Satisfaction Guaranteed or Money (Partially) Refunded: Efficient Refunds under Asymmetric Information

Abstract

Refunds are modelled as a competitive market response to asymmetric information. Firms have private information on their choice of product quality and compete by offering price-and-refund contracts. Consumers who care about quality draw inferences about the quality offered by the various firms from observed contracts. Conditions under which a revealing market equilibrium emerges are specified and the equilibrium quality and contract(s) characterized. The model predicts that when product risk is not insurable, consumers with higher incomes will pay higher prices for higher-quality goods, with higher refunds if the product fails.