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Two firms produce a good with a horizontal and a vertical characteristic called quality. The difference in the unobservable quality levels determines how the firms share the market. We consider two scenarios: In the first one, firms disclose quality; in the second one, they send costly signals thereof. Under non-comparative advertising a firm advertises its own quality, under comparative advertising a firm advertises the quality differential. In either scenario, under comparative advertising the firms never advertise together which they may do under non-comparative advertising. Moreover, under comparative advertising firms do not advertise when the informational value to consumers is small.

Comparative advertising is any form of advertising that explicitly or by implication identifies a competitor or goods or services offered by a competitor. It was illegal in many European countries until the late 1990s. By contrast, in the US comparative advertising has been encouraged by the Federal Trade Commission since the 1970s.2 A 1997 EU directive changed the situation in Europe by legalizing comparative advertising subject to the restriction that it should not be misleading.3 European Competition Authorities now tend to agree with their American counterparts in that comparative advertising is an important tool in promoting competition. Comparative advertising increases consumers' information about alternative products. It allows consumers to evaluate the performance of particular products against other products, thus enabling more informed purchasing decisions. Despite its importance there has been little economic analysis on comparative advertising. We will review this literature at the end of the introduction. In this paper we address the following questions. Does comparative advertising indeed generate more information for consumers than non-comparative advertising? Do firms advertise more once comparative advertising is allowed? Can the two advertising regimes be compared using welfare criteria? To answer these questions we consider a product with a horizontal characteristic called design and a vertical characteristic called quality. Two firms produce different designs. Consumers do not observe quality before purchase. Prices cannot signal quality.4 The firms compete for customers by advertising their quality. We first analyze a pure disclosure framework. If a firm advertises, it discloses the truth; it cannot falsify as such.5 We compare two scenarios. In the first firms can only engage in non-comparative advertising, i.e., a firm may disclose its own quality but not the competitor's. In the second scenario, the firms can also engage in comparative advertising. In both scenarios advertising is costly and firms may, therefore, choose to remain silent.

The purpose of this paper is to analyze non-comparative and comparative advertising in a framework where firms disclose or signal their quality. To do so, we develop a model that allows for a meaningful analysis of non-price signaling shutting down the channel of price signaling. In the least-cost equilibria of the signaling game firms advertise in exactly the same states as they do in the unique equilibria of the disclosure game. In both frameworks comparative advertising tends to perform better than non-comparative advertising: firms do not advertise at all if the informational content is of little value to consumers; moreover, they never advertise together. By contrast, under non-comparative advertising a firm advertises if its quality level is above a threshold. When both firms have high quality, both advertise and there is a duplication of advertising costs. We have considered a model where the market is covered so that only the quality differential matters, which obviously makes a strong case for comparative advertising. If, for example, prices are so high that neither loyal nor quality-conscious customers with θ close to zero buy, marginal consumers do not care about the quality differential; they care only about the quality of their favorite designs. In this case firms will only use non-comparative advertising and allowing for comparative advertising will have no effect. Nevertheless, in markets where consumers directly compare products there is scope for comparative advertising to improve the allocation through better information and lower advertising expenditures. Our result that only one firm uses comparative advertising is obviously driven by our one-dimensional quality assumption. As noted in the introduction, the result is at odds with the empirical findings of Anderson et al., 2010a and Anderson et al., 2010b where all firms used comparative advertising. Arguably, in the analgesics industry there are multiple quality features and firms claim superiority in the dimensions where they perform better. Analyzing comparative advertising with multiple quality features is an interesting topic for future research.