Sponsored search mechanisms, where advertisers bid for better placement in the listing of search results on search services such as Yahoo! and Google integrate the benefits of online search with advertising, and have emerged as the dominant revenue model for online search engines. Interestingly, Yahoo! and Google employ different mechanisms to determine the placement of bidders' advertisements. This provides an unprecedented opportunity to not only test some of the predictions of earlier research relating advertiser's quality and their advertising intensity, in the online setting, but to also examine whether intervention by the search intermediary impacts the performance of these markets. Using data from online sponsored search auctions this study examines whether the relationship between advertisers' quality and their advertising intensity varies across product categories as well as across the different search mechanisms. Our results highlight significant and interesting differences in the quality-advertising relationships across the two market mechanisms as well as across products characterized by differing degrees of quality uncertainty.

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Online sponsored search advertising has emerged as the dominant online advertising format largely because of their pay-for-performance nature, wherein advertising expenditures are closely tied to outcomes. While the pay-for-performance format substantially reduces the wastage incurred by advertisers compared to traditional pay-per-exposure advertising formats, the reduction of such wastage also carries the risk of reducing the signaling properties of advertising. Lacking a separating equilibrium, low-quality firms in these markets may be able to mimic the advertising strategies of high-quality firms. This study examines this issue in the context of online sponsored search markets. Using data gathered from sponsored search auctions for keywords in a market without intervention by the intermediary, we find evidence of adverse selection for products/services characterized by high uncertainty. On the other hand, there is no evidence of adverse selection for similar products in a regulated sponsored search market, suggesting that intervention by the search intermediary can have a significant impact on market outcomes and consumer welfare.

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Practice- and Policy-Oriented Abstract