41 Pages Posted: 31 Jan 2012
Date Written: January 2012
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.
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