'Is That a Gun in Your Pocket... ?' Advertising and Evaluation

Abstract

Candidates to a profitable privilege (e.g. an inventor) try to convince a decision maker (e.g. a patent examiner) of their distinctive value. The better candidates often exert higher signaling effort in order to differentiate from less valuable candidates. When the decision maker must also exert effort in order to understand the candidate, moral hazard in team is likely to happen. Therefore, one might expect lower signaling effort in equilibrium. I show that this intuition is false because less valuable candidates can manipulate the moral hazard problem of the decision maker. By exerting higher signaling effort, low quality candidates raise the cost of effort of the decision maker who is then likely to shirk. When the gains from differentiation are big, the better candidates set their effort level in order to overbid the less valuable candidates' mimicking efforts. This may lead both the former and the decision maker to overexert effort in equilibrium compared to what would be socially desirable.