Advertising through Influencers and Disclosure Regulation

Advertising through Influencers and Disclosure Regulation

• Aastha Gupta, Western Illinois University

Abstract:

Firms increasingly promote their products through social influencers. Followers who rely on product reviews by influencers do not directly observe the relationship between the influencers and the firms. As firms have an incentive to influence the reviewers through unobserved payments, it can be difficult to sustain market outcomes with informative independent reviews. Recent FTC regulations require mandatory disclosure of all paid advertising content so that buyers can differentiate between paid and independent product reviews. This paper investigates the impact of this disclosure policy on market outcomes when the influencer has the expertise to evaluate product quality and influence the beliefs of both potential buyers as well as the firm. The disclosure requirement is ineffective if the influencer has a high level of expertise, cares a lot about the economic value generated for followers, or has a high probability of being honest. In markets where the influencers do not care much about their followers or lack sufficient expertise and in markets with high uncertainty about product quality, the disclosure regulation changes the outcome from hidden paid advertising to unbiased independent reviews; this improves not only the consumer and social welfare but also the expected profit of the firm. Further, when the firm has private information about the distribution of its product quality, the disclosure policy facilitates signaling of this private information; paid (independent) review is posted when quality is more likely to be low (high).

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