Do Sellers Offer Menus of Contracts to Separate Buyer Types? An Experimental Test of Adverse Selection Theory

In the basic adverse selection model, a seller makes a contract offer to a privately informed buyer. A fundamental hypothesis of incentive theory is that the seller may want to offer a menu of contracts to separate the buyer types. In the good state of nature, total surplus is not different from the symmetric information benchmark, while in the bad state, private information may be welfare-reducing. We have conducted a laboratory experiment with 954 participants to test these hypotheses. While the results largely corroborate the theoretical predictions, we also find that private information may be welfare-enhancing in the good state.