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A performance‐based payment: Signaling the quality of a credence good

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  • Nathan Berg
  • Jeong‐Yoo Kim
  • Ilgyun Seon

Abstract

We consider credence goods. A typical example of a credence good is an expert service. Experts often offer rebates contingent on their client's failure or bonus payments contingent on their client's success. This paper provides a different rationale for performance‐based payments than reducing moral hazard. We show that a performance‐based payment can be a signal of the seller's ability. Due to different success rates across expert abilities, a high‐ability expert can commit to offering larger indemnity payments contingent on a client's failure or smaller bonus payments contingent on a client's success. Thus, high quality is signaled by performance‐based pricing.

Suggested Citation

  • Nathan Berg & Jeong‐Yoo Kim & Ilgyun Seon, 2021. "A performance‐based payment: Signaling the quality of a credence good," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 42(5), pages 1117-1131, July.
    • Handle: RePEc:wly:mgtdec:v:42:y:2021:i:5:p:1117-1131
    DOI: 10.1002/mde.3295
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