European Economic Review 24 (1984) 203-207. Nor~l,-~ ~iland PRIVATE DISCLOSURE Is Honesty Enough? David DE MEZA* London Schoo' of Economics, London WC2A 2AE, UK Received Febrt~ary 1983, final version received November 1983 If disclosure is costless a truthful monopolist selling to identical rational consumers will never withhold socially valuable infonaation. But it preferences differ between individuals and are non- hierarchical, then too little information may be revealed. I. Introduction Given that the law of misrepresentation effectively inhibits firms from making promotional claims which they know to be false, could it serve the public interest to require that product quality be ~'ully disclosed? The immediate answer is probably yes, for sellers can hardly be expected to volunteer incriminating information. However, this view overlooks the possibility that silence may be even more damaging than an unfavourable disclosure. Rational consumers will infer that true product quality is the lowest consistent with the claims made. Hence, if a product is not the worst possible, it pays even a monopolist to accurately declare just how good it is. This reasoning is the basis of the demonstration by Grossman and Hart (1980) and Grossman (1981) that in the absence of transactions costs there will be full voluntary disclosure. In reality there seem to be many occasions when companies fail to reveal apparently relevant information. ~ One explanation is that the costs of making an announcement are so high that even top quality sellers have no ' *V mcentl e to identify themselves. Alternatively, buyers may not be. smart enough to draw rational inferences. Another possibility is conjectured by Grossman (1981, pp. 478-479). He suggests, somewhat Delphically, that if consumers differ with respect to both reservation price and degree of risk aversion suppressing information may serve a sorting role and thereby enable *I am grateful to J.R. Gould for helpful suggestions and encouragement and also to S Grossman, O. Hart, and A. Shaked for useful disca~ions. The comments of two referees halve also led to improvements. 1E.g., Muller (1982) provides some startlJyg :tccouL's of the marketing practices of multinational pharmaceutical companies in LDCs. CA) 14-2921/84/$3.00 © 1984, Elsevier Science Publishers B.V. (North-Holland)