Informational asymmetry in the art market: lemons and pineapples

In 2015, Brazilian businessman Abílio Diniz and his wife Geyze promoted a dinner for over 50 people at their home in São Paulo, Brazil. During the event, guests were able to admire the works of art belonging to the couple’s collection, which decorated their residence.

However, days after the event, Heitor Martins, then director-president of MASP (São Paulo Museum of Art), called Abílio on the phone and questioned the authorship of two of Volpi's paintings: “Bandeirinhas” and “Bandirinhas com Mastro”. The fake canvases were, according to Martins, “contaminating” the couple's art collection.

The painter of the works, Alfredo Volpi, now deceased, immigrated from Italy to Brazil at the age of two and gained late recognition in the art world, close to his 60s. His most characteristic works are modernist and feature colorful flags and/or houses.

According to the website “MutualArt”, works by Alfredo Volpi have already been offered at international auctions at prices between 1,200 and 842,500 dollars, depending on the technique and size.

The cataloging and verification of Volpi's works has been, since 2012, a responsibility of the Volpi Institute. It is the Institute that defines whether a work by Volpi is true or false. But until 2012 this role belonged to Volpi's daughter, Eugenia Volpi Pinto. In 2007, at the time of the purchase of the paintings in question, Abílio would have received from the gallery owner the necessary certificates of authenticity and photos of Eugenia with the paintings.

A legal battle is raging over such works. On the one hand, Abílio and Geyze Diniz sued Galeria Pintura Brasileira, in São Paulo, where they bought the two paintings. On the other side is dealer Marcelo Barbosa, owner of the gallery. The subject has generated such interest that it was featured on TV Globo's “Fantástico” tv show on August 26th, 2020.

A successful businessman and former student at FGV, Abílio is 84 years old and has a fortune estimated at 2.3 billion dollars, according to the 2020 ranking of Forbes Magazine.

In 2019, at a conciliation hearing, Abílio's lawyer refused Marcelo's proposal to return his commission on the deal. Later, court-appointed expert João Carlos Lourenço attested to the works as forgeries. The Diniz couple demands compensation for moral damages of approximately 200 thousand reais.

It is important to note that this can happen anywhere in the world. In 2019 it was reported that Prince Charles, heir to the English throne, had unknowingly exhibited at his home in Dumfries (Scotland) fake works by Dali, Picasso, and Monet. The works would have been loaned by the bankrupt businessman James Stunt and the total value of the works, if they were real, would be 136 million dollars.

These two facts, one in Brazil, the other in Scotland, demonstrate the harmful effects of inequality in the level of information, or informational asymmetry, between different market agents. In this respect, the art market seems to be like the markets described by George A. Akerlof, a professor at the University of California, in his article that earned him the 2001 Nobel Prize in Economic Sciences: “The Market for Lemons: Quality Uncertainty and the Market Mechanism” (1970).

In his 13-page article, Akerlof demonstrates how informational asymmetry affects the economy, relating quality and uncertainty. The premise of the free circulation of information among all market agents, so dear to classical economists, is not always true.

Akerlof explains the phenomenon using theoretical data, in which he compares symmetric and asymmetric information through the utility function. And he exemplifies what he calls “adverse selection” with data from four markets: used cars, health insurance, minority employment, and credit in underdeveloped markets.

In the auto market, Akerlof wanted to understand why the prices of used cars fresh out of the dealership drop so much compared to the price of a brand-new car. He started from the premise that buyers prefer to buy new cars over used cars because they are suspicious of those who sell used cars. They would think, "If he wants to sell, maybe the car isn't good." Akerlof called the poor quality used cars “lemons”. In a free version to Brazilian Portuguese, they would be called “abacaxis” (pineapples).

Ideally, there would be a market for “good” used cars (more expensive) and a market for “lemons” (cheaper). But this does not happen in real life. The price of a good used car and a “lemon” is the same, and only sellers know the quality of what they are selling. The seller who owns a good car does not want to sell his used car at the market price determined by the poor-quality car. Consequently, only “lemons” would be available for sale. For Akerloff, the effect of this phenomenon would be a reduction in the average quality of the cars offered and, possibly, in the size of the market.

To mitigate the effect of information asymmetry, which prevents the distinction between a good product and a bad product, Akerlof proposed actions such as: offering a guarantee (to assure the buyer of the expected quality); the use of a differentiating brand by the seller (the consumer has whom to complain to); and franchising or brand licensing (which certifies and gives responsibility for quality).

Another 2001 Nobel Prize-winning economist Michael Spence also wrote about information asymmetry in his 1973 article, "Job Market Signaling." Signals would transport information from those who have it, the informed, to the less informed agents of the market. In his study Spence highlights the job market. He devises a model that considers hiring employees as an investment, by the contractor, made under the shadow of uncertainty. Candidates would signal their abilities and/or productive capacity by acquiring a certain level of education, which would imply psychological, physical, and monetary costs. Finally, the contractor's perception would determine the salary offered.

For the art market, among the agents who are indicators of the quality of a work, we highlight dealers, galleries, and auction houses. In the article published by the Warwick Economic Society “Asymmetric information in the art market” (2019), it is observed that privileged information (on price, availability, or demand for works of art) gives prestige and reliability to art galleries, dealers, and auction houses. Galleries and auction houses have reputations to uphold and tend to offer all the necessary checks for the authenticity of a work. Lack of transparency could lead to artificially high prices and artificial market growth. It could even generate “lemons” such as a fake picture. This “lemon” fake painting would be worse than a “lemon” car. After all, the “lemon” car can be taken to a repair shop, be fixed and still be useful. The “lemon” painting, on the other hand, has utility and value tending to zero.

The Warwick Economic Society article states that the expansion of the online art market makes verification more difficult, especially in transactions with strangers. But not only works of art can be faked. History, awards, exhibitions, and the elements that make up the name, or brand, of an artist can also be false.

In the same article, the way out is indicated: the “blockchain” technology, known for its use in the cryptocurrency market. This innovation operates as an electronic book that stores records of past and present transactions, increasing transparency in the art market. It could even help to expand the market, as the inexperienced buyer would be able to verify by which hands, and at what price, the work would have gone through before.

With the use of “blockchain” technology, there would be less chance of buying “lemons” or “pineapples” artworks. Good news for both Abílio and Geyze Diniz, as well as for everyone interested in art world.