Reputation and Product Recalls

September 2016
Boyan Jovanovic

We model intangible capital as a property of equilibrium play between a seller and buyers. A seller continually meets short-lived buyers. A low-effort signal occurs periodically. Its arrival triggers a reduction in prices that then gradually rise until the next low-effort signal and so on repeatedly. We then fit the model to data on product recalls and on stock-price reductions following such recalls. We estimate the model by constrained maximum likelihood. We then use the parameter estimates to compare welfare across several types of equilibria that the model gives rise to. We conclude that contract incompleteness leads to large welfare losses in this area.