Reputation in an Internet Auction Market

I. INTRODUCTION Without transmission of credible information, asymmetries may lead to underproduction of goods or even market failure. Reputation mitigates inefficiencies associated with information asymmetries by providing an informative signal of quality. (1) The difficulty in quantifying reputation means that few studies can analyze empirically the role of reputation in markets. Our analysis of a quantified, market-observed measure of reputation provides direct evidence of the effect of a seller's reputation on the terms of a onetime real-world transaction, thereby contributing empirical support to a fundamental economic principle. This study empirically examines person-to-person transactions within the Internet market known as eBay. In this virtual market of unseen participants and products, buyers and sellers face the risks of repudiation, as the counter party may deny the agreement after the fact. Buyers assume risks associated with lack of seller integrity and asymmetric information about the particular product, as the buyer is typically required to send payment before the seller ships the product. In addition, for many eBay transactions, the cost of enforcing a contract is high relative to the transaction's value, resulting in a practical absence of legal enforcement. (2) By providing a history of trade execution information, eBay benefits market participants by reducing information asymmetries while achieving substantial transaction cost economies. Market participants relate personal experiences, which eBay uses to calculate a numerical reputation measure for each user. Market participants, in turn, can use this reputation measure to assess counter party risk and adjust bidding behavior accordingly. In a sample of 460 auctions held between January 1998 and July 1998, we find a positive relation between prices and eBay's reputation measure. Higher-reputation sellers experience higher auction prices, ceteris paribus. Our findings suggest that repeat players are rewarded for building reputation. Consistent with the belief that the high-reputation seller's value of future transactions outweighs the value of taking advantage of the buyer in the current transaction, buyers are willing to pay more to a higher-reputation seller. This article contributes to the literature not only by providing quantitative support of long-accepted reputation theories but also by illustrating the use of nontraditional markets as a natural laboratory for experiments. This article is an example of how a newly formed electronic market can provide the elements necessary for analytical research. We find that eBay transactions for this item exhibit characteristics similar to transactions in more conventional markets, namely (1) prices are higher when there is less quantity supplied (when fewer of the items are available the same day), (2) prices are lower during periods of lower demand (times less likely to have high traffic), (3) sellers with higher shipping and handling costs receive lower prices, and (4) sellers failing to provide information about shipping and handling fees (i.e., larger information asymmetries) receive fewer bids. Dramatic innovations in online market structure and increasing availability of online market data should enable researchers to examine directly other traditionally non-quantifiable economic ideas. This article is organized as follows. Section II describes how reputation can be used to facilitate transactions in the presence of asymmetric information. Section III describes the eBay market, summarizes the listing and bidding processes, and discusses the reputation mechanism for this market. Section IV presents the price and reputation descriptive statistics associated with a consistently auctioned item and reports the empirical findings of how this item's highest bid price varies with the level of the seller's reputation. We conclude in section V with a discussion of eBay's continued attempts to add value to the market through recent structural changes. …