Suggested versus Extended Gifts: How Alternative Market Institutions Mitigate Moral Hazard

Gift exchange can partially mitigate supply-side moral hazard, even in anonymous market interactions. In a market where quality is not fully contractable, the amount that a price exceeds the market-clearing level for the lowest quality is a gift from the buyer. We show that the gift formation process, inextricably linked with a market institution’s price formation process, greatly influences the size and effectiveness of the gift. When the market institution dictates that prices are formed by bids posted by buyers, any gift is one extended to the seller. When the market institution dictates that prices are formed by offers posted by sellers, any gift is one suggested by the seller. We show in experiments that posted offer markets, in both monopsonistic and thicker markets, generate higher prices, i.e. larger gifts, and higher levels of product quality than posted bid ones. A deeper exploration reveals that at low prices the two market institutions yield similar low quality; however, at higher prices the posted offer institution generates a higher quality. Further analysis indicates that while both market institutions provide similar low quality at low prices, the posted offer institution delivers higher quality at higher prices. The better performance of the posted offer institution stems not only from higher prices but also from improved quality at those prices.