Contracting with Word-of-Mouth Management

Yuichiro Kamada () and Aniko Öry
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Yuichiro Kamada: Haas School of Business, University of California Berkeley

No 2048R, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

Abstract: We incorporate word of mouth (WoM) in a classic Maskin-Riley contracting problem, allowing for referral rewards to senders of WoM. Current customers� incentives to engage in WoM can affect the contracting problem of a firm in the presence of positive externalities of users. We fully characterize the optimal contract scheme and provide comparative statics. In particular, we show that offering a free contract is optimal only if the fraction of premium users in the population is small. The reason is that by offering a free product, the firm can incentivize senders to talk by increasing expected externalities that they receive and this is effective only if there are many free users. This result is consistent with the observation that companies that successfully offer freemium contracts oftentimes have a high percentage of free users.

Keywords: Word-of-mouth; referral rewards; freemium; contract theory (search for similar items in EconPapers)
JEL-codes: D82 L21 M3 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2016-07, Revised 2017-09
New Economics Papers: this item is included in nep-cta, nep-hrm and nep-mic
Note: Includes Supplemental Material
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Related works:
Working Paper: Contracting with Word-of-Mouth Management (2018)
Working Paper: Contracting with Word-of-Mouth Management (2016)
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