LSE FMG Discussion Paper No. 696
43 Pages Posted: 12 Jan 2012 Last revised: 22 Jan 2019
Date Written: June 8, 2016
We study transactions in which sellers fears being underpaid because their outside option is better known to the buyer. We rationalize various observed contracts as solutions to such smart buyer problems. Key to these solutions is granting the seller upside participation. In contrast, the lemons problem calls for granting the buyer downside protection. But, in either case, the seller (buyer) receives a convex (concave) claim. Thus, contracts usually associated with the lemons problem, such as debt or cash-equity offers, can be equally well manifestations of the smart buyer problem, although the two information asymmetries have opposite cross-sectional implications.
Keywords: Bilateral trade, asymmetric information, royalties, cash-equity offers, security design, contingent value rights, commissions, lemons problem
JEL Classification: D82, D86
Suggested Citation: Suggested Citation