Information-Forcing Effects of Non-Disclosure Rules

Giuseppe Dari-Mattiacci, Sander Onderstal, Francesco Parisi and Ram Singh
Additional contact information
Francesco Parisi: University of Minnesota
Ram Singh: Department of Economics, Delhi School of Economicss, University of Delhi

No 338, Working papers from Centre for Development Economics, Delhi School of Economics

Abstract: Contract law traditionally applies different disclosure duties on buyers and sellers. Sellers are generally required to disclose “negative” information about hidden defects of the products they sell. Failure to disclose can make the contract voidable and can give rise to liability. By contrast, buyers are generally under no comparable duties to disclose “positive” information about hidden qualities of the products they buy. The leading explanation for the law’s disparate treatment of buyers and sellers in these two asymmetric information problems is that imposing disclosure duties on buyers would undermine their incentives to acquire costly (but socially useful) information prior to forming a contract (Kronman, 1978). This explanation lacks a key step—the failure to correct asymmetric information problems would cause the inverse adverse selection problem (identified by Burckart and Lee (2016) and Dari-Mattiacci et al. (2021)) to arise. Uninformed sellers would withdraw from the market and resources would not move to higher-valuing users. In this paper, we develop a model to study the incentives created by disclosure and non-disclosure rules. We show that when parties can contract around defaults, the choice of alternative disclosure rules (duty to disclose vs. no duty to disclose) makes a difference. Unlike disclosure rules, non-disclosure default rules yield partially separating equilibria that preserve the buyers’ incentives to acquire information. They also foster trade opportunities between expert buyers and uninformed sellers. Our results add to the existing literature by providing an additional rationale for the different treatment of buyers and sellers in asymmetric information problems. JEL Codes : D44, D82, D86, K12.

Keywords: asymmetric information; penalty default rules; inverse adverse selection (search for similar items in EconPapers)
Pages: 54 pages
Date: 2023-08
New Economics Papers: this item is included in nep-acc, nep-cta, nep-des, nep-law, nep-mic and nep-reg
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