Incentives for Cost-Reducing Investment in a Signalling Model of Product Quality

Shiou Shieh

RAND Journal of Economics, 1993, vol. 24, issue 3, 466-477

Abstract: Often, consumers do not observe a firm's cost-reducing investment decision. The investment incentive can be weakened when product quality is unobservable before purchase because consumers do not know whether a lower price arises from lower costs or lower quality. This articles examines this issue in a signalling model with both hidden information (about quality) and hidden action (about investment). Surprisingly, asymmetric information about quality may strengthen or weaken a firm's incentive to adopt a process innovation, depending on whether low-price or high-price signalling is used.

Date: 1993
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