Honest versus Misleading Certification

Published date01 June 2017
Date01 June 2017
AuthorPhilippe Mahenc
DOIhttp://doi.org/10.1111/jems.12195
Honest versus Misleading Certification
PHILIPPE MAHENC
University Montpellier I (LAMETA)
Avenue Raymond Dugrand
Site de Richter, C. S. 79606, 34960 Montpellier Cedex 2, France
philippe.mahenc@univ-montp1.fr
This paper questions the honesty of third-party certification in the market for a good whose
environmental quality is not observable by consumers. The certifier maximizes a weighted sum of
its own revenue and social welfare. The higher the relative weight placed on revenue, the stronger
the certifier’s incentive to mislead consumers. Certification is analyzed as a costly signaling
mechanism that, besides displaying labels, transmits information through market prices. Honest
certification requires that prices credibly signal environmentalquality to prevent cheating. I show
that certification can only be honest when the certifier is driven more by social welfare than by
profit. In the reverse case, the certifier cannot help jamming the price signal, thereby granting
unreliable labels.
1. Introduction
Like any good with quality characteristics that are hardfor consumers to observe, organic
food needs third-party certification to be efficiently traded. But also, and above all, this
certification must be honest. Recently in the press, industry lobbying has been accused of
capturing the organic certification process and distracting the certifier from the objective
of disclosing accurate information.1If the certifier really gives in to corporate pressure,
this may have two consequences: first, the certifier tends to neglect consumer well-being
and focus instead on the desire of the industry to grow, and second, the certifier may
falsely claim that the food is organic to let more products in.
Beyond organic food, misleading certification is an issue that more broadly affects
all the goods with a credence attribute, whether environmental or ethical. For instance,
Hamilton and Zilberman (2006) point out the recent emergence of fraudulent labeling in
markets for environmentally friendly products. Furthermore, misleading practices are
This research received funding from the French Agence Nationale de la Recherche within the framework of
the project “GREENGO – New Toolsfor Environmental Governance: the role of NGOs – ANR-15-CE05-0008.”
I am grateful to a co-editor and two anonymous referees for their insightful comments and suggestions that
have led to significant improvements in the content and exposition of the paper.
1. This corporate pressure is acknowledged in recent newspaper articles. One can read for instance that
“major food companies . .. had added to pressure on the (US) government to expand the definition of what
is organic, in part because processed foods offered by big industry often require ingredients, additives or
processing agents that either do not exist in organic form or are not available in large enough quantities for
mass production.” (Kimberly Kindy and LyndseyLayton, “Purity of Federal “Organic”Label Is Questioned,”
Washington Post, July 3, 2009). Or else, “over the last decade, since federal organic standards have come to
the fore, giant agri-food corporations . . . —Coca-Cola, Cargill, ConAgra, General Mills, Kraft and M&M Mars
among them—have gobbled up most of the nation’s organic food industry.Between the time the Agriculture
Department came up with its proposed regulations for the organic industry in 1997 and the time those rules
became law in 2002, myriad small, independent organic companies—businesses like Cascadian Farm—were
snapped up by corporate titans .. . Major corporations have come to dominate the board that sets the standards
for organic foods . . . Corporate interests are behind the increase in nonorganic materials deemed acceptable
in “organic” food.” (Stephanie Strom, “Has “Organic” Been Oversized?” New York Times, July 7, 2012).
C2017 Wiley Periodicals, Inc.
Journal of Economics & Management Strategy, Volume26, Number 2, Summer 2017, 454–483
Honest versus Misleading Certification 455
not just driven by industry pressure: Feddersen and Gilligan (2001) show that a certi-
fier biased toward environmental protection may also have incentives that depart from
honesty. Nonetheless, certification bodies are usually under the oversight of a board
that consists of representatives from different sectors with a significant divergence of
interests, including the government, the industry, and environmental nongovernmental
organizations. A balanced composition of the oversight board might be expected to pro-
vide consumers with sufficient protection against misleading information. Throughout
the world, certification systems based on environmental standards range from those
involving multi-stakeholder groups that include the industry and nongovernmental or-
ganizations, such as the Marine Stewardship Council (MSC) or the Forest Stewardship
Council, to those reflecting strong governmental interests, such as the German Blue
Angel program.
In this paper, I examine whether honest third-party certification hinges on the mix
between two objectives: on the one hand, the profit-maximization objective that repre-
sents the interest of a monopolistic for-profit certifier,and on the other hand, the welfare-
maximization objective that represents a more general interest. Third-party certification
is analyzed as a costly signaling mechanism that, besides displaying “informative” la-
bels, transmits information on a credence attribute of the good (namely, environmental
quality) through market prices. As defined here, honest certification requires that price
signaling be credible in the sense that jamming the price signal sent by the market is too
costly for the certifier. The main insight of the analysis is that third-party certification
can only be honest if the certifier is driven more by social welfare than by profit. If, on
the other hand, the certifier values its own interest more than social efficiency, then the
certifier grants misleading labels and prevents the market prices from disclosing truthful
information.
The context is the following. In a market where consumers do not know precisely
to what extent the good they purchase pollutes the environment, a third-party certifier
grants a label, either brown or green, which is meant to disclose information on the
environmental quality of the good. Firms are committed to investment in environmental
quality. They must pay a fee for certification and they can choose to have their product
certified or not. Consumers also seek to infer information from the price signal sent by
the market. Understanding that the green good is more costly to produce than its brown
variant, consumers expect the market price to reflect at least the cost discrepancy. Hence,
the certifier must take care that the market clearing price be consistent with the label
granted to the firm. Specifically, the goods labeled differently as brown or green should
not be sold at the same “pooling” price, for the sake of label reliability. The certifier
can influence the market signal via setting a fee and this influence is all the stronger as
the certifier values its own revenue more than social welfare. In this context, I develop
a signaling model and investigate the existence of separating equilibria which ensure
honest certification through different market prices for the brown and green goods.
As there exists no separating equilibrium when the certifier is purely self-interested, I
further characterize pooling equilibria in this limit case.
The model assumes that consumers are willing to pay more for the green than
for the brown good.2Market prices account for vertical differentiation between the two
2. The recent literature on environmental economics provides some evidence that environmentally con-
scious consumers pay a price premium for environmentally friendly products.A survey can be found on page
50 of the Steering Committee of the State-of-Knowledge Assessment of Standards and Certification (2012).
Overall, these studies indicate that demand and willingness to pay vary widely from one market to another:

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