The competitive advantage of honesty

Abstract

We study competitive markets where firms may lie to their workers to reduce costs. Consumers may benefit from firms’ dishonesty through lower market prices. Does firms’ (dis-)honesty affect consumers’ purchasing decisions? Our experiment shows that when honesty is fully transparent, it can provide a competitive advantage: Honest firms sell more and – despite higher costs – achieve higher profits. This finding is in line with our equilibrium predictions when allowing for dishonesty-averse consumers. By identifying circumstances in which consumers – although not the addressee of dishonesty – “punish” firms for their within-firm dishonesty, we contribute both to behavioral ethics and behavioral industrial organization.