Credence Goods in Markets with Collective Reputation: Nature of Equilibria and the Value of Certification

Fraud can cause markets for credence goods to collapse, but collective reputation has been suggested as a potential solution, especially when buyer valuations for quality are high. We develop a discrete model of a market for label credence goods and provide conditions for no-fraud equilibria based on collective reputation. We identify conditions under which all equilibria may be asymmetric or involve mixed strategies and hence sellers may face coordination problems. Our analysis suggests such coordination problems are the greatest when the size of the high-quality market is approximately half of the overall market (that incorporates both high- and low-quality goods), in the absence of any focal point or coordination device. Concerning certification, we find that it may not be particularly useful when buyer valuations for credence attributes are high under a well-performing collective reputation regime and a relatively small-sized low-quality market. However, we also determine that certification may serve its purpose the most when buyer valuations for credence attributes are low (contrary to standard intuition) and/or the size of the high-quality market is around half of the overall market (i.e., the high- and low-quality markets are of approximately equal size). Finally, our results indirectly indicate that agencies/NGOs concerned about fraudulent behavior may focus their attention on markets where heterogenous firms enjoy collective reputation.