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Dynamic Quality Signaling with Moral Hazard

Author

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  • Francesc Dilmé

    () (Department of Economics, University of Pennsylvania)

Abstract

Asymmetric information is an important source of inefficiency when assets (like firms) are transacted. The two main sources of this asymmetry are unobserved idiosyncratic characteristics of the asset (for example, quality) and unobserved idiosyncratic choices (actions done by the current owners). We introduce moral hazard in a dynamic signaling model where heterogeneous sellers exert effort to affect the distribution of a stochastic signal (for example sales or profits) of their firms. Buyers observe the signal history and make price offers to the sellers. High-quality sellers try to separate themselves from the less quality ones in order to receive high price offers, while the latter try to pool with the first group to avoid receiving a low price. We characterize the competitive equilibria of the model, and we propose an adaptation of existing refinements to the incorporation of moral hazard in dynamic signaling that implies uniqueness of equilibria. We find that similar individual characteristics across types of sellers make everyone worse off, since competition increases signaling waste. Also, due to the new intensive margin (effort), non-trivial signaling will take place even when the cost of signaling is large. In particular cases, we find analytical solutions, that allow transparent comparative statics analysis. The model can be applied to education where grades depend not only on the students’ skills, but also on their effort.

Suggested Citation

  • Francesc Dilmé, 2012. "Dynamic Quality Signaling with Moral Hazard," PIER Working Paper Archive 12-012, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  • Handle: RePEc:pen:papers:12-012
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    File URL: https://economics.sas.upenn.edu/sites/default/files/filevault/12-012.pdf
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    References listed on IDEAS

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    1. Georg Noldeke & Eric van Damme, 1990. "Signalling in a Dynamic Labour Market," Review of Economic Studies, Oxford University Press, vol. 57(1), pages 1-23.
    2. Kremer, Ilan & Skrzypacz, Andrzej, 2007. "Dynamic signaling and market breakdown," Journal of Economic Theory, Elsevier, vol. 133(1), pages 58-82, March.
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    Cited by:

    1. Francesc Dilme & Fei Li:, 2012. "Dynamic Education Signaling with Dropout, Second Version," PIER Working Paper Archive 13-048, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 03 Sep 2013.
    2. Francesc Dilme & Fei Li, 2013. "Dynamic Education Signaling with Dropout Risk, Third Version," PIER Working Paper Archive 14-014, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 24 Apr 2014.

    More about this item

    Keywords

    Dynamic Signaling; Dynamic Moral Hazard; Endogenous Effort;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity

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