DP8190 Who Should Pay for Certification?

Author(s): Konrad O Stahl, Roland Strausz
Publication Date: January 2011
Keyword(s): asymmetric information, certification, information acquisition, inspection, lemons, middlemen, signaling
JEL(s): D40, D82, L14, L15
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8190

Who does, and who should initiate costly certification by a third party under asymmetric quality information, the buyer or the seller? Our answer --- the seller --- follows from a non--trivial analysis revealing a clear intuition. Buyer--induced certification acts as an inspection device, whence seller--induced certification acts as a signalling device. Seller--induced certification maximizes the certifier's profit and social welfare. This suggests the general principle that certification is, and should be induced by the better informed party. The results are reflected in a case study from the automotive industry, but apply also to other markets -- in particular the financial market.