DP11220 | You Are Judged by the Company You Keep: Reputation Leverage in Vertically Related Markets

Publication Date

04/08/2016

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Abstract

This paper analyzes a mechanism through which a supplier of unknown quality can overcome its asymmetric information problem by selling via a reputable downstream …firm. The supplier’'s adverse-selection problem can be solved if the downstream fi…rm has established a reputation for delivering high quality vis-à-vis the supplier. The supplier may enter the market by initially renting the downstream fi…rm’s reputation. The downstream fi…rm may optimally source its input externally, even though sourcing internally would be better in terms of productive efficiency. Since an entrant in the downstream market may lack reputation, it may suffer from a reputational barrier to entry arising from higher input costs.