Journal of Real Estate Finance and Economics, 28:2/3, 255±271, 2004
# 2004 Kluwer Academic Publishers. Manufactured in The Netherlands.
Productive Signaling Equilibria and
Over-Maintenance: An Application to Real
The Arison School of Business, The Interdisciplinary Center Herzliya, P.O. Box 167, Herzliya 46150, Israel
When there is asymmetric information regarding the quality of a traded durable asset, the informed seller might
signal asset quality to prospective uninformed buyers by investing in improvements and maintenance. In contrast
to Spence (1973), however, this signal may be productive. We derive conditions of signal productivity under
which signaling separating, signaling pooling, and no-signaling pooling equilibria persist. We examine welfare
implications of the model and identify the over-investment in maintenance effect that persists in ef®cient markets
with asymmetric information and productive signaling. Furthermore, we conduct comparative statics analysis of
the results and showthe range of parameter values in which a particular equilibrium is attained. While the model
and its outcomes apply to various durable assets, we particularly refer in the analysis to real estate markets.
The phenomenon according to which prospective sellers of durable assets invest in asset
improvement before a planned transaction is well-known, although apparently not
suf®ciently examined in the empirical literature. For example, in the secondary market for
real estate, it is common that shortly before listing a real estate asset for sale, the owner
invests in asset improvements such as repairing old equipment, ®xing accumulated
malfunctions in the plumbing system, renovating interior and exterior wall condition, and
gardening. A similar phenomenon is often observed in other secondary markets for
durable goods such as the secondary market for automobiles.
In this study, we show that when there is asymmetric information regarding the quality
of a durable asset, investing in pre-transaction asset improvement and maintenance serves
as a signaling mechanism for better quality. We choose the real estate market as a
characteristic framework in which we construct a signaling model along the lines of
Spence (1973) and showthat because, at the time of transaction, asset quality is not
perfectly observable to the demanding party (buyer or renter), owners signal quality by
investing in veri®able improvements. Furthermore, if the marginal improvement cost is
inversely related to asset quality, then the necessary single crossing property condition is
satis®ed and a separating equilibrium may be attained.
In contrast to Spence (1973), the signal (that is, improving the asset) in our model may
We then showconditions under which signaling separating, signaling