We show that experience good sellers facing myopic buyers can solve the inherent moral hazard problem by communicating their observation of quality before trade, provided that communication is part of their public track record. Such cheap-talk communication, if trusted, allows market prices to reflect the actual value created, thus providing an immediate reward for the seller’s effort which complements the conventional, reputational incentives. Pre-trade communication achieves maximal efficiency when truthful and the full efficiency as the noise in the seller’s observation vanishes. We fully characterize the conditions for communication to improve efficiency and the extent to which it does so.
cheap talk; moral hazard; reputation mechanism; trust.;
Bruno Jullien, and In-Uck Park, “Communication, Feedbacks and Repeated Moral Hazard with Short-lived Buyers”, TSE Working Paper, n. 19-1027, July 2019, revised April 2020.