Ratings, Reputation and Investment in Quality: The Importance of Getting a Second Chance

Abstract

We consider how facilitating consumer's ability to compare firms' past performace with that of their competitors affects firms' incentives to invest in quality of experience goods. We show that, counterintuitively, when consumers are better informed and investment in quality is noisy, firms may invest less in quality. The reason is that the easier it is for consumers to learn about more successful competitors, the less likely it is that a firm's reputation will be able to rebound from initial failure. This in turn reduces firms' incentive to invest in acquiring a good reputation.

Keywords: reputation, information, product quality, second chance

JEL Classification: L15, D82, D83