Signaling in e-commerce. How can information asymmetry be minimized?

Seminar Paper, 2019

30 Pages, Grade: 2,3


Table of contents

1 Introduction

2 Theoretical Background
2.1 Information asymmetry
2.2 Signaling Theory

3 Signaling in E-commerce
3.1 Trust in the e-commerce
3.2 Satisfaction in the e-commerce
3.3 How Trust and Satisfaction influence the purchase intention
3.4 The purchase intention

4 Conclusion



This seminar work has the purpose to clarify the importance of the signaling theory in the area of e-commerce. In order to do this, first of all the aspect of information asymmetry will be elaborated and it will be demonstrated how signals can be categorized. After this the signaling theory will be transferred to the area of e-commerce. In the e-commerce the signals aim to indirectly reduce any uncertainty the buyer might have. This uncertainty can be directly influ- enced by factors such as trust and satisfaction. Furthermore, trust and satisfaction build up the purchase intention a buyer evolves. So, several signals will be presented which reduce the un- certainties by influencing these factors.

Index of Figures

Figure 1: Principal/agent problem caused by asymmetric information (Den Buttera, 2012, p 264) .

Figure 2: The Antecedents of Seller Uncertainty: Adapted from Dimoka et al., 2012, p. 396 f

Figure 3: The Antecedents of Product Uncertainty: Adapted from Dimoka et al., 2012, p. 396 f.

Figure 4: The categories of Satisfaction: Adapted from J. Kim et al., 2002, p. 243

Figure 5: Conceptual framework of the influences on the purchase intention (Pan et al., 2015, p. 510)

1 Introduction

The main aspect of this seminar work is the question how the information economical problem of information asymmetry can be minimized in the e-commerce.

With the example of Akerlofs lemons market it will be elaborated how a market failure can occur based on the asymmetric information distribution on a market. Even though there are several theories to explain the existence of buyer’s uncertainty towards a seller, only the sig- naling theory will be further elaborated since the focus of this work is on possibilities to reduce the information deficit in the e-commerce. Furthermore, the signaling theory and the different types of signaling will be elaborated. The third chapter will be elaborating how various different signals can be used by an e-commerce seller to build up trust towards the buyer and also build up the satisfaction the buyer has after a transaction with the seller. The trust and likewise the satisfaction of the buyer are one of the crucial influences on the purchase and repurchase inten- tion the visitor of a website develops or not. This purchase intention is influenced by several variables as well. Overall the seller has to make sure that the signals he uses are generating enough interest for a future orientated performance promise and future orientated business re- lationships. The findings demonstrate possible ways for integrating the discussed signals into an efficient marketing mix.

2 Theoretical Background

This Chapter will focus on giving an introduction to the topic of signaling. In order to do this first the information asymmetry will be evaluated and embedded into the theoretical framework of the principal agent theory. As a way of resolving the problem of information asymmetry the signal theory will then be elaborated and it will be shown how the different signals can be categorized.

2.1 Information asymmetry

To understand the Signaling Theory which this assignment is about the information economical aspect of information asymmetry must be described. So this part of the assignment focuses on giving a basic definition of information asymmetry by recapitulating Akerlofs market of lemons and in consequence how the specific case of adverse selection and moral hazard describe the problems buyers and sellers experience regarding the quality of a good (Akerlof, 1970, p. 489 ; Kirmani & Rao, 2000, p. 67).

Asymmetric information can cause significant problems for the efficient functioning of a mar- ket. In the so-called optimal information situation, the buyer and the seller of a specific good have the exact same information about the quality of this good and the related transaction (Varian, 2002, p. 718).

In the real economy, however, numerous markets lack this optimal situation and the costs for one side to obtain these information about a good and its quality are very high. Therefore, it’s almost impossible for both sides to have the same information. This problem is very well known for the labor market, but it’s also relevant for the consumer market (Varian, 2002, p. 718). It is important to mention that information asymmetry occurs only for so called “experience products”. These are products where the quality can only be evaluated after the purchase (Nelson, 1974, p. 730). If a buyer, for instance, wants to buy a used car, it is hard for him to find any information about the quality of this car before he buys it. He doesn’t know if the car is of high or low quality. Meanwhile, on the other hand, the seller of the used car has perfect information about the condition and the quality of the car (Varian, 2002, p. 719).

The case of asymmetric information is embedded within the principal agent theory, as shown in figure 1. Pratt and Zatthauser defined this problem 1985 in a more general manner as “whenever an individual depends on the action of another, an agency relationship arises.” (Pratt & Zeckhauser, 1985, p. 2). Additionally, the authors defined the principal and the agent as follow: “The individual taking the action is called the agent. The affected party is the principal.” (Pratt & Zeckhauser, 1985, p. 2). A more specific definition was given by Jensen and Meckling in 1976. They declared that the principal agent problem is defined as a contract “[…] under which one or more persons (the principal(s)) engage another person (the agent) to perform some service on their behalf which involves delegating some decision-making authority to the agent.” (Jensen & Meckling, 1976, p. 308). The main aspect of this principal agent problem is the con- tract between the principal and an agent. So, the information asymmetry between the two sides of the principal agent theory can arise in two situations. The first one is moral hazard, where the seller can change the quality of one specific product from one transaction to another. And the other situation is adverse selection. In this situation the seller can’t change the quality of a specific product with every transaction and so the problem of information asymmetry only oc- curs if the buyer doesn’t learn about the quality (Kirmani & Rao, 2000, p. 67). In the following, these two situations will be described.

