Reputation for Quality

Résumé

We propose a new model of firm reputation that interprets reputation directly as the market belief about product quality. Quality is persistent and is determined endogenously by the firm's past investments. We analyse how investment incentives depend on the firm's reputation and derive implications for reputational dynamics. We consider three types of consumer learning. When consumers learn about quality through good news, investment incentives are decreasing in reputation, leading to a unique work-shirk equilibrium and convergent dynamics. When consumers learn through bad news, investment incentives are increasing in reputation, leading to a continuum of shirk-work equilibria and divergent dynamics. Finally, when consumers learn through Brownian news and the cost of investment is low, incentives are hump-shaped but a work-shirk equilibrium exists and is essentially unique.

Codes JEL