Non-Disclosure Rules as Penalty Defaults
38 Pages Posted: 13 Aug 2021
Date Written: July 30, 2021
In Akerlof's 1970 Market for Lemons, asymmetric information arises because sellers are better informed than buyers. A seller’s informational advantage creates an adverse selection problem. When buyers are better informed than sellers, a mirror-image problem arises. Although both asymmetric information situations lead to inefficiencies in the market, informed buyers are not generally required to disclose positive information to their uninformed sellers. After reviewing the traditional explanations for the different legal treatment of buyers and sellers in asymmetric information situations, we develop a different rationale to explain this difference. Our analysis suggests that rules that do not require buyers to disclose positive information operate as information-forcing, penalty default rules. Informed buyers are not required to disclose their positive information, but uninformed buyers separate themselves from informed buyers, by signaling their lack of private information, leading to an inverse correction of this asymmetric information problem.
Keywords: asymmetric information, duties to disclose, penalty default rules, inverse adverse selection
JEL Classification: D44, D82, D86, K12
Suggested Citation: Suggested Citation