Dynamic Certification, Reputation for Quality and Industry Standard

Dynamic Certification, Reputation for Quality and Industry Standard

September 15,2016Working Paper No. 3371

We study firm’s incentives to build and maintain reputation for quality, when quality is persistent and can be certified at a cost. We characterize all Markov-perfect equilibria where the timing of certification and investment depend only on firm’s reputation. They vary in frequency of certification and payoffs, including low payoffs due to over-certification trap. We contrast the MPEs with the highest-payoff equilibria. We interpret that industry certification standards can help firms coordinate on such good equilibria. The optimal standard allows firms to maintain high quality forever, once it is reached for the first time, and it can be either lenient or harsh - endowing firms with multiple or one chance to improve and certify quality.

Keywords
Voluntary Disclosure, Certification, dynamic games, Optimal Stopping