Reputation-Driven Industry Dynamics
Abstract: This paper studies the entry-exit dynamics of an experience good industry. Consumers observe noisy signals of past ﬁrm behavior and hold common beliefs regarding their types, or reputations. There is a small chance that ﬁrms may independently and unobservably be exogenously replaced. The market is perfectly competitive: entry is free, and all participants are price-takers. Entrants have an endogenous reputation uE. In the steady-state equilibrium, uE is the lowest reputation among active ﬁrms: ﬁrms that have done poorly leave the market, and some re-enter under a new name. This endogenous replacement of names drives the industry dynamics. In particular, exit probabilities are higher for younger ﬁrms, for inept ﬁrms, and for ﬁrms with worse reputations. Competent ﬁrms have stochastically larger reputations than inept ﬁrms both in the population as a whole and within each cohort, and thus are able to live longer and charge higher prices.
Keywords: reputation, industry dynamics, free entry, exit and entry rates
JEL: C7, D8, L1