The Value of a Reputation System

John Kennes and Aaron Schiff ()

Industrial Organization from University Library of Munich, Germany

Abstract: This paper explores the trade-off between the short-term benefits of false quality advertisements against the longer term costs of reputation damage. A directed search model is constructed in which submarkets are created by the advertisements and reputations of sellers. A reputation system links misleading advertisements in the present period to a lower reputation in the next period. We show that a reputation system always increases the prices of high quality products and directs search more accurately towards the sellers with such products. We also show that buyers are hurt by a reputation system if the market is thin -- has few sellers -- because the equilibrium increase in prices is greater than the equilibrium increase in the quality of trade. Finally, we show that a reputation system which screens for honesty increases social welfare by making sellers more truthful. However, we also show that a reputation for honesty is not always highly valued and that an alternative reputation system which screens for type can be more effective.

Keywords: reputation systems; directed search (search for similar items in EconPapers)
JEL-codes: D44 D83 M37 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2003-01-23
New Economics Papers: this item is included in nep-mic
Note: Type of Document - PDF; prepared on IBM PC - PC-TEX; to print on Any; pages: 31 ; figures: included
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:wpa:wuwpio:0301011

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