Reputation & Regulations: Evidence from eBay∗

Asymmetric information potentially leads to adverse selection, market inefficiency, and market failure. To mitigate these problems, market designers rely on different policies. Some adopt reputation policies in which they certify high-quality users and help them signal their quality; others provide marketplace guarantee policies and, in the process, prevent low-quality users from participating. We have a unique opportunity, on a single platform eBay, to evaluate the reputation mechanism and then to analyze possible efficiency gains in light of the introduction of the buyer protection program to the existing reputation mechanism. We demonstrate that eBay’s reputation signal raises the average sales price and the fraction of successful sales for certified sellers by 4% and 3%, respectively. Also we show that adding a buyer protection program provides an efficiency gain through two mechanisms that lead to fewer undesirable transactions: a reduction in moral hazard through an increase in sellers’ quality, and a reduction in adverse selection through higher exit rate for low-quality sellers. In addition, buyers’ payoffs are higher in these transactions due to buyer protection, leading to higher prices for all seller groups. The increase in prices is larger for low-reputation sellers, therefore markups for high-reputation sellers decrease. Finally, our estimates suggest this policy increases the total welfare by 4.7%, which demonstrates an efficiency gain as a result of added guarantee mechanism.