Promoting a Reputation for Quality

Daniel N. Hauser (University of Pennsylvania)

Abstract: A firm builds its reputation not only by investing in the quality of its products, but also by controlling the information consumers observe. I consider a model in which a firm invests in both product quality and a costly signaling technology in order to build its reputation, defined as the market's belief that its quality is high. The signaling technology influences the rate at which consumers’ receive information about quality: the firm can either promote, which increases the arrival rate of signals when quality is high, or censor, which decreases the arrival rate of signals when quality is low. I study how the firm's incentives to build quality and to signal depend on its reputation and current quality. Whether the firm promotes or censors plays a key role in the structure of equilibria. Promotion and investment in quality are complements: the firm has a stronger incentive to build quality when the promotion level is high. Costly promotion can, however, reduce the firm's incentive to build quality as higher quality will lead to higher promotion expenses; this effect persists even as the cost of building quality approaches zero. Censorship and investment in quality are substitutes. The ability to censor can destroy a firm's incentives to invest in quality, because instead of building quality a firm may simply opt to reduce information about low quality products.

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