An Empirical Examination of Quality Certification in a “Lemons Market”

Abstract

This article examines the effect third‐party certification has on a market characterized by adverse selection. Using an original data set from the market for young thoroughbreds, we show that certification alleviates problems of adverse selection by examining the effect certification has on breeder decisions to retain or sell horses and the effect these decisions have on observed prices. Data on the racetrack performance of the horses confirm the results.

Market Structure, Reputation, and the Value of Quality Certification

“…In a similar spirit to Jin and Leslie (2003), Wimmer and Chezum (2003) find that certified racehorses sell for higher prices and go on to have better racing careers than uncertified horses. Improved sorting can allow the benefits of quality certification to extend to low-quality products, as Tadelis and Zettelmeyer (2011) describe in a field experiment looking at a used car auction market.…”

The Price of Disclosure in the Thoroughbred Yearling Market

“…Chezum and Wimmer (1997) illustrate that variation in seller characteristics as they relate to racing intensity influences price. More closely related to our study, however, is Wimmer and Chezum (2003). In this article, the authors investigate the role of quality certification in mitigating the type of adverse selection identified in Chezum and Wimmer (1997).…”

“…Yearlings included in Books 1 and 2 meet Keeneland's criteria to be considered among the select individuals based on grading of pedigree and conformation. Wimmer and Chezum (2003) suggest that this inspection process serves as part of a certification mechanism in which yearlings in Books 1 and 2 are implicitly certified as meeting Keeneland's quality standards for inclusion in the select part of the sale. 6 Books 1 and 2 notwithstanding, the average quality of yearlings declines throughout the remainder of the books.…”

Do Better Informed Investors Always Do Better? A Buyback Puzzle

“…Auction participants seem to agree: using a small private database on thoroughbred yearlings, Eberhart () reports evidence consistent with Kirkpatrick's claim. In addition, Wimmer and Chezum () find that yearling certification (an auction house quality guarantee that essentially communicates the private information of breeders) eliminates the adverse selection discount of Chezum and Wimmer, suggesting that auction participants believe that breeders possess an information advantage.…”