Screening when some agents are nonstrategic: does a monopoly need to exclude?

We characterize the optimal screening mechanism for a monopolist facing consumers with privately known demands, some of whom have limited abilities to misrepresent their preferences. We show that consumers with better abilities to misrepresent information benefit from the presence of consumers who lack such abilities. Whenever the fraction of the latter group is positive, there is no exclusion: the firm supplies a positive quantity of the good to all consumers whose valuations exceed marginal cost of production. Our analysis is motivated by the evidence indicating that some individuals have limited ability to misrepresent themselves and imitate others.     

Competition under consumer loss aversion

We address the effect of expectation‐based consumer loss aversion on firm strategy in imperfect competition. Consumers are fully informed about match value and price at the moment of purchase. However, some consumers are initially uninformed about their tastes and form a reference point consisting of an expected match value and price distribution, whereas others are perfectly informed all the time. We show that if firms have symmetric costs, a larger share of informed consumers leads to a more competitive outcome. The reverse holds if cost asymmetry in duopoly is sufficiently large.     

Product safety,contracts, and liability

A firm sells a dangerous product to heterogeneous consumers. Higher consumer types suffer accidents more often but may enjoy higher gross benefits. The firm invests resources to reduce the frequency of accidents. When the consumer's net benefit function (gross benefits minus expected harms) is decreasing in consumer type, the firm contractually accepts liability for accident losses and invests efficiently. When the consumer's net benefit function is increasing in consumer type, the firm contractually disclaims liability and underinvests. Legal interventions, including products liability and limits on contractual waivers and disclaimers, are necessary to raise the level of product safety.     

When does a firm disclose product information?

A firm chooses a price and the product information it discloses to a consumer whose tastes are privately known. We provide a necessary and sufficient condition on the match function for full disclosure to be the unique equilibrium outcome whatever the costs and prior beliefs about product and consumer types. It allows for products with different qualities as well as some horizontal match heterogeneity. With independently distributed product and consumer types, full disclosure is always an equilibrium and a necessary and sufficient equilibrium condition is that all firm types earn at least the full‐disclosure profit.     

Inflation and Welfare in Retail Markets: Prior Production and Imperfectly Directed Search

This paper considers the effect of monetary policy and inflation on retail markets: goods are dated and produced prior to being retailed; buyers direct their search on price and general quality; buyers’ match‐specific tastes are private information. Sellers set the same price for all buyers, some of whom do not value the good highly enough to buy it. The market economy is typically inefficient as a social planner would have the good consumed. Under free entry of sellers, the Friedman rule is optimal policy. When the upper bound on the number of participating sellers binds, moderate levels of inflation can be welfare improving.     

Comparative advertising: disclosing horizontal match information

Improved consumer information about horizontal aspects of products of similar quality leads to better consumer matching but also to higher prices, so consumer surplus can go up or down, while profits rise. With enough quality asymmetry, though, the higher‐quality (and hence larger) firm's price falls with more information, so both effects benefit consumers. This occurs when comparative advertising is used against a large firm by a small one. Comparative advertising, as it imparts more information, therefore helps consumers. Although it also improves the profitability of the small firm, overall welfare goes down because of the large loss to the attacked firm.     

Search for differentiated products: identification and estimation

When consumers search for differentiated products, a given search decision can be explained either by low search cost or by low tastes for the set of products already found. We propose an identification strategy that allows to estimate the search cost distribution in the presence of unobserved tastes. The required data takes the form of conditional search decisions: observations of search actions combined with previously observed product displays. We develop an application using clickstream data from a hotel search platform. Estimates of price elasticity of demand in the search model differ from those in the static model, reflecting the bias due to endogeneity of search‐generated choice sets.     

Avoiding market dominance: product compatibility in markets with network effects

As is well recognized, market dominance is a typical outcome in markets with network effects. A firm with a larger installed base offers a more attractive product which induces more consumers to buy its product which produces a yet bigger installed base advantage. Such a setting is investigated here but with the main difference that firms have the option of making their products compatible. When firms have similar installed bases, they make their products compatible in order to expand the market. Nevertheless, random forces could result in one firm having a bigger installed base, in which case the larger firm may make its product incompatible. We find that strategic pricing tends to prevent the installed base differential from expanding to the point that incompatibility occurs. This pricing dynamic is able to neutralize increasing returns and avoid the emergence of market dominance.     

Asymmetric Information and Risky Debt Maturity Choice

When capital market investors and firm insiders possess the same information about a company's prospects, its liabilities will be priced in a way that makes the firm indifferent to the composition of its financial liabilities (at least under certain, well-known circumstances). However, if firm insiders are systematically better informed than outside investors, they will choose to issue those types of securities that the market appears to overvalue most. Knowing this, rational investors will try to infer the insiders' information from the firm's financial structure. This paper evaluates the extent to which a firm's choice of risky debt maturity can signal insiders' information about firm quality. If financial market transactions are costless, a firm's financial structure cannot provide a valid signal. With positive transaction costs, however, high-quality firms can sometimes effectively signal their true quality to the market. The existence of a signalling equilibrium is shown to depend on the (exogenous) distribution of firms' quality and the magnitude of underwriting costs for corporate debt.     

Store characteristics in retail oligopoly

I use a consumer choice model for the British supermarket industry to compare the incentives of firms, selecting store characteristics, with the interests of consumers. I perform a series of counterfactual changes to store size and location and rank the alternatives by gains per unit of fixed cost. Jointly, firms gain most from large stores, which increase total consumer expenditure. Individually, however, firm incentives are strongly influenced by business‐stealing effects, resulting in a close agreement with consumers, who value middle‐sized stores and distance‐reducing relocations. These individual firm incentives provide little consumer‐protection justification for recent size and location regulations.     

