Does Costly Persuasion Signal Quality?

Abstract

We present a buyer-seller setup in which seller type is private information and buyer utility is state contingent. States of nature are commonly unknown and the seller can design information through a Bayesian experiment by facing a cost based on Shannon’s entropy. We show that the seller of high type has an incentive to design more precise information and is willing to bear a higher cost. Hence, when the cost is sufficiently high, separation can occur without price distortions. Differently, when the cost is excessively low, price signaling is also needed to separate.

Keywords: persuasion, signaling, information design, asymmetric information

JEL Classification: D82, D83, L11