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P rice and M oney ‐B ack G uarantees as S ignals of P roduct Q uality

P rice and M oney ‐B ack G uarantees as S ignals of P roduct Q uality Why is it so common for the seller to provide guarantees that say “Satisfaction guaranteed or your money back” along with the sale of a product? Newly introduced goods and mail‐ordered products are usually sold with such guarantees. In honoring money‐back guarantees, why is it a common business practice to pay back exactly the purchase price rather than a portion of it? In this paper we study the informational role and optimality of the common business practice of money‐back guarantees in a signaling model with quality uncertainty and risk‐neutral buyers. We find that money‐back guarantees and price together completely reveal a monopoly firm's private information about product quality, Moreover, the private information is revealed at no signaling cost. Furthermore, we show that in terms of the level of monetary compensation specified by a guarantee, price is the profit‐maximizing level of monetary payback in case of product failure. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Economics & Management Strategy Wiley

P rice and M oney ‐B ack G uarantees as S ignals of P roduct Q uality

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References (16)

Publisher
Wiley
Copyright
Copyright © 1996 Wiley Subscription Services, Inc., A Wiley Company
ISSN
1058-6407
eISSN
1530-9134
DOI
10.1111/j.1430-9134.1996.00361.x
Publisher site
See Article on Publisher Site

Abstract

Why is it so common for the seller to provide guarantees that say “Satisfaction guaranteed or your money back” along with the sale of a product? Newly introduced goods and mail‐ordered products are usually sold with such guarantees. In honoring money‐back guarantees, why is it a common business practice to pay back exactly the purchase price rather than a portion of it? In this paper we study the informational role and optimality of the common business practice of money‐back guarantees in a signaling model with quality uncertainty and risk‐neutral buyers. We find that money‐back guarantees and price together completely reveal a monopoly firm's private information about product quality, Moreover, the private information is revealed at no signaling cost. Furthermore, we show that in terms of the level of monetary compensation specified by a guarantee, price is the profit‐maximizing level of monetary payback in case of product failure.

Journal

Journal of Economics & Management Strategy – Wiley

Published: Sep 1, 1996

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