Is Bigger Better? Investing in Reputation

19 Pages Posted: 16 Dec 2002

See all articles by Arthur Fishman

Arthur Fishman

Bar-Ilan University - Department of Economics

Rafael Rob

University of Pennsylvania - Department of Economics

Date Written: March 15, 2002

Abstract

We develop a model in which the value of a firm's reputation for quality increases gradually over time. In our model, a firm's ability to deliver high quality at any given period depends on how much it invests in quality. This investment is the firm's private information. Also, a firm's current quality is unobservable. Thus the only observable is a firm's past performance - the realized quality of the products it delivered. We assume that information about a firm's past performance diffuses only gradually in the market. Thus, the longer a firm has been delivering high-quality products, the larger the number of potential customers which are aware of it. We show that in equilibrium, the firm's investment in quality increases over time, as its reputation - the number of consumers who are aware of its history - increases. This is because the greater its reputation, the more it has to lose from tarnishing it by under-investing and, conversely, the more it has to gain from maintaining it. This is recognized by rational consumers. Therefore, older - and hence larger firms - command higher prices as quality premia. This in turn feeds back into firms' investment incentives: The fact that they are able to command higher prices motivates older and larger firms to invest still more. So the older and larger a firm is, the more valuable an asset its reputation is.

Keywords: reputation, investment, quality, firm size, firm age

JEL Classification: D82, D83, L15

Suggested Citation

Fishman, Arthur and Rob, Rafael, Is Bigger Better? Investing in Reputation (March 15, 2002). Available at SSRN: https://ssrn.com/abstract=312145 or http://dx.doi.org/10.2139/ssrn.312145

Arthur Fishman (Contact Author)

Bar-Ilan University - Department of Economics ( email )

Ramat-Gan, 52900
Israel
972-3-531-8366 (Phone)
972 3 535 3180 (Fax)

Rafael Rob

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-6775 (Phone)
215-573-2057 (Fax)

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