Disclosure Rules in Contract Law

How does the prospect of sale affect the seller’s incentive to investigate—to acquire socially valuable information about the asset? How do the disclosure rules of contract law influence the investigation decision? Research has shown that if sellers and buyers are symmetrically informed at the preinvestigation stage, then a mandatory disclosure rule leads to a first-best outcome, and a voluntary disclosure rule leads to a suboptimal outcome. But in many real-world cases, owners of assets have better information about their assets even before they investigate.

In such asymmetric-information settings, we show that mandatory disclosure no longer attains a first-best outcome. And, under certain conditions, voluntary disclosure is the more efficient rule.