Dynamic Certification and Reputation for Quality

Abstract

We study a firm investing in quality and building its reputation for quality. Quality can be certified at a cost. We consider two types of equilibria: one in which certification decisions are made based on firm’s reputation and the second in which they are made based on the time since last certification. We show that reputation-based certification has a very limited effect on incentives to invest in quality, with investment only when the firm’s reputation is the lowest. We also show that the firm in this case suffers from an over-certification trap in which the benefits of reputation are dissipated by excessive certification. These problems can be avoided with time-based certification, which can allow first-best investment in quality despite the investment being unobservable. We also show that the optimal certification duration results in the firm certifying when its reputation is high. JEL Classification: C73, D82, D83, D84.

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Cite this paper

@inproceedings{Marinovic2015DynamicCA, title={Dynamic Certification and Reputation for Quality}, author={Ivan Marinovic and Andrzej Skrzypacz and Felipe Varas}, year={2015} }