When you’re selling goods, being a Certifier is enough—you can vouch for the quality of the Prada handbag or the Ben Franklin-era sailboat because these products’ quality is not going to change before it reaches your buyer. Not so with services: regardless of service providers’ underlying ability, they can decide how much effort to put in and how honestly to conduct business. Sussing out hidden information about sellers, as Certifiers do, won’t protect buyers from shirking and cheating, problems that can come up after buyers sign on the dotted line. These problems of shirking and cheating, variously called moral hazard, postcontractual opportunism, or hidden action1—are especially acute when a player’s actions are hidden and when buyers and sellers don’t have an ongoing relationship. An ongoing relationship can protect against such problems, as long as the future value of the relationship is higher than the gains from cheating or shirking today. The lack of such a relationship, on the other hand, gives players an incentive to act opportunistically. This isn’t to say that everybody or even most people will cheat or shirk—but even if there are only a few bad apples, would-be trading partners don’t necessarily know who they are. For buyers and sellers to trust each other under those conditions, they need to know that someone—a third party— will reliably and fairly enforce the contract.
KeywordsGood Behavior Reputation System Loyalty Program Local Bank Private Enforcement
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- 1.This term comes from the economist Kenneth Arrow. Hidden information can lead to the problem of adverse selection (the lemons problem), while hidden action can lead to moral hazard. For a discussion of hidden information (also called hidden characteristics) and hidden action, see Mark Bergen, Shantanu Dutta, and Orville C. Walker Jr., “Agency Relationships in Marketing: A Review of the Implications and Applications of Agency,” Journal of Marketing 56, no. 3 (July 1992): 1–24.CrossRefGoogle Scholar
- 3.One cattle breeder in Palermo told Gambetta, “When the butcher comes to me to buy an animal, he knows that I want to cheat him. But I know that he wants to cheat me.” This mutual distrust would prevent the two from doing business. “Thus we need, say, Peppe [that is, a third party] to make us agree. And we both pay Peppe a percentage of the deal.” Peppe acts as the Enforcer. See Diego Gambetta, The Sicilian Mafia: The Business of Private Protection (Cambridge, MA: Harvard University Press, 1993), 15.Google Scholar
- 7.The most complete discussion of this argument is by Ara Norenzayan, Big Gods: How Religion Transformed Cooperation and Conflict (Princeton: Princeton University Press, 2013).Google Scholar
- 12.Note the difference between pseudonyinity and anonymity; by giving users the opportunity to establish a track record under a given pseudonym, a system that allows pseudonyms combines the best features of anonymity with the best features of real names. For a discussion of some of the economics of pseudonyms, see Eric J. Friedman and Paul Resnick, “The Social Cost of Cheap Pseudonyms,” Journal of Economics and Management Strategy 10, no. 2 (Summer 2001): 173–99.CrossRefGoogle Scholar
- 17.This is a central argument of a book chapter that examines enforcement activities by middlemen as seemingly varied as the Roppongi Hills shopping center in Tokyo and the Harvard Business School. See Kevin J. Boudreau and Andrei Hagiu, “Platform Rules: Multi-Sided Platforms as Regulators,” in Annabelle Gawer (ed.), Platforms, Markets and Innovation (Northampton, MA: Edward Elgar Publishing, 2009).Google Scholar
- 35.This is the notion of a “psychological contract violation.” Research on such violations in online marketplaces finds that when a seller lets down a buyer, the buyer tends to sever the relationship not only with that buyer but also with the marketplace as a whole. See Paul A. Pavlou and David Gefen, “Psychological Contract Violation in Online Marketplaces: Antecedents, Consequences, and Moderating Role,” Information Systems Research 16, no. 4 (2005): 272–99.CrossRefGoogle Scholar
- 38.The phrase “shadow of the future” was coined by the political scientist Robert Axelrod. See Robert Axelrod, The Evolution of Cooperation (New York: Basic Books, 1984).Google Scholar