Abstract
In an environment in which home firm costs are private information, home firm output can signal these costs to a foreign competitor and a home policymaker. High‐cost home firms have an incentive to misrepresent themselves as low‐cost. This is understood by the foreign firm and the home policymaker and results in the first‐period optimal per‐unit output subsidy to the home firm being less than it would be if home firm output was not a signal of home firm costs. These results are extended to the case of simultaneous signalling and signalling through price.
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