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Quality Sorting and Networking: Evidence from the Advertising Agency Industry

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  • Mohammad Arzaghi

Abstract

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.

Suggested Citation

  • Mohammad Arzaghi, 2005. "Quality Sorting and Networking: Evidence from the Advertising Agency Industry," Working Papers 05-16, Center for Economic Studies, U.S. Census Bureau.
  • Handle: RePEc:cen:wpaper:05-16
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    File URL: https://www2.census.gov/ces/wp/2005/CES-WP-05-16.pdf
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Mohammad Arzaghi & J. Vernon Henderson, 2008. "Networking off Madison Avenue," Review of Economic Studies, Oxford University Press, vol. 75(4), pages 1011-1038.
    2. Frank Limehouse & Robert McCormick, 2011. "Impacts of Central Business District Location: A Hedonic Analysis of Legal Service Establishments," Working Papers 11-21, Center for Economic Studies, U.S. Census Bureau.
    3. Vernon Henderson, J., 2007. "Understanding knowledge spillovers," Regional Science and Urban Economics, Elsevier, vol. 37(4), pages 497-508, July.

    More about this item

    Keywords

    Advertising; Agglomeration; Industrial Concentration; Business Services; Discrete Choice; Knowledge Spillovers; Learning; Location Decision; Poisson Regression; Nested Logit; Screening; Separating Equilibrium; Sorting;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance
    • L84 - Industrial Organization - - Industry Studies: Services - - - Personal, Professional, and Business Services
    • M37 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Marketing and Advertising - - - Advertising
    • R12 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General Regional Economics - - - Size and Spatial Distributions of Regional Economic Activity; Interregional Trade (economic geography)
    • R30 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - General

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