Asymmetric information is a situation where there is imperfect knowledge between the stakeholders in a space where that knowledge will influence decision making. In particular, it occurs where one party in the situation has different information to another, usually a superior knowledge as it affects the matter at hand. In a simple sense, a good example is when selling a car, the owner is likely to have full knowledge about its service history and hence value. The potential buyer, by contrast, will not have access to such information and thus may not be able to trust the seller’s divulged information. You are more likely to trust a Hotel that allows honest feedback on their website rather than one that only publishes similar positive feedback.
Two types of Asymmetric Information
George Akerlof was awarded the Alfred E. Nobel Prize in Economic Science (2001) for his 1970 paper “The Market for Lemons- Quality Uncertainty and the Market Mechanism", This groundbreaking work used the second-hand car market to investigate this problem of asymmetric information between buyers and sellers. Akerlof noted it could lead to adverse selection, this problem with asymmetric information takes place before the transaction; where good products or services are held back because of the average going price for lower quality products in the market.
Secondly, asymmetric Information gives rise to Moral hazard which is a concept that individuals have incentives to alter their behaviour when their risk or bad-decision making is borne by others. This problem with asymmetric information takes place after the transaction. For example, a person with insurance against automobile theft may be less cautious about locking their car because the negative consequences of vehicle theft are now (partially) the responsibility of the insurance company.
Asymmetric information theory suggests that sellers may possess more information than buyers, skewing the price of goods sold. A Client seeking the services of a consultant is likely to have other quotes for the same services, thereby skewing the negotiation in his favor. The converse is also true where the Client is inexperienced and hence does not have options, this will inadvertently skew the bargain in favour of the Consultant. But where both have either worked together previously or have balanced knowledge, they are more likely to have a fair bargain.
The theory argues that low-quality and high-quality products can command the same price, given a lack of information on the buyer's side. This is often the experience of some Clients who negotiate based on their lack of knowledge only to discover that there is a difference in quality of service delivery between professionals offering same services.
How to deal with Asymmetric information
It is obvious that both Adverse Selection and Moral Hazard are issues faced in the engagement of a professional consulting service. The challenge of adverse selection could influence the pricing of a professional service while the challenge of moral hazard could affect the quality of service provided. Consequently, where it is perceived that there is an information asymmetry, either party could put the following in place or implement same to mitigate the effect of the information asymmetry;
For the Client:
Direction of Investments-. Seek a firm that shows proper investment in their practice, it is a signal that the firm intends to stay in the long-term. In this case, the firm has a greater incentive to provide reliable services and avoid costs to its reputation. This is why the rates charged by more established firms will be higher than from new entrants into the market.
Request Indemnity insurance – this will more than likely cause the consultant to commit to providing the best service and insulate against the dilemma of Moral hazard.
Engage an Expert -. If you are going to engage the services of a professional, it would be worth paying for the services of a qualified person to evaluate the information provided by the firm through independent assessments. This would give you more information, also, the firm would be wary of providing sub-standard service if you were to have another professional providing QA/QC.
Request full disclosure – make a formal request for full disclosure from the other party, this will make it more likely to have it taken in as evidence in the case of default by the other party. The knowledge of this will also serve to guide the actions of the other party.
For the Consulting practice:
Give warranties-. Another way to avoid asymmetric information is for a professional firm/ practice to give warranties for the reliability of their service.
Conduct an evaluation – while most firms are like the seller, though unusual, but for the sake of integrity of the practice, it is advisable you conduct an evaluation of the Client to know their culture and attitude to projects.
Set a bar – it is important to be known for a standard than not to be known for any. Establish your minimum viable product [MVP] for all your services and consistently deliver above it.
The future of Asymmetric Information
Some people argue that the internet has helped to reduce the incidence of asymmetric information by the share volume of information that is available on almost anything. While this may be true, however, any student of big data knows that the value of information is only as good as the source and veracity of that information - wrong information is no information. - volume does not necessarily mean good. Professional services are only as good as their ability to meet the requirements of the client, hence the best assurance of dealing with Asymmetric information in the future is providing the Client with all information you have and know which may impact the project. It has also been postulated that the emergence and growth of blockchain will be able to solve this problem and create a balanced information for both parties.