When it comes to the world of business, problems such as deceit, bribery, and fraud are abundant. Although the catastrophic nature of these are well documented, these risky behaviors are still being undertaken today. One of the more prominent problems today is the misuse of information in a transaction. In order to avoid being on the losing end of a deal, all parties involved have to perform their due diligence.
The “Lemon” Problem
One of the primary reasons that due diligence should be practiced is due to what is known as the “lemon” problem. This phenomenon is derived from one party withholding information. The Lemon Problem is commonplace within the used car market. This presents a common scenario where the seller of the car has a much better understanding of the car’s true value in comparison to prospective buyers. A consumer may believe that they are purchasing a prime car, known as a “peach,” but ultimately end up with a sub-par “lemon” instead. Existing in the marketplace for both consumer products and in the area of investing, this sour ending can compromise the market and lead to a variety of unsatisfactory deals and investments.
When signing a contract, it is important to have a full understanding of the situation. Asymmetric information is present whenever one party possesses greater material knowledge in a transaction and fails to disclose it to others. This unfair advantage can jeopardize future communication and reputations. Another term for asymmetric information is known as adverse selection. Adverse selection results in prices for goods and other investments that do not reflect their honest value. An average price will be computed to protect against risk of purchasing a faulty product. As a result of this, lemons are over-valued while premium products are under-valued in comparison. Performing due diligence or working with partners that embrace business integrity would eliminate this problem. Holding your business to a high degree of integrity will also result in an increased market share as consumers view the brand as more reliable.
The Solution to Adverse selection
In order to avoid the frustration of purchasing an overvalued asset, due diligence is required. Due diligence may be a legal obligation, but it more commonly applies to voluntary investigations. The presence of a warranty would prove to be the easiest safeguard against any unfavorable actions. In the absence of a warranty, either personal research can be done or an outside party may be hired. A financial intermediary acts as a middleman between two parties in a transaction and can offer a number of benefits to consumers such as safety and liquidity. This stands as the most convenient solution to overcoming the lemon problem and ensuring a satisfactory purchase especially when dealing with debt securities or equity investments.
The Benefits of having integrity
Holding your business practice to a certain level of integrity will boost your company’s health in the long run. Although short term gains through unethical acts may be tempting, the overall well-being of a company could suffer serious long-term setbacks. Having a sense of integrity is a positive contributor to a company’s culture. This will result in higher employee satisfaction and retention rates. Customers will also become more trusting and willing to endorse the brand knowing that they can count on the same quality of service at every transaction. This can lead to increased brand exposure through referrals, which also leads to cheaper customer acquisition costs as people will actively seek your product/service. Distributors and producers tend to conduct business with firms that embrace integrity due to their confidence that the relationship is healthy. Remaining outside of the scrutiny of the public eye can go a long way in helping your brand’s image, and can be the difference maker in determining if you will capitalize upon the next available opportunity.