Working Paper: CEPR ID: DP8774
Authors: Mike Burkart; Samuel Lee
Abstract: In many bilateral transactions, the seller fears being underpaid because its outside option is better known to the buyer. We rationalize a variety of observed contracts as solutions to such smart buyer problems. The key to these solutions is to grant the seller upside participation. In contrast, the lemons problem calls for offering the buyer downside protection. Yet in either case, the seller (buyer) receives a convex (concave) claim. Thus, contracts commonly associated with the lemons problem can equally well be manifestations of the smart buyer problem. Nevertheless, the information asymmetries have opposite cross-sectional implications. To avoid underestimating the empirical relevance of adverse selection problems, it is therefore critical to properly identify the underlying information asymmetries in the data.
Keywords: asymmetric information; bilateral trade; cash-equity offers; commissions; contingent value rights; debt-equity swaps; lemons problem; royalties
JEL Codes: D82; D84
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| buyer's superior information (D83) | seller hesitance (D44) |
| buyer's superior information (D83) | trade friction (F19) |
| contracts providing upside participation for sellers (L14) | mitigate adverse effects of smart buyer problem (D91) |
| smart buyer problem (D10) | trade frictions (F19) |
| identifying contracts (K12) | erroneous conclusions in empirical studies (C90) |
| information asymmetries (D82) | trade outcomes (F10) |