Face Value: Information and Signaling in an Illegal Market

[Author Affiliation]Trevon D Logan, * The Ohio State University and NBER, 410 Arps Hall, 1945 North High Street, Columbus, OH 43210, USA; E-mail: logan.155@osu.edu ; corresponding author.Manisha Shah, [dagger] University of California, Los Angeles and NBER, 3250 Public Affairs Building, Los Angeles, CA 91195; E-mail: manishashah@ucla.edu . [Acknowledgment]We would like to thank George Akerlof, Rodney J. Andrews, Raj Arunachalam, Andrea A. Cann, Lisa D. Cook, Brahima Coulibaly, Scott Cunningham, Angus Deaton, Avinash Dixit, Claudia D. Goldin, Karla Hoff, Joseph Kaboski, Simon Loertscher, Joseph M. Newhard, Christina Paxson, John Pepper, Ruth Peterson, Patricia Reagan, Seth Sanders, Ebonya Washington, Nathan Woodfork, three anonymous referees, and numerous seminar participants who provided helpful suggestions. The usual disclaimer applies.1. IntroductionFormal enforcement is often seen as the cornerstone of contract design. While information can overcome the problems of asymmetric information (Akerlof 1970; Spence 1973), principals are unlikely to engage agents unless the information conveyed is credible and verifiable. While the use of formal institutions such as courts is rare relative to the volume of transactions, the standard argument is that the presence of formal institutions gives contracts their authority. In Schelling's (1960) classic terminology, the power to sue and be sued gives parties the ability to make credible, enforceable commitments, a prerequisite to most transactions. Without means of redress, the information that principals and agents share would, a priori, have little value.Numerous studies have documented how informal networks, long-term relationships, and reputations overcome problems of asymmetric information. Indeed, researchers have developed large literatures that look at limited contractibility (Hart 1995; Tirole 1999) and situations in which formal enforcement is costly (Greif 1993) to consider the additional mechanisms that must be in place if existing institutions are lacking or unable to mediate disputes. However, the literature has not developed an empirical answer to whether the value of information without formal enforcement approaches its value when formal enforcement is present.In this article we ask two questions: (i) Are formal enforcement mechanisms necessary for the information that principals and agents share to have value? (ii) If not, then what is the value of information in an environment without formal enforcement? Ideally, we would like to analyze an illegal market to answer these questions. Illegal markets rule out the possibility that market function or variation in the information environment is due to the presence of formal enforcement. Similarly, in an illegal market the information that principals and agents convey to one another may not be credible or verifiable, and misrepresentation is not likely to be punished. The problem is that most illegal markets have coarse information environments. It is therefore challenging to obtain information on prices, quantities, and consumer and producer behavior, making empirical answers to these questions especially difficult. We overcome these problems by analyzing an illegal market with a rich information structure: the online market for male sex work.We begin with a general description of this seldom-studied market. We then document the ways in which the clients of male sex workers informally police the market: by informing other clients of deceptive sex workers and by reviewing sex workers on independent, client-owned Web sites. The informal policing in the market raises the cost of misrepresentation for would-be fraudulent escorts and rewards the truthful self-disclosure of honest escorts, encouraging truthful self-disclosure. We further exploit this institutional knowledge to identify the specific information clients treat as signals of escort quality. …