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 lemon and 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

Year Signing Bonus

Base Salary

Reporting Bonus

1991 $250,000 $150,000

1992 $170,000

1993 $190,000 $20,000

GuaranteedNon-Guaranteed

Signaling in NFL NegotiationsReview of Economic and Statistics (2003)

Michael Conlin and Patrick Emerson

Proportion that “Make Team” and Mean Number of Starts

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 .20 .30 .30 .20

GPA 2.5 3.0 3.5 4.0

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 2.5 3.0

.2/.5

=.4

Original shareStudents remaining

.3/.5

=.6

.4*2.5 + .6*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 .20 .30 .30 .20

GPA 2.5 3.0 3.5 4.0

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 DressingThe Impact of Mandatory Disclosure Laws On Product Choice

Alan Mathios

http://www.jstor.org/view/00222186/ap020088/02a00130/0

Hygiene Scores for LA Restaurants

The Effect of Information on Product Quality

By Phil Leslie and Ginger Jin

http://www.mitpressjournals.org/doi/pdfplus/10.1162/003355303321675428?cookieSet=1

Shipping Charges in Online Auction PlatformsShrouded 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 AdmissionsBy 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 ReportCriteria Weight Subcriteria Weight

Student Selectivity 15% SAT/Act scoresAcceptance RateYieldHigh school class standing top

10%

40 %15%10%35%

Academic reputation (survey of other colleges)

25%

Faculty resources 20%

Graduation and retention rate 20%

Financial resources (expenditure per student)

10%

Alumni giving (rate) 5%

Graduation rate performance 5%

Strategic Behavior of CollegesBy Michael Conlin, Stacy Dickert-Conlin and Gabrielle Chapman

Journal of Economic Behavior and Organizations (2013)