Sales Talk, Cancellation Terms, and the Role of Consumer Protection

This paper analyses contract cancellation and product return policies in markets in which sellers advise customers about the suitability of their offering. When customers are fully rational, it is optimal for sellers to offer the right to cancel or return on favorable terms. A generous return policy makes the seller's 'cheap talk' at the point of sale credible. This observation provides a possible explanation for the excess refund puzzle and also has implications for the management of customer reviews. When customers are credulous, instead, sellers have an incentive to set unfavorable terms to exploit the inflated beliefs they induce in their customers. The imposition of a minimum statutory standard improves welfare and consumer surplus when customers are credulous. In contrast, competition policy reduces contractual inefficiencies with rational customers, but it is not effective with credulous customers.