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Quality Sorting and Networking: Evidence from the Advertising Agency Industry

  • Mohammad Arzaghi

This paper provides a model of knowledge sharing and networking among single unit advertising agencies and investigates the implications of this model in the presence of heterogeneity in agencies’ quality. In a stylized screening model, we show that, under a modest set of assumptions, the separation outcome is a Pareto-undominated Nash equilibrium. That is, high quality agencies locate themselves in a high wage and rent area to sift out low quality agencies and guarantee their network quality. We identify a necessary condition for the separating equilibrium to exist and to reject the pooling equilibrium even in the presence of agglomeration economies from networking. We derive the maximum profit of an agency and show the condition has a directly testable implication in the empirical specification of the agency’s profit function. We use a sample of movers—existing agencies that relocate among urban areas—in order to extract a predetermined measure of their quality prior to relocation. We estimate the parameters of the profit function, using the Census confidential establishment-level data, and show that the necessary condition for separation is met and that there is strong separation and sorting on quality among agencies in their location decisions.

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Paper provided by Center for Economic Studies, U.S. Census Bureau in its series Working Papers with number 05-16.

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Length: 39 pages
Date of creation: Oct 2005
Date of revision:
Handle: RePEc:cen:wpaper:05-16
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