Quality Choices and Reputation Systems in Online Markets - An Experimental Study

In internet transactions where customers and service providers often interact once and anonymously, a reputation system is particularly important to reduce information asymmetries about product quality. In this study we experimentally examine the impact of the customers' evaluation abilities on strategic quality choices of a service provider. Our study is motivated by a simple theoretical model where short-lived customers are asked to evaluate the observed quality of the service provider's product by providing ratings to a reputation system. A reputation profile informs about the ratings of the last three sales. This profile gives new customers an indicator for the quality they have to expect and determines the sales price of the product. From the theoretical model we derive that the service provider's dichotomous quality decisions are independent of the reputation profile and depend only on the probabilities of receiving positive and negative ratings when providing low or high quality. However, when mapping our theoretical model to an experimental design we find that subjects in the role of the service provider deviate from optimal behavior and choose actions which are conditional on the current reputation profile. In addition, increasing the probability of a negative rating and decreasing the probability of a positive rating both do not affect strategic quality choices.