Abbildung in dieser Leseprobe nicht enthalten

Figure 1: Principal/agent problem caused by asymmetric information (Den Buttera, 2012, p. 264)

The first case of information asymmetry is called moral hazard. It describes the state in which the agent chooses an action which can’t be monitored by the principal or cannot be verified as this action afterwards. The agent chooses to exploit the information asymmetry between him and the principal and acts in an opportunistic way (Bannier et al., 2005, p. 119). A well-known example for a moral hazard situation can be found in the field of insurance. In this case the insurance company acts as the principal since it provides a service for the insurant, who consequential takes the part of the agent. The insurance company has less information than the agent about his actions and so the agent might be tempted to cheat the insurance company by behaving less farsighted than in the case that he or she is not insured (Den Buttera, 2012, p. 264).

The second situation is the case of adverse selection. In the year 1970 Akerlof showed with his model of the lemons market the difficulties which can occur on a market based on the infor- mation asymmetry. His scientific paper “The Market for Lemons: Quality Uncertainty and the Market Mechanism” is named as one of the most important works of the field of information economy (Spence, 2002, p. 434). The model of the lemons market will be elaborated in the following part.

The market for used cars has a potential of 50.000 units of high quality and 50.000 units of low quality. The cars of lower quality are the so-called lemons of the market and the high-quality cars the so-called plumps of this market (Akerlof, 1970, p. 489). The buyers on this market are willing to pay 11.000 € for a used car of high quality and 6.000 € for a lemon. On the other side, the sellers of these used cars are accepting prices for the high-quality plumps from 10.000 € on and for the lemons from 5.000 € on (Drewello et al., 2018, p. 234). In a market with total infor- mation symmetry between the buyers and the sellers, the lemons will sell between 5.000 € and 6.000 € and the plumps of the market will be sold for a price between 10.000 € and 11.000 € (Varian, 2002, p. 719). But since the buyer can’t observe the quality of any car which is offered at this market it is the most logical assumption that the buyer will align his willingness to pay (WTP) on the average expectation of the quality. The relation between plumps and lemons on this market is 50/50, so the WTP of the buyer for a used car will be 1/2* 11.000 € + 1/2* 6000 € = 8.500 €. The problem is that the sellers of the used cars aren’t willing to sell their plumps for under 10.000 €. So, as a consequence the buyers with a WTP of 8.500 € only have access to the 50.000 lemons of the market and the other 50.000 plumps won’t be sold. This pareto inefficiency is called adverse selection and it leads as a consequence to a market failure (Drewello et al., 2018, p. 235). In order to prevent this case, high quality sellers are forced to use specific signaling mechanisms to inform the potential buyer about the quality of their good (Spence, 2002, p. 436).

2.2 Signaling Theory

The Signaling Theory is one of the main aspects of the information economy and tries to resolve the core problem of asymmetric information between two parties (Spence, 2002, p. 434). In order to give an explanation on how the problem can be resolved, the following chapter will focus on giving a definition of the signaling theory and how specific mechanisms are used to minimize the information asymmetry. Also, different types of signaling will be defined. The signaling theory is a widely accepted theory. In his scientific paper “Job Market Signaling”, which was published in 1973, Spence laid the foundation for the signaling theory by examining the information asymmetry for the case of the labor market (Spence, 1973, p. 355). In the course of time the signaling theory gained reputation in various other economical fields other than the labor market (Connelly, Certo, Ireland, & Reutzel, 2011, p. 40). In the field of management studies, the theory is significantly important because of the high relevancy of the information asymmetry. The same applies to the area of human resource management and es- pecially the recruitment process, which is highly dependent on the information situation of the principal and the agent, in this case the employer and the job candidate, and the lack of infor- mation symmetry between the both. Additionally, the signaling theory is often applied in the sectors of entrepreneurship and diversity research (Connelly et al., 2011, p. 40).

The term “signal” has been defined several times by several authors. The definitions that de- scribe this term the best are the following by Porter and San Martin & Camarero:

- “A […] signal is any action by a competitor that provides a direct or indirect indication of its intentions, motives, goals, or internal situation.” (Porter, 1980, p. 75).
- „Information asymmetry […] implies that it [the seller] needs to send signals […] so that the consumer can make inferences about the quality provided and about the seller’s intention.” (San Martín und Camarero, 2005, p. 79).

All of the definitions have in common that they acknowledge the importance of the information asymmetry between the seller and the buyer and that this asymmetry can be resolved via sig- naling.

