The Welfare Cost of Signaling

Fan Yang, Ronald Harstad
2017 Games  
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more » ... von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Abstract: Might the resource costliness of making signals credible be low or negligible? Using a job market as an example, we build a signaling model to determine the extent to which a transfer from an applicant might replace a resource cost as an equilibrium method of achieving signal credibility. Should a firm's announcement of hiring for an open position be believed, the firm has an incentive to use a properly-calibrated fee to implement a separating equilibrium. The result is robust to institutional changes, outside options, many firms or many applicants and applicant risk aversion, though a sufficiently risk-averse applicant who is sufficiently likely to be a high type may lead to a preference for a pooling equilibrium. Adverse selection becomes a concern when a party A faces a decision based on information possessed by a party B, whose utility is also affected by A's decision. That is, under what circumstances can party A rely on information communicated by party B? Spence's 1973 paper [1] introduced a model in which employers may use education as a screening device. In a related context, Akerlof (1970) [2] provided perhaps the most widely-taught adverse-selection example. Stiglitz (1975) [3] discussed the concept of screening in the context of employment and education. All of the above mechanisms are costly ways of solving an adverse-selection problem by creating an incentive to self-select. By contrast, in cheap-talk games (Crawford and Sobel, 1982 [4], Chakraborty and Harbaugh, 2010 [5] and the references in the latter), where communication is privately and (probably) socially costless, information that can credibly be transmitted is limited, usually severely. This paper asks: Since a sender must incur a cost of transmitting if the message is to be credible (for present purposes, the cost of obtaining, say, an MBA degree, is here labeled a cost of transmitting), to what extent can the cost be reduced for society by using a transfer instead of a pure resource cost? We address this question not to explain common occurrences in markets, but to better understand the foundations of the economics of transacting under asymmetric information. To explore these foundations, suppose that a firm can credibly commit to considering only those applicants who pay an application fee that might be substantial. 1 A test that might distinguish between applicants in some aspect of their suitability could still be conducted, but only if the firm's resource costs of administering the test and evaluating the effectiveness shown are quite small and an applicant's resource costs of preparing for and taking the test are negligible compared both to the resource costs of a usual signal and to the size of the application fee (the firm comparing a privately known threshold to the applicant's credit score, or her/his driving record, or her/his number of semesters on the Dean's list 1 Also credibly commit to not collecting application fees as a profitable activity without an appropriately compensated job waiting for the chosen applicant.
doi:10.3390/g8010011 fatcat:xgvon6uzdbc5tbjlafixe655qm