Asymmetric Information

Manager’s Checklist for Asymmetric Information

• Identify the Information Gap: Who knows more in this transaction? What don’t I know?
• Assess the Risk: Is the main risk adverse selection (picking the wrong partner/product) or moral hazard (the other party’s behavior changing after the deal)?
• Look for Signals: Is the other party offering credible signals of their quality (e.g., warranties, certifications, strong references)?
• Implement a Screen: Can you create a test or process to reveal more information (e.g., a technical interview, a pilot project)?
• Align Incentives: Structure the contract so both parties win by doing the right thing (e.g., performance bonuses, commission structures, vesting periods).

Common Pitfalls to Avoid

• Assuming Trust: Don’t rely solely on trust, especially in high-stakes situations. Verify claims.
• Ignoring the Problem: Pretending everyone has the same information is a recipe for being taken advantage of.
• Over-investing in Mitigation: Don’t spend more on screening and monitoring than the deal is worth.
• Creating Perverse Incentives: Make sure your solution doesn’t accidentally encourage bad behavior.