Honest versus Misleading Certification

Abstract

This paper questions the honesty of third-party certification in the market for a good whose environmental quality is not observable by consumers. The certifier maximizes a weighted sum of its own rev- enue and social welfare. The higher the relative weight placed on revenue, the stronger the certifier’s incentive to mislead consumers. Certification is analyzed as a costly signaling mechanism that, be- sides displaying labels, transmits information through market prices. Honest certification requires that prices credibly signal environmental quality to prevent cheating. I show that certification can only be hon- est when the certifier is driven more by social welfare than by profit. In the reverse case, the certifier cannot help jamming the price signal, thereby granting unreliable labels.