Asymmetric Information and Overinvestment in Quality

According to standard economic wisdom, asymmetric information about product quality leads to a quality deterioration in the market. Suppose that a higher investment level makes the realization of high quality more likely. Then, if consumers observe the investment (but not the realization of product quality) before purchase, they can infer the probability distribution of high and low quality that may be put on the market. This, as we show, may make the firm overinvest in quality compared to a market with full information.