Incentives of low-quality sellers to disclose negative information

Abstract

The paper studies incentives of low-quality sellers to disclose negative information about their products. We develop a model in which one's quality can be communicated via cheap-talk messages only. This setting limits the ability of high-quality sellers to separate, as any communication strategy they pursue can be costlessly imitated by low-quality sellers. We study two factors that can incentivize low-quality sellers to communicate their quality: buyers' loss aversion and competition. Quality disclosure reduces buyers' risk, thereby increasing their willingness to pay for the product. It also introduces product differentiation, softening the competition.