Cameron Klein December 13, 2013 Journal Review You are required to do an article summary from the Journal

of Economic Perspectives. Each article is typically 20-30 pages long. The articles are non-technical, yet explain the cutting edge of many economic research. In no more than 5 pages, you must summarize the article and state what you found interesting about it. These are due the day of our Final Exam. Articles may not be more than 15 years old. I chose to my do my article summary on What the Seller Wont Tell You: Persuasion and Disclosure in Markets, written by Paul Milgrom, from the Journal of Economic Perspectives in 2008. Paul Milgrom, the Shirley and Leonard Ely Professor of Humanities and Sciences at Stanford University, focuses on the power of knowledge in interactions between naturally skeptical buyers or inverstors and profit driven sellers. Milgrom introduced a novel "persuasion game", in which a salesperson has private information about a product, which he can, if he chooses, verifiably report to a potential buyer. (That is, the salesperson can, if he wishes, conceal his information, but he cannot misreport it if he reveals it.) Milgrom demonstrates that, with substantial generality, at every sequential equilibrium of the sales encounter game, the salesperson employs a strategy of full disclosure. This result has come to be known as the "unraveling result," because Milgrom shows that, in any candidate equilibrium in which the buyer expects the salesperson to conceal some observations, the salesperson will have an incentive to reveal the most favorable (to himself) of those observations---thus, any strategy of concealment will "unravel". Milgrom also observed that when there is competition among informed, selfinterested agents to persuade an uninformed party, all of the relevant information may be disclosed in equilibrium even if the uninformed party (e.g. the buyer) is not as sophisticated as was assumed in the analysis with a single informed agent (e.g. the salesperson). The unraveling result has implications for a wide variety of situations in which individuals can strategically choose whether to conceal information, but in which lying carries substantial penalties. These situations include courtroom battles, regulation of product testing, and financial disclosure. Milgrom's persuasion game has been hugely influential in the study of financial accounting as a tool for understanding the strategic response of management to changes in disclosure regulation. This work has led to a large literature on strategic communication and information revelation. Paul Milgroms article, What the Seller Wont Tell You: Persuasion and Disclosure in Markets, opened up by using the example of venture capital or more specifically, Inittiial Public Offerings, in which a company is looking to raise capital and makes a sales pitch to the potential investors. These presentations are heavily rehearsed and are intended to convince the skeptical audience to invest in the company/venture. This tyoe of situation is not unique to the financial industry. Milgrom talks about the study of the adverse selection, which refers to a market process in which undesired results occur when buyers and sellers have asymmetric

Cameron Klein December 13, 2013 information (access to different information); the "bad" products or services are more likely to be selected. However, he is most interested in the ways sellers use information to mitigate problems that result from adverse selection specifically the withholding or disclosure of the integral information. Once identifying and explain the problem at hand, Milgrom turned the attention to incentives that dictate such market outcomes whether it be a social effiecient outcome or not. Simply put, those sellers with the highest quality goods are most likely to be fully transparent, as any information would most likely reinforce their products appeal and reputation. Furthermore, a study presented in the article, by Frankel, McNichols, and Wilson found that the more frequent the seller interacts with the buyer an extra incentive to supply information. There has already been public intervention to help to ensure all buyers are correctly informed. MIlgrom tackles the the questions of how involved and in what ways government regulation will ensure that sellers refrain from selectively releasing information and thus ensuring informed consumers. Milgrom stated, in many cases, the key problem that arises is not that sellers are unwilling to reveal information, but that sellers can report or reveal information selectively. The most extreme example of selectively releasing information is evident in the pharmaceutical industry. Many drug makers selectively report and reveal information specifically dealing with potential side-effects from the drugs. After showing examples in the pharmaceutical industry, Milgrom offered a couple policy responses to prevent such practices. First, Milgrom proposes a government mandate to disclose all test results. However, this is can be problematic as it is virtually impossible to identify what the sellers knows or doesnt know. Additionally, such a policy would incentivize sellers to only run tests where they are confident that the results will be beneficial and not to run tests where theyre skeptical. Milgrom concludes that this type of policy does not result in market forces solving the adverse selevtion problem. Milgrom goes on to offer alternative policies, such as holding sellers accountable for information they should have known. This policy is slightly different from the previous one in that, purposefully refraining from certain testing will be mitigated because the it is no longer based on whether they knew it or not but rather should they have known it. As would be expected, this type of policy is also riddled with flaws, as proving what a seller should know is a daunting task. After presenting government policies that can help to resolve the issues at hand, Milgrom turns to the private sector and competition as a means to alleviate problems that arise from adverse selection. When there are competing providers of information, the problem is well addressed with out any regulation. When reputations and thus future profits are on the line, Milgrom expects the market to reveal all pertinent information to consumers. Despite solving the problem of adverse selection, this competition model will often fail to reveal possible

Cameron Klein December 13, 2013 alternatives and/or compliments. He wrote, For imformation competition to work well, the buyer needs to know the set of relevant suppliers so that each relevant alternative has an advocate. Milgroms competieition theory is therefore reliant on yet another case of informed buyers. We can see knowledge is power in many different economic interactions that occur. Without diving in too deeply to the mechanisms that Milgrom presents for which sellers disclose information in an attempt to persuade buyers. Milgrom is most concerned with whether the issues revolving assymetric information is best solved through competition or government regulation. Milgrom concludes that, ...markets provide powerful incentives for sellers to supply useful and verifiable product information, but that it is heavily reliant on the need for sophisticated buyers. With out the sophisticated, naturally skeptical buyers, that weigh nondisclosed information as a negative, the mechanisms that Milgrom lays out as an equilibrium collapse. Even with a sophisticated buyer, Milgrom recognizes that sellers will still in some cases find it in their best interest to test selectively. Furthermore, Milgrom encourages government policy to create liability for not withholding information. On the other hand when the buyer is novice, the possibility of adverse selection increases dramatically. Competiton between sellers is cited as helping mitigate adverse selection but depending on the circumstances even with competition, adverse selection will occur. Many mathematical models used to in intermediate microeconomics rely heavily on the assumption of perfect/complete information. However, in reality the idea that all agents in a market have symmetrical complete information is often times not the case. Before returning to school at Carolina I took two years off in which I worked in construction. I had given and observed with estimates on jobs, and ever since have been a very skeptical consumer of anything construction related. There is clearly assymetric information when a contractor is bidding for a job, and much like the examples given by Milgrom, often find it best to selectively reveal information regarding their own and competitors product or service. This can often times lead to adverse selection and thus an inefficient allocation of wealth. There are certain laws already in place to help ensure that consumers are informed, but many industries or interactions require further competition between sellers in order for all information to accurately get revealed. It is very interesting to be able to apply game theory and specifically persuasion games to my previous work experience. Persuasion is no more than a manipulation of information to take advantage of psychological limitations and knowledge bases. In concluding, Milgrom highlights the benefits of competition among sellers no matter the industry. He also provides support for government regulation that helps to identify relavent product characteristics and overall ensure an informed buyer. This is a very important in economics, specifically within game theory, as it sheds light on to avoid adverse selection when considering market structure.