Truthful Cheap Talk: Why Operational Flexibility May Lead to Truthful Communication

This paper shows that operational flexibility interacting with informational uncertainty may lead to truthful information exchange in equilibrium even when the communication is nonbinding and unverifiable, i.e., “cheap talk.” We consider a model consisting of a manufacturer releasing a new product with uncertain release date and demand, and a retailer who must determine the allocation of limited capacity between a preexisting third-party product and the manufacturer’s new product that may or may not be released on time. The manufacturer has a private forecast about the likelihood of the product release and/or about the demand, which he shares (either truthfully or not) with the retailer. We show that under the “traditional” supply chain structure (one-time opportunity to order) no truthful equilibrium can emerge. However, if (1) the supply chain structure allows for postponement, i.e., the ability to delay orders at a certain cost by the retailer, and (2) the manufacturer has informational uncertainty about the retailer’s capacity, then truthful information exchange may emerge in equilibrium, where the manufacturer transmits his true forecast and the retailer treats the transmission as truthful. The genesis of this effect is preference reversal, where the manufacturer is not sure which way to distort the forecast to best motivate the retailer to wait for the new product. Thus, we show that a truth-revealing mechanism can emerge from a relatively rich setup featuring two-sided information asymmetry interacting with postponement. This paper was accepted by Gad Allon, operations management.