decrease if an undesirable firm is required to reveal its type. Finally, I show that the extent to which misrepresentation can take place increases with the cost of advertising coverage.
Information asymmetry between sellers and buyers often prevents socially desirable trade. This article presents a new mechanism that mitigates the inefficiencies caused by information asymmetry. I consider decentralized markets under adverse selection and show that such markets can be endogenously segmented in a way that improves social welfare. Endogenous segmentation is driven by low-quality sellers ' incentive to attract more buyers by separating from high-quality sellers. The mechanism helps us understand the roles of several real-world institutions, such as multiple marketplaces, costless advertisements, and nonbinding list prices.
A meta-analysis is conducted that integrates empirical findings from the two-sided advertising literature. First, the study provides a summary of findings of the persuasive impact of two-sided advertising. Secondly, using regression analysis, the influence of message structure, marketer, and receiver variables on the persuasive impact of two-sided messages is tested. Finally, the crucial problem of the net-effect of source credibility and the amount of negative information on attitudes toward the brand is investigated. The results confirm that the persuasive impact of message sidedness depends on suggested variables (amount of negative information, attribute quality, placement of negative information, correlation between negative and positive attributes and marketers' voluntariness). Also the curvilinear relationship between the amount of negative information and brand attitude is supported.
The authors integrate previous research that has investigated experimentally the influence of price, brand name, and/or store name on buyers' evaluations of prod¬uct quality. The meta-analysis suggests that, for consumer products, the relation¬ships between price and perceived quality and between brand name and perceived quality are positive and statistically significant. However, the positive effect of store name on perceived quality is small and not statistically significant. Further, the type of experimental design and the strength of the price manipulation are shown to significantly influence the observed effect of price on perceived quality.
This study tries to evaluate empirically the validity and generality of causal models based on alternative theories and the integrative frame-work provided by Crowley and Hoyer (1994) to explain the underlying persuasive mechanisms of two-sided messages in marketing. In addition to an empirical test of the models, the study theoretically discusses and empirically explores suggestions for model modifications. Applying meta-analytic-based causal estimation, the results show that the parsimonious model based on attribution theory provides high generality and affirms the prevalent use of the theory in previous studies. All other models could be meaningfully improved by integrating alternative processes of less-effortful message elaboration as suggested by dual-process theories. The results suggest that the impact of argument quality in two-sided messages is in line with previous models assuming effortful message elaboration, while less-effortful elaboration processes seem to rely on the number of arguments used in two-sided messages. © 2007 Wiley Periodicals, Inc.
The nature of perceived risk and its relationship to risk-handling behavior are explored. To date, researchers have operationalized a variety of risk-related constructs, and it is argued that these constructs can be usefully combined to form a unified theory of risk perception and handling.
Market outcomes depend on the quality of information available to its participants. We measure the effect of information disclosure on market outcomes using a large-scale field experiment that randomly discloses information about quality in wholesale automobile auctions. As the theoretical literature predicts, information disclosure increases expected revenues. However, in contrast with conventional theories, the biggest gains are for the best- and worst-quality cars. We argue that information disclosure causes better matching of heterogeneous buyers to different quality cars. This novel explanation both rationalizes patterns in our data and is confirmed by additional tests. Our findings have implications for the design of other markets, including online consumer auctions, procurement auctions, and labor markets.
We examine the link between price, quality, seller claims, and seller reputation in Internet auctions. After purchasing actual baseball cards and having them professionally graded, we find that some buyers in the online graded market are misled by incredible claims of quality. They pay higher prices but do not receive better quality and, in fact, are defrauded more often. Online seller reputation is effective for identifying good-faith sellers. But conditional on completed auctions, reputable sellers do not provide better quality. Evidence also suggests that high-claim sellers target less-experienced buyers. We attribute these patterns to two loopholes in the eBay rating system.
We benefited from the comments of Austan Goolsbee, Raphael Thomadsen, John Shea, Dan Vincent, David Reiley, Larry Ausubel, Peter Cramton, V. Joseph Hotz, Jeff Smith, Jimmy Chan, Vincent Crawford, Mark Duggan, and attendees at numerous seminars and conferences. We are particularly grateful to Seth Sanders and John List for their constructive advice at the early stage of the research, to Timothy Bresnahan, Rachel Kranton, and Thomas Hubbard for their detailed suggestions in reshaping earlier versions, and to Editor Ariel Pakes and two anonymous referees for their careful readings. Special thanks to eight friends who acted as our agents in purchasing baseball cards in retail markets, and to numerous sports card store owners who shared their insights on the sportscard industry. Excellent research assistance from Randy Alexander Moore and Krzysztof Fizyta is gratefully acknowledged. Any remaining errors are ours.
