Jim Turnure Principal, Energy Group

Option Value and Principal-Agent Models (II)

• The ‘market for lemons’ is first identified by Akerlof (1970) as an effect of incomplete information in the marketplace. The information contained in market prices is often an average that does not accurately reflect product quality. As a result, there is an incentive for producers to offer products of lower quality and withhold products of higher quality. The impact of this type of imperfect information is to restrict the availability of consumer products based on an insufficiently detailed pricing system.
• Principal-agent information asymmetry was first studied by Aumann and Maschler for the US Arms Control and Disarmament Agency in the mid-1960s. Extensions of this approach include Maskin and Tirole (1990), who examined the problem of imperfect information and conclude that inefficiency will generically result when agents do not have the full set of information available. The lack of complete information is equivalent to a form of irrationality on the part of agents which restricts their ability to arrive at the efficient (Pareto-optimal) arrangement.

Option Value and Principal-Agent Models (III)

• Establishing an analytic framework using this approach will generally lead to a focus on the role of information, especially market pricing and consumer’s ability to evaluate relevant product features.
• Quantitative estimation of information asymmetry usually occurs on an industry or product-specific level, leading to indicators of the rate of diffusion of new technologies on a similar basis. This is an intermediate level of aggregation (relative to more disaggregate firm-level or transaction-specific indicators).
• Specific models estimate the benefits of more rapid technology diffusion in different ways. In general these models require assumptions about the value of product quality to consumers.
• R&D benefit estimates using these concepts will be program-specific, with an emphasis on product quality and the deployment of technology. These are not always the focus of particular R&D programs, so these are not always the most useful measures. In addition these models can be so specific to a single product market that they raise compatibility issues vis-à-vis other benefit estimates.