On the Role and Design of Art Royalties

Abstract

Resale royalties for artworks have long been a subject of policy debate, recently reignited by the rise of non-fungible tokens and smart contracts. Despite ongoing discussions, consensus remains elusive regarding the net benefits of royalties for creators and society, as well as the optimal design of royalty policies. This paper emphasizes the critical role of information asymmetry in determining the effectiveness of resale royalties in the art market. We show that both prices and royalty rates can act as quality signals in markets where creators are better informed than buyers. Notably, even an exogenous positive royalty rate can strengthen the signaling role of prices, especially in markets with a limited number of informed buyers, where high-quality creators cannot rely solely on price as a signal. Additionally, a fixed royalty rate can serve directly as a signaling mechanism, with high-quality creators adopting a strategy of setting lower upfront prices paired with higher royalty rates to differentiate themselves from lower-quality creators. The benefits of this strategy for high-quality creators depend not only on their ability to signal quality but also on inefficiencies in the secondary market induced by the royalty rate, which negatively affect all creators and reduce overall social welfare. The net welfare impact is contingent upon the expected distribution of artwork quality and the level of information asymmetry in the market. These findings offer valuable insights for policy debate on resale royalties and hold significant implications for both traditional art markets and digital platforms that employ smart contracts.

Keywords: Smart contract, Art market, NFT, Royalty fee, Signaling, Resale platform, Platform design