When is it possible for one person to persuade another to change her action? We consider a symmetric information model where a sender chooses a signal to reveal to a receiver, who then takes a noncontractible action that affects the welfare of both players. We derive necessary and sufficient conditions for the existence of a signal that strictly benefits the sender. We characterize sender-optimal signals. We examine comparative statics with respect to the alignment of the sender's and the receiver's preferences. Finally, we apply our results to persuasion by litigators, lobbyists, and salespeople. (JEL D72, D82, D83, K40, M31)
This essay reviews the theoretical and empirical literature on quality disclosure and certification. After comparing quality disclosure with other quality assurance mechanisms and describing a brief history of quality disclosure, we address two sets of theoretical issues. First, why don't sellers voluntarily disclose through a process of "unraveling" and, given the lack of unraveling, is it desirable to mandate seller disclosure? Second, when we rely on certifiers to act as the intermediary of quality disclosure, do certifiers necessarily report unbiased and accurate information? We further review empirical evidence on these issues, with a particular focus on healthcare, education, and finance. The empirical review covers quality measurement, the effect of third-party disclosure on consumer choice and seller behavior, as well as the economics of certifiers. (JEL D18, K32, L15, M31)
This paper considers the pricing decision by a seller who has private information about quality. Demand is perfectly inelastic (rectangular). For example, there may be a single buyer who wants exactly one unit and whose valuation is known by the seller. It is noted that, contrary to widespread belief, separating equilibria do exist in this model, allowing some trade of high quality products even when the average quality is low. Moreover, by slightly perturbing demand, we can use standard equilibrium refinements to uniquely select the best separating equilibrium outcome. Since the chosen outcome has a very simple structure regardless of the number of quality levels, this model could be a useful workhorse in applications.
Can negative publicity ever increase consumer choice, and if so, when? Three studies, using a combination of econometric analysis and experimental methods, delineate contexts under which negative publicity will have positive versus negative effects. While prior research have shown only downsides to negative press (e.g., reduced product evaluations and sales), the studies demonstrate that negative publicity can have positive through increasing consumer awareness. While a negative review in the New York Times hurt sales of books by well-known authors, for example, it increased sales of books by unknown authors. The studies underscore the importance of a temporal delay between publicity and purchase and the mediating role of increased awareness in these effects.
Marketers disclose quality information directly to potential consumers using a variety of communication channels. This study investigates how competition may influence duopoly firms' incentive to voluntarily and truthfully reveal quality information. It is shown that firms in competitive markets reveal less information than a monopoly firm does. In addition, sequential disclosure leads to asymmetric equilibrium disclosure behavior: The disclosure leader discloses unambiguously less information than that in the simultaneous disclosure case, whereas the disclosure follower ex ante reveals less (more) private information than both the disclosure leader and that in the simultaneous disclosure case when the disclosure cost is sufficiently low (high). We also examine the firms' equilibrium ex-ante profits and social welfare. It is demonstrated that there may exist a U-shaped relationship between equilibrium monopoly profits (or social welfare under both monopoly and duopoly) and the disclosure cost. Moreover, in comparison to the simultaneous disclosure case, sequential disclosure can lead to increasingly softened competition, improving both firm profitability and social welfare.
Thesis (M.B.A.)--San Diego State University, 1977.
Signaling strategies that sellers of higher-quality products or securities employ to differentiate their products include (1) development of a reputation for quality, (2) third-party certification, (3) warranties, and (4) information disclosure. These signaling strategies are compared using data from the online auction market for classic comic books. This market's advantages include that (1) the information asymmetry is substantial, (2) good measures of reputation are available, and (3) all four signals are common. We explore which signals are strongest and why, which are substitutes or complements, and how choice among the other three strategies depends on the reputation of the seller.
This article develops a framework that encompasses past two-sided persuasion research and incorporates additional theory and research on optimal arousal and attitude toward the ad to provide explanations for inconsistencies in previous findings. In particular, explanations are provided for the following: (1) when credibility gains will be enhanced, (2) when refutation is needed, (3) how the message should be structured (in terms of amount and placement of negative information), and (4) what types of attributes should be discounted (in terms of importance, type, and correlation with other attributes). In addition, directions for future research are discussed. Copyright 1994 by the University of Chicago.
The Nash equilibrium solution concept for games is based on the assumption of expected utility maximization. Reference dependent utility functions (in which utility is determined not only by an outcome, but also by the relationship of the outcome to a reference point) are a better predictor of behavior than expected utility. In particular, loss aversion is an important element of such utility functions.
