Actions that affect the value of a service are often self-reported rather than publicly observable. The diligence of a contractor, the education level of job applicant, or the true mileage of a used car are typically reported by the seller. This opens the door for lying and misrepresentation.
In “Self-Reported Actions, Signaling, and Auditing,” my co-author Mike Waldman and I present a model in which multiple receivers bid for the service of a sender, the value of which depends on a action taken by the sender. Instead of the action itself, receivers only observe a message reported by the sender indicating which action was taken. Receivers may opt for costly auditing to verify that the message matches the action.
We find that lying may increase social welfare when the action serves as a signal of a desirable trait of the sender. A positive likelihood of misrepresentation lowers the value of the action as a signal, and therefore counteracts the well-known over-investment result in the signaling literature. Therefore, factors that promote misrepresentation, such as a lower disutility of lying or a higher auditing fee, may increase social welfare.
This result stands in stark contrast to cases in which the action does not signal the sender’s type. We also find that the level of auditing is inverse U-shaped in the probability of the sender being dishonest, and that receivers may audit more often if the action does not serve as a signal, despite gaining less information when auditing. We apply our insights to education signaling, college applications, and odometer fraud in the used car market.
Find the full text paper HERE . I will present it at this year’s virtual editions of the EEA and the ESWC.