Abstract

This paper analyzes the rating of a product of unknown quality by a certifier who internalizes the buyers' surplus and receives payments from a seller. It shows that contrary to conventional wisdom, a regulation that prohibits contingent payments hinders information revelation and harms social welfare when the contract between seller and certifier is public. If the contract is private (buyers do not observe the payments), contingent payments lead to “rating inflation”: high ratings are issued for a wide range of qualities and ratings have limited information value. Mandating flat fees then prevents rating inflation and can increase welfare.

Abstract

When issuers use uniform fixed price offerings and compete for monitoring capital, monitors, being scarce, capture some rent during the IPO and reduce the attractiveness of shares for retail investors. In order to attract retail investors the issuer has to underprice its shares. Bookbuilding allows issuers to discriminate among investors. If issuers use bookbuilding they are worse off compared to the situation where they stick to a fixed price offering, because discrimination triggers Bertrand competition for scarce monitors and forces issuers to give them all the rent. In contrast, in a uniform fixed price offering the competition for monitors is less severe since the effective price charged for monitors is the same as the fair price for retail investors and it is never profitable for the issuer to attract a monitor by charging a lower price.

Abstract

In environments where proceeds of new ventures are difficult to assess for outsiders projects are often started by experts. However, eventually the ventures must be "sold" to outsiders for experts to cash in. The following question arises why uninformed outsiders would be willing to buy ventures from informed experts? We show that if a family of similar projects can be started by numerous experts, some information about the prospects of projects is revealed to outsiders when the experts bring projects to the market. If many experts are selling projects it must be the case that many of them found their projects promising, and outsiders' valuations of these projects increase. Thus the information of individual experts gets aggregated and revealed to outsiders through the experts' actions (wisdom of the crowd). This mechanism exhibits strategic complementarity among experts' decisions to investigate projects. If many experts investigate and start projects then the market price reveals a project's prospects and this in turn creates incentives for an expert to investigate and start a project in the case of a good signal. If, on the other hand, no expert investigates, the market price is not revealing and an expert has no incentives to investigate. Given that a venture started at random without an investigation has a negative expected value, the market for new ventures ceases.