Using trust and reputation in government-to-business relationships: the authorized economic operator (AEO) as an example

This paper regards the government-to-business (G2B) relationship as a principal/agent relationship with asymmetric information. It brings about monitoring costs for the government, bonding costs for the businesses and a residual loss for society. In the case of government regulation these costs can be seen as transaction costs, which can be minimized in a trust-based design of the regulation. We illustrate this in a case study of authorized economic operator (AEO) certification in the Netherlands. Being certified reduces Customs costs for businesses and moreover enhances their reputation of being a trustworthy trading partner. The costs of the loss of such valuable reputation act as a trigger mechanism in the repeated game of trust which is the solution to the fundamental problem of exchange of information in this G2B relationship. Hereto it is essential that the AEO certification and its reputation effect are sufficiently valuable so that certified companies are not tempted to cheat and that there is no adverse selection where only ‘lemon’ companies become certified. That is why governments should strongly promote AEO certification in order to exploit the network externalities and make it a worldwide standard. The use of IT and risk assessments can be helpful in this institutionalizing of AEO certification.