Raphael Levy (University of Mannheim)

“Two-sided reputation in certification markets”

Abstract

We consider a market where a seller needs to resort to a certifier to overcome adverse selection. There is uncertainty about the certifier’s
preferences for disclosing negative information about the seller. The profit of a monopolistic certifier is an inverted U-shaped function of his reputation for transparency: being perceived as more transparent allows him to attract more good sellers but a high expected precision
may deter bad sellers. As a result, the certifier tries to reach a balanced reputation to attract both types. Hence, reputation has a disciplining effect when the certifier is perceived as rather opaque, but gives incentives for information retention when he is perceived as more transparent. When two certifiers coexist in the market, “multihoming” is an equilibrium, i.e., the seller solicits certification from both certifiers. Multihoming provides an additional source of information but makes high reputations even less desirable, which exacerbates certifiers’ incentives to conceal information. Therefore, total welfare may be higher in a monopoly than in a duopoly.