Incentives of Low-Quality Sellers to Disclose Negative Information

Abstract

The paper studies incentives of low-quality sellers to disclose negative information about their product. We develop a model where one’s quality can be communicated via cheap-talk messages only. This setting limits ability of high-quality sellers to separate as any communication strategy they pursue can be costlessly imitated by low-quality sellers. Two factors that can incentivize low-quality sellers to communicate their quality are buyers’ risk-attitude and competition. Quality disclosure reduces buyers’ risk thereby increasing their willingness to pay. It also introduces product differentiation softening the competition. We show that equilibria where low-quality sellers separate exist under monopoly and duopoly. Even though low-quality sellers can costlessly imitate high-quality sellers, equilibria where high-quality sellers separate can also exist but under duopoly only.

Keywords: Negative information, product differentiation, cheap talk, lemon markets

JEL Classification: D21, L15