A Learning Theory of Referrals

Abstract

Many service industries, including the medical and legal professions in some countries, display a gated structure. Rather than approaching a final producer directly, a consumer will first seek a referral from an intermediary. Such an industry structure might help to alleviate adverse selection problems between parties that interact infrequently. Intermediaries aggregate many short-run transactions between various consumers and a particular producer. As such, they might be able to learn a producer's level of proficiency more rapidly than an individual consumer. However, the presence of a positive information externality means that too few consumers will seek a referral. As such, some form of regulation to encourage consumers to seek a referral might be warranted.

Keywords: Adverse Selection, Gatekeepers, Indirect Reputation, Learning, Referral

JEL Classification: C72, C73, D49, D82, I11, L14, L80, L84