Reputation Building and New Customers with Limited Information

Abstract

This paper shows the existence of potential customers with limited information generates reputation-building behavior of a firm in experience good markets even when consumers attain only noisy signals. If consumers experiences produce noisy sig- nals about firms effort to make products, firms might be mired in a moral-hazard problem to deceive their customers by exerting low effort, secretly. If potential customers only can observe a few recent outcomes, however, the firm cannot stop exerting high effort although current consumers become so convinced that the firm who trades with them is a good firm.