Innovation & Information Marriott School – MBA 693R Innovation & Information MBA 693R Winter 2009 Mark H. Hansen Paul C. Godfrey

Innovation & Information Marriott School – MBA 693R

Innovation & Information Marriott School – MBA 693R Economics of Information Information Asymmetry this branch of economics became formalized in the early 1970’s three economists received the 2001 Nobel prize for their work in this area the fact that one party to a transaction knows more than another party affects the terms of trade

Innovation & Information Marriott School – MBA 693R Economics of Information Adverse Selection misrepresenting the value of inputs George Akerlof “The Market for Lemons” 1970 buyers cannot tell if an input is of low quality or high quality buyers therefore is only willing to pay for average quality sellers of high quality goods pull out of the market average quality falls and so does price

Innovation & Information Marriott School – MBA 693R Economics of Information Signaling signaling the value of an input – to overcome adverse selection Michael Spence “Job Market Signaling” 1973 it is costly to signal the value of an input it is less costly to signal high quality for those who really do have high quality education, debt financing versus equity, paying dividends even though they are taxed heavily

Innovation & Information Marriott School – MBA 693R Economics of Information Screening less informed party can give more informed party an incentive to reveal information Joseph Stiglitz “Incentives and Risks in Sharecropping” 1974 a less informed seller may benefit by allowing a more informed buyer to set a price that reflects what the buyer really knows 50/50 split in sharecropping, insurance deductibles

Innovation & Information Marriott School – MBA 693R price alone doesn’t tell the whole story Economics of Information Screening if we don’t account for information asymmetries, we may miss an ‘efficient market’ The theories that I (and others) helped develop explained why unfettered markets often not only do not lead to social justice, but do not even produce efficient outcomes. Interestingly, there has been no intellectual challenge to the refutation of Adam Smith’s invisible hand: individuals and firms, in the pursuit of their self-interest, are not necessarily, or in general, led as if by an invisible hand, to economic efficiency. Stiglitz, 2007 You can’t rule out the government, but you also can’t rule it in.

Innovation & Information Marriott School – MBA 693R Economics of Information Adverse Selection Why does this matter to strategists? **information asymmetry is a huge market imperfection** Markets Disappear Signaling Screening Competitive Advantage unmanaged, unprincipled managed in a principled way