Contracting Environments and Efficiency in Markets with Hidden Information: An Experiment

Abstract

This paper provides a systematic analysis of the role of contracting environments
on market outcomes and efficiency in markets with hidden information
using experimental methods. When markets are plagued by hidden information,
competition does not necessarily ensure efficient market outcomes. This crucially
depends on the nature of hidden information: While theoretically efficiency is attained
via competition under hidden information of the private values form, severe
distortions may occur under common values (such as in the classic Akerlof lemons
or Rothschild-Stiglitz insurance markets). The extent of distortions in the latter
case furthermore depends on the nature of competitive contracting. We present a
parsimonious experimental design that allows to compare the different contracting
environments ranging from monopoly to nonexclusive competition for both
types of hidden information markets, private and common values. The degree of
equilibrium play that we find is strikingly high, particularly in the complex cases
of competitive common values markets. While competition ensures efficiency under
private values, it is not the case under common values where distortion arises
under exclusive and exclusion under nonexclusive contracting.

Keywords: Adverse selection, private and common values, nonexclusive competition

JEL Classification: D82, L10, C92