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If you are reading this because you are curious (about the title) – you have been deceived.

This article is exactly on this subject “deception”.

Deception and Information Asymmetry

Think back.  Have you any recent recollection of making a wrong decision?  For example:
1. Invested in a fund you shouldn’t.
2. Read an article in the newspaper you shouldn’t (I’m not referring to this article)
3. Undertook a job that you think you shouldn’t have.
4. Employed someone you now regret.
5. Married the wrong guy/gal.
6. Invested money in someone or some company whom you think would pay you the promised returns but you now think the person or management won’t.
7. Bought a book that claimed to help you make money…
8. Attended a seminar that claimed to make you rich beyond your wildest dreams…

You get the idea.

Why do you feel bad about these “adverse selection” (making the wrong decision)?  Was losing the money (time and effort) the only reason for feeling bad?  My thought is “maybe not”.  The discomfort of adverse selection lies in the fact that despite doing your homework diligently, you are still a victim of deceit. 

Deception is not simply just information asymmetry but, in my opinion, a form of higher order information asymmetry.  While asymmetric information is a situation where buyers and sellers are not equally well informed about the characteristics of goods and services for sale in the marketplace, deception is when information conveyed is manipulated to encourage a favorable outcome or decision to the party conveying the information.

Can we avoid being conned?

In my previous article “Highly Valued Companies are Good Flirts”, I introduced the two basic principles that determine if a signal is credible – “Costly to fake” and “Full disclosure”. 

In summary, an individual or company, who could provide high quality service or product, will undertake certain costs in order to show (or signal) their quality.  These costs include marketing (money spent on office space can also be considered), research and development, and warranties and recalls.  Such costs create good signals because they are too hefty for “imitators” to undertake in the long run.

If a signal can convey information about the quality of a company or individual (because it is costly to fake), then all individual will be forced to send that signal and disclose their true quality.  Why would those who cannot provide high quality goods and services send such a signal?  Why couldn’t they just stay silent?  By not disclosing their true quality, potential traders or partners will assume that the quality of such a company or individual must be lower than the average.

Using these two principles as determinants for the strength of the signal, we can therefore establish the approximate quality of the other party we are dealing with and avoid the frustration of adverse selection.

Faking the Costly to Fake.

Though the costly to fake principle is a good determinant of the quality of the other party, many of us still do fall prey to deception even after relying on signals.

In general, information contained in a signal is strong when the signal behind the costly to fake principle is based on some fact.  For example, male toads croak at night to attract the attention of the female toad.  Since female toads are unable to see in the night, they are unable to ascertain the size of the male toad.  Croaking therefore sends a strong signal in regards to the size of the toad – the bigger the toad, the lower tone.

Unfortunately, there is a weakness in this principle when applied to humans. Things are not as clear cut as facts. Sometimes these facts are more of supporting signals rather than actual facts. We thus look for these supporting signals, and not facts, to ascertain if a signal is costly to fake.  Therefore, even if the ultimate signal is costly to fake, this supporting signal may not be that costly to fake.

Employing fresh grads is a good example.  Job applicants are required to send in their cover letter, resume, and academic certificates to allow the HR department to prepare a shortlist of applicants.  A well-written cover letter and resume are signals that the applicant is of good quality since time and effort have to be spent to prepare them.

But good cover letters and resumes are more often supporting signals that can be faked.  The candidate could have spent hours or days working on a simple resume or cover letter.  He could have also asked another person to help him prepare those documents.

What about good academic grades?  A good student has thirst for knowledge and not anxiety to graduate.  He takes academic grades as a benchmark to his understanding of that knowledge and not a signal of his ability.  Diligence, wits, and ability are the qualities that HR looks for when analyzing the academic achievements of an applicant but grades can also be faked simply by being extremely diligent only near exam periods or being exam smart.

There are 3 other possible situations that will allow someone to fake the supporting signal:

1. Short run effect – good signals may be costly to fake over the long run but not necessary true in the short run.  A smart toad may therefore strain itself to fake a low tone croak.

2. Cost Transfer – if the cost of faking can be transferred to another party, there is no reason why a costly to fake signal cannot be undertaken over the long run.  Government grants and naïve investors are possible targets for such cost transfers.  Unlike the short run effect, cost transfer may allow faking over a longer period of time.

3. Cyclical effect – Faking may not necessary be done consistently over time but employed cyclically.  When market demand is strong, suppliers can make a quick buck by faking the quality of their goods and services and then go into “hibernation” until the next wave arises. 

It is in these situations where we continue to be deceived even when we have spent effort to avoid adverse selection.

The Global Positioning Method

The Global Positioning System (GPS) works on the principle of trilateration.  To pinpoint your position on the globe, the GPS takes the measurements of the distance between your position and three other satellites.  Though using 3 satellites is sufficient to calculate your position, the use of more satellites actually increases the accuracy. (To find out more about trilateration, please visit http://electronics.howstuffworks.com/gps.htm).

Likewise, to estimate the quality of a signal, we can use the same trilateral method. This is especially useful when the signal is based on a supporting signal.

Most of us would try to detect multiple signals in order boost the level of confidence of the estimated quality of a person or firm.  Though the use of multiple signals is good, the fact that some signals can be faked would create conflict or confusion during analysis. Thus we all need our 3 independent satellites to sense the signal or supporting signal. And as with the GPS system, the more satellites used, the higher the level of accuracy.

So as in the case of the job interview mentioned above, applicants are made to attend multiple interview sessions with various interviewers. This will increase the level of confidence in the employment process. The idea is to observe the applicants at different intervals and detect inconsistencies.  Periodic observations can be faked.  An applicant’s dressing, attitude, speech, and presentation can be easily faked during short periodic interview sessions. But the more the interviews, the higher the level of accuracy.

Therefore, on top of just relying on the two fundamental signaling principles explained at the beginning of the article, we may also want to be aware of the 3 mentioned possibilities of how a signal or supporting signal can be faked.  This will help strengthen the reliability of some signals and ouster the use of others (even though these signals are usually good guides).

Conclusion

Relying on the “Costly to Fake” and “Full Disclosure” principles of signals is really not enough to “know” a person since the former can be faked.  Knowing when a good signal can be faked is also just as important. 

So don’t be deceived by eye-catching titles or headlines when deciding whether to read an article.  Know that at OTR, we prefer to spend more time writing our articles then designing our headlines.

Any opinions or comments ?