Incentives for Voluntary Practices, Fraud, and Certification

Abstract

We analyze the strategic decision of firms to voluntarily provide high quality on a credence attribute of a product in settings where there is scope for fraud that can be alleviated through third-party certification. Equilibrium outcomes crucially depend on endogenous consumers' beliefs about the credibility of firms’ uncertified claims. We find that fraud can only arise under intermediate production costs for high quality relative to fraud costs. Thus, fraud does not emerge with deterrent fraud costs, or when fraud is so cheap that consumers do not trust firms' claims at all. Moreover, increasing certification costs can broaden the range of parameter values for which firms commit fraud. In regards to the choice of voluntary practices, we show that decreases in the costs of high quality do not necessarily entail increased voluntary investments in high quality production or certification. These novel results are robust to different market structures, and question the general desirability of public subsidies for promoting voluntary practices.