Screening, Signaling and Voluntary Disclosure

Screening and Signaling Definitions: Screening- An attempt by an uninformed party to sort individuals according to their characteristics. Signaling- An attempt by an informed party to send an observable indicator of his or her hidden characteristics to an uniformed party.

Examples of Screening 1. Screening to enable price discrimination (coupons, rebates, outlet malls,…) 2. Screening to sort different types of workers. 3. Choice of deductibles associated with different types of insurance. 4. Obtaining a physical to obtain a favorable life insurance policy.

Examples of Signaling 1. Obtaining an advanced degree such as an MBA or PhD. 2. Seller offering a warranty. 3. Labor contract negotiations/ Negotiating a compensation package.

Example 1: Signaling with a Warranty Suppose there are sellers of lemons and sellers of peaches and buyers cannot tell a lemon from a peach (like the adverse selection example we did). Suppose a seller can obtain a price of $2,000 if he has a lemon and the buyer knows it’s a lemon and a price of $3,000 if he has a peach and the buyer knows it’s a peach. Finally, assume all sellers can credibly offer a warranty.

Example 1: Signaling with a Warranty Let the probability of a lemon breaking down be.70 and the probability of a peach breaking down be.10. Suppose the warranty states that if the car breaks down, the seller will pay the buyer $1,500 to repair the car.

Example 1: Signaling with a Warranty Will the seller with a lemon offer the warranty? Marginal Benefit (MB) from offering the warranty is $1,000. Marginal Cost (MC) from offering the warranty is.7*1500=$1,050. Will the seller with a peach offer the warranty? Marginal Benefit (MB) from offering the warranty is $1,000. Marginal Cost (MC) from offering the warranty is.1*1500=$150. MB MC for seller with peach. Therefore, seller with peach can credibly signal to buyer that the car is a peach by offering the above warranty.

Example 2: Signaling in National Football League Contract Negotiations Representative Contract YearSigning Bonus Base Salary Reporting Bonus 1991$250,000$150, $170, $190,000$20,000 Guaranteed Non-Guaranteed

Signaling in NFL Negotiations Review of Economic and Statistics (2003) Michael Conlin and Patrick Emerson

Proportion that “Make Team” and Mean Number of Starts

Voluntary Disclosure Not Covered in Textbook

You’re on a job interview and the interviewer knows what the distribution of GPAs are for MBA students at MSU: Percent GPA Expected/Average grade for everyone:.2*2.5+.3*3.0+.3*3.5+.2*4.0 = 3.25 Geoff Humphrys at the Lear Center advises anyone who has a 3.5 GPA or higher to volunteer their GPA. Is this a stable outcome?

What does the potential employer believe about the people who stay quiet? They know their GPA is below a 3.5, but how far below? Guess the average grade of everyone who didn’t get at least a 3.5. What is that? Percent GPA /.5 =.4 Original share Students remaining.3/.5 =.6.4* *3.0 = 2.8 People with 3.0s will reveal themselves because they don’t want employer to assume they have a 2.8 Percent GPA

Voluntary disclosure Full disclosure principle - if some individuals stand to benefits by revealing a favorable trait, others will be forced to disclose their less favorable values. If disclosure is costless, only the lowest types will not reveal their quality

Voluntary Disclosure and Signaling Voluntary Disclosure differs from Signaling because we are assuming that the cost of lying (i.e., saying you have a GPA of 4.0 when you have a GPA of 3.5) is so large than no one does it. Therefore, the decision is to either reveal your private information truthfully or don’t reveal.

Voluntary Disclosure If it is true that only the lowest types don’t reveal and that consumers/employers (the uninformed party) can infer they are the lowest type, then government should not have to intervene in the market – for example, they should not require firms producing salad dressings to report the fat content and they should not require restaurants to report their hygiene score.

Fat content in Salad Dressing The Impact of Mandatory Disclosure Laws On Product Choice Alan Mathios

Hygiene Scores for LA Restaurants The Effect of Information on Product Quality By Phil Leslie and Ginger Jin

Shipping Charges in Online Auction Platforms Shrouded Attributes and Information Suppression: Evidence from the Field (e-Bay and on-line auction platforms in Taiwan and Ireland) By Jennifer Brown, Tanjim Hossain and John Morgan (QJE 2010)

Film Studios Withholding Movies from Critics To Review or Not to Review? Limited Strategic Thinking at the Movie Box Office By Alexander Brown, Colin Camerer and Dan Lovallo (AEJ: Micro 2012)

Inference of SAT score in College Admissions By Michael Conlin and Stacy Dickert-Conlin

Why would Colleges go to Optional SAT Policy? Attract a different type of student (those that don’t test well but do well in college) Maybe more diverse? Improve ratings Average SAT score included in U.S. News and World Report If don’t have SAT scores for lowest score students, reported average increases.

U.S. News and World Report CriteriaWeightSubcriteriaWeight Student Selectivity15%SAT/Act scores Acceptance Rate Yield High school class standing top 10% 40 % 15% 10% 35% Academic reputation (survey of other colleges) 25% Faculty resources20% Graduation and retention rate20% Financial resources (expenditure per student) 10% Alumni giving (rate)5% Graduation rate performance5%

Strategic Behavior of Colleges By Michael Conlin, Stacy Dickert-Conlin and Gabrielle Chapman Journal of Economic Behavior and Organizations (2013)