Testing Incentives in a Buyer-Seller Relationship

One of the most celebrated features of modern manufacturing is the newfound capacity for information sharing between firms. Manufacturing guides suggest that buyer-seller communication can help firms achieve more efficient production and trading decisions (Schonberger (1986)), as long as the trading firms truthfully report to one another. In this paper, we study the incentives for firms to strategically misreport private information and solve for the least costly mechanism soliciting truthful communication. When firms can communicate with one another strategically, we find that the cost of motivating truthful reporting may outweigh the benefit associated with the information being shared. By analyzing a buyer and seller’s product testing decision, we characterize which of the firms ought to collect private information, and how the choice of tester affects individual testing incentives, end-product quality and industry surplus. ∗University of California, Los Angeles.