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Final Report Summary - RMM (Reputation and Market Microstructure)

The main motivation behind this project is the need for a comprehensive understanding of the effects of reputation on market outcome and structure when negotiation and/or price search are main ingredients. Although it is a growing area of research, the current literature does not have well-established theoretical predictions. In this respect, outcomes of this project will constitute significant contributions to the current literature.
The main message in reputation literature is that in a strategic environment, a player who has the opportunity to mimic a commitment type and build reputation on resolve will be advantaged especially when the other parties are lack of this opportunity. However, the literature is silent about whether reputation is so advantageous in all circumstances. For example, does reputation building benefit the sellers and buyers when there is a strong competition among them? Does perceived as being a commitment type always advantageous? Does reputation provide leverage to a negotiator whose bargaining power is weaker in an environment where the rival also has the opportunity to build reputation? This project aimed to answer these and similar questions in various setups.
There are numerous important outcomes achieved in this project. The most important one is that under reputational concerns, equilibrium outcomes of a competitive market may not be Walrasian. In particular, even when the market is (almost) frictionless, the ability of committing to a specific share, the opportunity of building reputation about inflexibility and the anxiety to preserve their reputation can provide significant market power to the players that have no market power in the absence of reputational concerns. Therefore, the role of reputation is substantial, and so ignoring its presence would be severely misleading. That suggests the ability to build reputation gives significant leverage to the weak (long) side of the market. More strikingly, if the information flow between the players is not perfect (which usually is the case in many markets), the weak side of the market can benefit from reputation even more. Moreover, when the weak side of the market competes in an auction-like environment, where the buyers simultaneously bid their prices and the monopolist seller receives the entire surplus, the ability of building reputation through negotiation would give the buyers significant market power. Dr. Ozyurt also shows that in a competitive environment being perceived as a resolved type would be disadvantageous. Therefore, “excessive reputation” on obstinacy would also be a disadvantage, just like lack of reputation is so in many settings.
In addition, Dr. Ozyurt investigates the impacts of reputation on a monopolistic market and shows that reputational concerns may significantly benefit the consumers even though there is no competition in the supply side. The analyses also show that the monopolist’s pricing strategy will depend upon the consumers’ awareness about the monopolist’s pricing agreements with the other buyers. More formally, if the monopolist operates in a dynamic market where there is a flow of consumers entering to the market sequentially, then the monopoly price can be sustained in equilibrium if the monopolist can commit to reveal its sales agreement with every single customer. However, if the consumers cannot observe the monopolist’s previous actions, then the monopoly price is not consistent with equilibrium.

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Sabanci University
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