To demonstrate the signaling theory Kirmani and Rao illustrated a general example for a basic signaling model (Kirmani & Rao, 2000, p. 68). In this model two types of sellers are identified. First the high-quality sellers which produce the plumps on the market like it was already de- scribed and in contrast the low-quality sellers which produce the so-called lemons on the market. Because only the particular seller knows about the true quality of their product and the buyers and other third parties like potential shareholders do not know about this quality the premise of information asymmetry is given in this model. So, in consequence, each seller can decide on their own if they want to use specific signaling mechanisms to provide information about the actual quality of the product to the potential buyer or the investors.

The high-quality sellers receive the payoff A if they use a signal and the payoff B if they decide to renounce any signaling mechanism. Conterminous, the low-quality sellers receive the payoff C if they make use of signaling and the payoff D if they spare on signaling. As Kirmani and Rao stated signaling is a viable strategy when two conditions hold. First it is more economically reasonable for sellers which products are of high-quality to use signaling as a marketing tech- nique than not doing so. This means that A > B (Kirmani & Rao, 2000, p. 68).

Secondly for sellers which products are of low quality the payoff of not using signaling in any way is higher than providing signals (Perridon & Steiner, 2007, p. 515). Therefore, it is D > C. This leads to the occurrence of a so-called separating equilibrium. This means the sellers self- select into the more profitable strategy and make it rational for the buyer to easily distinguish between the high-quality seller and the low-quality seller since the seller that transmits a signal must be the high-quality seller.

If for some reason the low-quality seller would mimic the signal of the high-quality seller, it would suffer from monetary loss in two ways. First in a direct way because signaling is very costly and these costs would be forfeited if the buyer would identify the true quality of this low- quality seller. And secondly the seller would lose money indirectly because of the opportunity costs of a renounced strategy choice. If the payoff values in this shown model were such that A > B and C > D, both types of sellers would benefit from signaling. This state is described as a pooling equilibrium. Here the buyers cannot distinguish between the two types of sellers and in consequence would not be able to separate the plumps from the lemons because for the low- quality sellers the gains from falsely claiming high quality outweigh the losses from being dis- covered. In consequence, this would lead to a market failure because in time the high-quality sellers would be driven out of the market and only the low-quality sellers can sustain (Kirmani & Rao, 2000, p. 68). The basic assumption of this model is illustrated in the figure below.

Abbildung in dieser Leseprobe nicht enthalten

Figure 2: Signaling Model (Kirmani & Rao, 2002, p. 68)

So, as it has been shown the seller has an urge to inform the buyers about the product in order to overcome the problem of the information asymmetry. Therefore, the seller tries to change the initial asymmetric informational structure of the market. To achieve this information transport, sellers must use specific signaling mechanisms. These can be separated into two types. First the “default-independent signals“ and on the other side the „default-contingent” signals (Kirmani & Rao, 2000, p. 68). The default-independent signals can be defined by the fact that the expenditures of these signals incur for the sellers regardless if their product has the described quality or not. These expenditures generally occur for the seller before or while using this type of signaling mechanism. Furthermore, these costs can be differentiated into sale-inde- pendent and sale-contingent. Sale-independent costs occur whether the sales which are planned because of the signaling occur or not, so therefore in a pre-purchase manner (Kirmani & Rao, 2000, p. 68). Contrary the sale-contingent costs only occur when a transaction between a buyer and the seller has already taken place (Damon Aiken et al., 2004, p. 257). Advertisement rep- resents the perfect example for this type of signaling with sale-independent costs because the low-quality sellers can advertise their product in a way that the buyers think its quality is very high even if that is not the case (Basuroy, Desai, & Talukdar, 2006, p. 288). Nonetheless it makes sense for high-quality sellers to use advertisement as a signal because when a high- quality seller has high advertising expenditures the buyer believes that the advertised product must have a high quality (Kirmani & Wright, 1989, p. 352). On the other side, the default- contigent signals don’t raise any costs until the promise of the sellers that their product is of a specific quality is refuted. The costs that the signal may cause and the profits it may achieve are futuristic and occur after a transaction between the seller and the buyer takes place (Damon Aiken et al., 2004, p. 257). These signaling mechanisms can also be categorized into revenue- risking and cost-risking types. An example for revenue-risking signaling is a high-price because it can hold back the future revenue. Cost-risking signaling on the other hand takes place when, for instance, a warranty holds future costs at risk (Kirmani & Rao, 2000, p. 69).

This categorization is best illustrated by the following figure.

Abbildung in dieser Leseprobe nicht enthalten

Figure 3: The categories of signals: Adapted from Kirmani and Rao (Yen, 2006, p. 302)


Excerpt out of 30 pages


Signaling in e-commerce. How can information asymmetry be minimized?
University of Kaiserslautern
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ISBN (eBook)
ISBN (Book)
signaling, E-commerce, Signale, Internet, Information asymmetry, Information
Quote paper
Hendrik Niehoff (Author), 2019, Signaling in e-commerce. How can information asymmetry be minimized?, Munich, GRIN Verlag,


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