Reputational Economies of Scale
29 Pages Posted: 13 Apr 2018
Date Written: April 3, 2018
For many years, most scholars have assumed that the strength of reputational incentives is positively correlated with the frequency of repeat play. Firms that sell more products or services were thought more likely to be trustworthy than those that sell less because they have more to lose if consumers decide they have behaved badly. That assumption has been called into question by recent work that shows that, under the standard infinitely repeated game model of reputation, reputational economies of scale will occur only under special conditions, such as monopoly, because larger firms not only have more to lose from behaving badly, but also more to gain. This article argues that reputational economies of scale exist even when there is competition and without other special conditions, if the probability of detection is positively correlated with the frequency of repeat play. It also shows that reputational economies of scale exist in a finite horizon model of reputation. Reputational economies of scale help explain why law and accounting firms can act as gatekeepers, why mass market products are more likely to be safe, why firms are less likely to exploit one-sided contracts than consumers, and why manufacturers market new products under the umbrella of established trademark.
Keywords: reputation, repeat-play, economies of scale, gatekeeper, product liability, umbrella trademark
JEL Classification: K12, K13, K22, K32, D86, O34
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