We extend games to include loss aversion characteristics of the players. We define two types of loss-aversion equilibrium, a solution concept endogenizing reference points. The two types reflect different procedures of updating reference points during the game. Reference points emerge as expressions of anticipation which are fulfilled.
We show existence of myopic loss-aversion equilibrium for any extended game, and compare it to Nash equilibrium. Comparative statics show that an increase in loss aversion of one player can affect her and other players' payoffs in different directions.
In markets with qualitative uncertainty, pricing on the basis of average quality will be unattractive to participants whose products are above average in quality. This note examines the possibility of quality certification as an alternative to exit from the market in such situations. Examples dealing with labor market uncertainties illustrate the economic properties of the quality certification process, which unravels from the top down. The economic motivations and patterns of this form of price discrimination are similar to those encountered in standard "lemons" models.
This is an article about modeling methods in information economics. A notion of "favorableness" of news is introduced, characterized, and applied to four simple models. In the equilibria of these models, (1) the arrival of good news about a firm's prospects always causes its share price to rise, (2) more favorable evidence about an agent's effort leads the principal to pay a larger bonus, (3) buyers expect that any product information withheld by a salesman is unfavorable to his product, and (4) bidders figure that low bids by their competitors signal a low value for the object being sold.
There are many laws that require sellers to disclose private information about the quality of their products. But the theoretical justification for these laws is not obvious: economic theory predicts that a seller will voluntarily disclose such quality information, however unfavorable, as long as it is costless to do so. Here we show that competitive pressures between firms can undermine this full disclosure result, and explain why it may be the case that only high-quality firms choose to disclose. In this setting, mandatory disclosure laws can promote competition and raise consumer surplus at the expense of firm profits, potentially increasing the efficiency of the market. Copyright 2009 The Authors. Journal compilation 2009 Blackwell Publishing Ltd. and the Editorial Board of The Journal of Industrial Economics.
We use data on the enrollment decisions of federal annuitants to estimate the influence of publicized ratings on health plan choice. We focus on the impact of ratings disseminated by the National Committee for Quality Assurance (NCQA), and use our estimates to calculate the value of the information. Our approach exploits a novel feature of the data-the availability of non-public plan ratings-to correct for a source of bias that is inherent in studies of consumer responsiveness to information on product quality: since publicized ratings are correlated with other quality signals known to consumers (but unobserved by researchers), the estimated influence of ratings is likely to be overstated. We control for this bias by comparing the estimated impact of publicized ratings to the estimated impact of ratings that were never disclosed. The results indicate that NCQA's plan ratings had a meaningful influence on individuals' choices, particularly for individuals choosing a plan for the first time. Although we estimate that a very small fraction of individual decisions were materially affected by the information, for those that were affected the implied utility gains are substantial.
An axiomatic model of preferences over lotteries is developed. It is shown that this model is consistent with the Allais paradox, includes expected utility theory as a special case, and is only one parameter (" beta") richer than the expected utility model. Allais paradox type behavior is identified with positive values of "beta." Preferences with positive "beta" are said to be disappointment averse. It is shown that risk aversion implies disappointment aversion and that the Arrow-Pratt measures of risk aversion can be generalized in a straight-forward manner to the current framework. Copyright 1991 by The Econometric Society.
We develop a model of reference-dependent preferences and loss aversion where “gain-loss utility” is derived from standard
“consumption utility” and the reference point is determined endogenously by the economic environment. We assume that a person's
reference point is her rational expectations held in the recent past about outcomes, which are determined in a personal equilibrium by the requirement that they must be consistent with optimal behavior given expectations. In deterministic environments,
choices maximize consumption utility, but gain-loss utility influences behavior when there is uncertainty. Applying the model
to consumer behavior, we show that willingness to pay for a good is increasing in the expected probability of purchase and
in the expected prices conditional on purchase. In within-day labor-supply decisions, a worker is less likely to continue
work if income earned thus far is unexpectedly high, but more likely to show up as well as continue work if expected income
is high.
The conclusions of the Bertrand model of competition are substantially altered by the presence of asymmetric information about rivals' costs. Asymmetric information eliminates the discontinuity in the Bertrand model and significantly alters the properties of the market equilibrium. In the Bertrand-Nash equilibrium when rivals' costs are unknown, firms price above marginal cost and have positive expected profit. The analysis is extended to franchise competition. The market equilibrium is sensitive to market structure and yields incentives for entry. Copyright 1995 by Blackwell Publishing Ltd.
False advertising and consumer protection policy
- A. Rhodes
- C. M. Wilson
Dynamic marketing for a changing world
- R. A. Bauer
Risk in buyer behavior contexts: A clarification
- R. N. Stone
- F. Winter