Certifying Firms; Allen Vong (University of Macau)

Abstract

A firm serves a sequence of consumers who are uncertain about the firm's competence and effort to provide quality. I study the design of certification ratings that give a competent firm commitment power for quality provision. I show that the certifier faces a novel tension between giving consumers information and giving the firm commitment power. I construct a rating system that resolves this tension. The competent firm receives a top rating upon consecutively many good quality outcomes. Upon one bad outcome, it is punished by a low rating for a long expected duration, and each additional bad outcome extends this duration.