Promoting Trust in E-commerce: Theory and Evidence∗

Economists have long recognized the importance of trust in trade and economic development, but few empirical studies address how trust is maintained and enhanced. We set up a rational expectation model that allows the marketplace to boost trust via buyer insurance or seller penalty. The model shows that buyer insurance will reduce seller trustworthiness in equilibrium because insurance increases buyer willingness to trade and therefore invites strategic sellers to enter and cheat. In contrast, penalty on cheating sellers can enhance seller trustworthiness in equilibrium. Using transaction-level data from Eachnet.com (an eBay equivalence of China), we show that more generous buyer insurance leads more sellers to cheat. In comparison, seller reputation helps maintain seller honesty and the introduction of warning system makes sellers more trustworthy. Consistent with the theory, these findings suggest that trust-promoting policies may not be effective if they only aim at buyer trusting without incentives to improve trustworthiness. ∗We are grateful for the generous provision of data from Eachnet.com. Comments from Lixin Ye, Xiaohong Chen, Colin Xu and attendants at the 2009 Industrial Organization and Management Strategy at Tsinghua University and the seminar of Peking University are deeply appreciated. All errors are ours. †Guanghua School of Management and IEPR, Peking University ‡University of Maryland and NBER §Guanghua School of Management, Peking University ¶Guanghua School of Management and IEPR, Peking University