A Learning Theory of Referrals

Abstract

Many service industries, including the medical and legal professions in some countries, display a gated structure. Rather than approaching a …nal producer directly, a consumer will …rst seek a referral from an intermediary. Such an industry structure might help to alleviate adverse selection problems between parties that interact infrequently. Intermediaries aggregate many short-run transactions between various consumers and a particular producer. As such, they might be able to learn a producer's level of pro…ciency more rapidly than an individual consumer. However, the presence of a positive information externality means that too few consumers will seek a referral. As such, some form of regulation to encourage consumers to seek a referral might be warranted.

A Shirking Theory of Referrals

“…While this paper focuses solely on a potential moral hazard problem in the treatment market, a potential adverse selection problem in the treatment market is considered in a companion paper (Eldridge[20]). 1 0 If the equilibrium prices for referrals and treatment are positive, this assumption is not needed.…”

A Shirking Theory of Referrals

“…There is a related literature that uses reputation to explain the existence of institutions, primarily …rms 18 , unions 19 and retailers 20 . This literature builds on earlier work examining the extent to which reputation e¤ects and market forces provide an incentive for parties to exert e¤ort when such e¤ort is costly and unobservable.…”