When Should You Believe Your Competitor’s Announcement

The question which we pose in this paper is under what conditions a firm should believe its competitors’ announcements. We have adopted a gaming framework (Shubik 1975) to capture the interaction between a sender who issues a price increase signal and who can choose between telling the truth and bluffing, and a receiver who has to decide whether or not to believe the sender. The manner in which firms interact concerning price increase announcements and the outcomes obtained depend on several factors: (1) the level of opportunism, (2) the receiving firms’ ability to interpret competitors’ announcements correctly, and (3) the decision criteria used by the receiving firms when interpreting competitors’ signals, which reflect whether they trust or suspect their competitors. We assessed these factors by conducting experiments with practicing managers in order to investigate the implications for players under various scenarios. Analyses were performed for four payoff-based scenarios (all combinations of opportunistic/nonopportunistic sender and receiver); for three groups of receiving managers (possessing below, above and random interpretation ability); under two decision criteria used by receiving managers when interpreting signals (representing trusting and suspicious managers). We examined different strategies available to both players, proposed by Brams (1985). We compared the expected payoffs both players would get when playing different pairs of strategies, and identified the resulting Pareto-inferior outcomes. Based on these analyses we provide some normative implications germane to price increase signaling interactions. In general, results show that in almost all cases the receiver should believe the sender’s signals. That is, regardless of the receiver’s interpretation ability or decision criteria, his strategy of always believing never leads to Pareto-inferior outcomes. In addition to that, regardless of the receiver’s interpretation ability or decision criteria, the sender always does best (gets the highest expected payoff) by ignoring the receiver’s interpretation ability and playing a mixed strategy. The receiver’s rational response to this strategy is always to believe. The receiver’s best outcome depends on the decision criteria used and his own interpretation ability. When Should You Believe Your Competitor’s Announcement?