Price‐matching guarantees

Are price‐matching guarantees anticompetitive? We examine the incentives for price‐matching guarantees in markets where information about prices is costly. The conventional explanation of price matching as facilitating cartel pricing finds some theoretical support, but our model provides an additional explanation. A price‐matching guarantee may be a credible and easily understood means of communicating to uninformed consumers that a firm is low priced. The credibility of the signal is assured by the behavior of informed consumers. We contrast the testable implications of our model with those arising from two theories of price matching as anticompetitive, and show that available evidence supports the signalling theory.     

Advertising as a search deterrent

This article examines a monopoly firm's incentive to disclose information through advertising when consumers can choose between buying immediately and searching for additional information. Because sales drop when search reveals low match values to consumers, the firm has an incentive to deter search. We show that partial information disclosure emerges as a useful tool for search deterrence when search costs are low. Informative advertising and consumer search can be viewed as complements in producing information. Although transparency policies reduce search expenditures and improve purchase decisions, whether they are socially desirable depends on the magnitude of search costs.     

The use of intellectual capital information in investment decisions: An empirical study using analyst reports

Do financial analysts convey intellectual capital information in their recommendations? This study of a sample of analyst reports on large, listed Spanish companies provides some evidence on the question. Analysts usually report information regarding a company's strategy, customers, and processes; they less often provide information about research, development, and innovation. When controlling for endogeneity, we find that certain firm characteristics appear to influence the use of intellectual capital information. Analysts use this information in the case of highly profitable companies. The results also show a significant effect of growth opportunities on intellectual capital disclosure by financial analysts.     

Provider performance reports and consumer welfare

A provider's performance report consists of his service average outcome and volume. The two variables depend on the provider's private quality type and current demand, but he can raise his average outcome by dumping vulnerable consumers. Prospective consumers infer providers' qualities from their reports. Performance reporting drives some providers to dump consumers when competition is intense, but it may not reveal providers' qualities when their average quality is high. Statistical adjustment aiming at making reports independent of consumer characteristics can lead to more dumping, less informative reports, or both. There is more dumping when volume information is withheld and less dumping when ratings information is coarse.     

Consumer obfuscation by a multiproduct firm

This article shows that a multiproduct firm has incentives to obfuscate its products by using search costs to induce consumers to search through its products in a particular order. The consumers who draw high valuations of the first product terminate their search earlier than the consumers who draw low valuations. Thus, the firm has incentives to raise the price of the earlier searched product. The optimal search cost for an obfuscated product is such that consumers inspect the product only if the match values of the previously searched goods have been very poor.     

Corporate governance roles of information quality and corporate takeovers

We examine the corporate governance roles of information quality and the takeover market with asymmetric information regarding the value of the target firm. Increasing information quality improves the takeover efficiency however, a highly efficient takeover market also discourages the manager from exerting effort. We find that perfect information quality is not optimal for either current shareholders’ expected payoff maximization or expected firm value maximization. Furthermore, current shareholders prefer a lower level of information quality than the level that maximizes expected firm value, because of a misalignment between current shareholders’ value and total firm value. We also analyze the impact of antitakeover laws, and find that the passage of antitakeover laws may induce current shareholders to choose a higher level of information quality and thus increase expected firm value.     

The economics of earnings manipulation and managerial compensation

This article examines managerial compensation in an environment where managers may take a hidden action that affects the actual earnings of the firm. When realized, these earnings constitute hidden information that is privately observed by the manager, who may expend resources to generate an inflated earnings report. We characterize the optimal managerial compensation contract in this setting, and demonstrate that contracts contingent on reported earnings cannot provide managers with the incentive both to maximize profits and to report those profits honestly. As a result, some degree of earnings management must be tolerated as a necessary part of an efficient agreement.     

Dynamic pricing: when to entice brand switching and when to reward consumer loyalty

This article develops a theory of dynamic pricing in which firms may offer separate prices to different consumers based on their past purchases. Brand preferences over two periods are described by a copula admitting various degrees of positive dependence. When commitment to future prices is infeasible, each firm offers lower prices to its rival's customers. When firms can commit to future prices, consumer loyalty is rewarded if preference dependence is low, but enticing brand switching occurs if preference dependence is high. Our theory provides a unified treatment of the two pricing policies and sheds light on observed practices across industries.     

Board independence,internal information environment and voluntary disclosure of auditors’ reports on internal controls

When there is high information asymmetry between directors and managers, independent directors do not have enough information to perform their functions. Only when faced with a good internal information environment can such directors acquire enough information to provide advice and monitor managers, and only under these conditions can increasing their proportion on the board effectively reduce agency problems, such as driving managers to disclose information to investors. Using a sample of Chinese listed firms that voluntarily disclose their auditors’ reports on internal controls from 2007 to 2009, this study explores how the information acquisition costs of independent directors affect their monitoring effectiveness by investigating the disclosure decisions of their internal control audits. We find that when the information asymmetry between insiders and outside directors is low and the proportion of independent directors on a board is high, a firm is more likely to voluntarily disclose its internal control audit report.     

Advertising dynamics and competitive advantage

Can advertising lead to a sustainable competitive advantage? To answer this question, we propose a dynamic model of advertising competition where firms repeatedly advertise, compete in the product market, and make entry as well as exit decisions. Within this dynamic framework, we study two different models of advertising: in the first model, advertising influences the goodwill consumers extend toward a firm (“goodwill advertising”), whereas in the second model it influences the share of consumers who are aware of the firm (“awareness advertising”). We show that asymmetries may arise and persist under goodwill as well as awareness advertising. The basis for a strategic advantage, however, differs greatly in the two models of advertising. We show that tighter regulation or an outright ban of advertising may have anticompetitive effects and discuss how firms use advertising to deter and accommodate entry and induce exit in a dynamic setting.