To mitigate inefficiencies arising from asymmetric information, some markets rely on government interventions, whereas others rely on reputation systems, warranties, or guarantees. This paper explores the impact of two mechanisms, namely, reputation badges and buyer protection programs, and their interaction on eBay’s marketplace. Adding buyer protection reduces the premium for the reputation badge and increases efficiency in the marketplace. These efficiency gains are achieved by reducing moral hazard through an increase in sellers´ quality and by reducing adverse selection through a higher exit rate for low-quality sellers. Our estimates suggest buyer protection increases the total welfare by 2.9%. This paper was accepted by Matt Shum, marketing.

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Markets prone to asymmetric information employ reputation mechanisms to address adverse selection and moral hazard. In this paper, we use a change in such a reputation mechanism to examine its effect on improving adverse selection and moral hazard. In May, 2008, eBay changed its reputation mechanism to prevent sellers from giving negative feedback to buyers. This change was intended to prevent sellers from retaliating against buyers who gave them negative feedback. We observe an improvement in the overall quality of the marketplace as a result of this change. We attribute 49%-77% of this improvement to reduced adverse selection as low-quality sellers exit the market or their market share drops, and the rest to a reduction in moral hazard as sellers improve the quality of their service.

Adverse selection among sellers on eBay is prevalent, as shown by many authors, and ever since Akerlof [1970], it is known that adverse selection can hinder trade. In this paper, I study how actors in a marketplace can introduce mechanisms to overcome adverse selection, and I focus on one mechanism employed by eBay: sellers' reputation. Using a unique data set that follows sellers on eBay over time, I show that reputation, according to various measures, is a major determinant of variations in the prices of homogeneous goods sold on eBay, in particular, for iPods. Inspired by this observation, I develop a model of firm dynamics where firms have heterogeneous qualities that are unobservable by consumers. Reputation is used as a signal of private information to buyers in order to improve allocations. I structurally estimate this model to uncover deep parameters of buyers' utility and sellers' costs as well as sellers' unobservable qualities. The estimated model suggests that reputation has a positive effect on the expected profits of high quality sellers and their market shares. I perform a counterfactual to establish the value of reputation. Removing reputation mechanisms put in place by eBay significantly increases the market share of low quality sellers and decreases the market share of high quality sellers. This will lowers the price in the market which as a result lowers the quantity of items sold in the market. Finally, buyers' welfare is significantly improved as a result of the reputation mechanism. * I am indebted to Patrick Bajari and Thomas Holmes for valuable advice. I would also like to thank