The Effect of Inaccurate Quality Signaling under Information Asymmetry

Abstract

Purpose - This study attempts to provide a new theoretical perspective on the quality signaling and its impact on a market under information asymmetry, focusing on how the accuracy and the cost of quality signaling affect sellers’ and buyers’ profit, suggesting appropriate designs of quality signaling methods which mitigates information asymmetry.
 Design/methodology/approach - In order to examine the effect of quality signaling on strategic interactions within the market, we establish an analytic model where market outcomes are determined by seller’s quality claim and price, and buyers are risk-neutral. By investigating this analytic model through relevant game trees, we find the subgame perfect Nash equilibria of the market and predict related market outcomes based on sellers’ quality signaling strategy.
 Findings - Our analytic model shows counterintuitive results that seller profit will be the lowest with inaccurate quality signaling and the highest with no quality signaling, mostly due to the certification cost. Consequently, sellers should proceed with caution if the quality signaling is less than accurate, as it may backfire. We believe that this is due to the fact that the inaccuracy of quality signaling causes some confusion and uncertainty in both sellers and buyers’ decision to maximize profit, making it hard for sellers to predict buyers’ behavior.
 Research implications or Originality - Although the sources and types of quality signaling errors have been investigated in the literature, there has not been satisfactory understanding regarding how inaccuracy of quality certification affects specific market outcomes. We expect that our theoretical model would provide important implications on how to utilize quality signaling to solve adverse selection issues in markets under information asymmetry.