Seller reputation, information signals, and prices for heterogeneous coins on eBay.

• Author: Melnik, Mikhail I.

1. Introduction

   It has long been recognized that a market with asymmetrically distributed information may experience a market failure (Akerlof 1970). This insight is especially relevant for the rapidly expanding area of online commerce, where information is not uniformly distributed between the buyer and the seller. In online transactions, the buyer cannot examine the product directly and has to rely upon the seller's description of the product and upon the accuracy of any such description; the buyer also has to rely upon the seller for compliance with the terms of transaction. However, it may be the case that the past reputation of the seller may act as a mechanism by which information about the current behavior of the seller can be transmitted to the buyer. In such a setting, a seller's reputation may well reduce information asymmetries and thereby allow the market to function. For heterogeneous goods in particular, where product characteristics vary significantly from one good to another and where there is much uncertainty about the quality of the goods, it seems likely that a seller's reputation and other information measures may play an especially important role in persuading buyers to participate in a market. In this paper we examine the impact of seller reputation and various information variables on buyers' willingness to pay for a heterogeneous good sold via Interact auctions, using U.S. silver Morgan dollar coins in "Almost Uncirculated" condition that are sold on eBay. We find consistent evidence that a seller's overall reputation has a positive and statistically significant impact on a buyer's willingness to pay, and that negative comments about a seller often have a negative impact on price. Importantly, these reputational effects tend to increase in importance when there is more uncertainty about the quality of the coin.

   With some exceptions (McDonald and Slawson 2002), theoretical models have typically generated a positive relationship between the reputation of the seller and the resulting price of the transaction, in large part because the seller's reputation is a proxy for quality characteristics that are unobserved prior to the completion of the transaction (Klein and Leffler 1981; Shapiro 1983; Allen 1984; Houser and Wooders 2000). Experimental findings have also tended to support the theoretical conclusions (DeJong, Forsythe, and Lundholm 1985; Miller and Plott 1985; Camerer and Weigelt 1988; Holt and Sherman 1990). However, until recently empirical analysis of this issue has been limited because of the absence of reliable measures of reputation.

   The rapid growth of e-commerce, in combination with the establishment of reputation measures by many consumer-to-consumer Web sites, has now enabled researchers to analyze the issue empirically. (1) Online consumer-to-consumer auction Web sites such as eBay.com, Yahoo.com, and Amazon.com provide a unique opportunity to study the effects of a seller's reputation in the online environment. (2) The most recognized of these Web sites is eBay. It has experienced rapid growth in its user base since its birth in September 1995, and by April 2005 its confirmed registered user base had surpassed 147 million (including 60 million active users). (3) These Web sites assume no responsibility for the items listed on their sites and simply act as auctioneers. The seller assumes full responsibility for the description of the product and for the compliance with the terms of transaction. Of special note, in almost all instances the shipment of the product occurs after the payment is received so the buyer assumes a risk when sending a payment. (4) For instance, the seller may ship a damaged item, may not correctly describe the product in the auction, or may not send the item at all.

   However, most online auction Web sites, including eBay, have set up a mechanism that allows buyers to rate the seller and to post short comments about their experience with the seller following the completion of their transaction. (5) The feedback system used by eBay enables the buyer to classify any comment about the seller as positive, negative, or neutral, and the difference between the number of positive and negative comments left by unique buyers constitutes the seller's rating. This rating is then displayed prominently on every auction presented by this seller. Each visitor to the seller's auction can also examine the rating in more detail, including the breakdown of the rating in terms of its positive, negative, and neutral comments. The comments themselves are also available, and vary from praises like "Excellent seller, friendly communications, Thank You!" to warnings aimed at other perspective buyers, such as "Collected payment, never shipped the item, avoid this seller." (6) If information on the seller's reputation can reduce information asymmetries, then such mechanisms may play an important role in facilitating the growth of these Web sites.

   Indeed, anecdotal evidence suggests that reputation matters in online auctions. For example, an individual seller brought a $2.6 million suit against both eBay.com and a buyer for negative comments posted by the buyer about the quality of the services provided by the seller (Grace v. eBay, Inc., now settled). More generally, several empirical studies have used data generated by online auction Web sites, including these various measures of reputation, to examine the impact of a seller's reputation and other informational variables on buyers' willingness to pay for auction goods. Although the magnitudes of the impacts of reputation measures vary significantly across these studies, in part due to the variety in the choices of the products across these studies and in part due to the choices of control variables, the emerging consensus is that there exists a statistically significant relationship between the seller's reputation and the buyer's willingness to pay. Houser and Wooders (2000), Dewan and Hsu (2001), Kalyanam and McIntyre (2001), McDonald and Slawson (2002), and Melnik and Alm (2002) all find a positive and statistically significant relationship between the seller's overall reputation and the buyers' willingness to pay; these studies also sometimes find that negative reputation indicators (e.g., the number of complaints) have a negative and statistically significant impact on willingness to pay. (7) Other empirical evidence also suggests that the overall reputation of the seller may not be statistically significant, but that negative reputation plays an important role in the determination of the buyer's willingness to pay (Lucking-Reiley et al. 1999). (8)

   One of the key aspects in all of these studies is the choice of the product for such analysis. Almost all of the existing literature on the effects of reputation in online auctions is based on homogeneous, or standardized, goods. For example, Lucking-Reiley et al. (1999) examine U.S. Indian head pennies with grades in near mint state, Houser and Wooders (2000) examine willingness to pay for a Pentium III, 500-MHz processor, Resnick and Zeckhouser (2002) use Rio MP3 digital audio players and Britannia Beanie Babies in mint condition, and Melnik and Alm (2002) choose a mint condition U.S. $5 coin. (9) The selection of a homogeneous good allows the researcher to better control for the characteristics of the product (e.g., its book value), and so to better capture the signaling aspects of the seller's reputation. Nevertheless, the role of the seller's reputation in such a setting seems likely to be somewhat limited because there is little if any variation in the quality of a homogeneous good. In contrast, a heterogeneous good is one for which there remain characteristics of the good that are uncertain for the buyer but that may well affect the buyer's willingness to pay, even in the presence of verifiable components of the good's description (e.g., a visual scan or a grade from a professional grading service). For such goods, a seller-provided description of the product may become more important to a buyer unable to determine the precise quality of the auctioned good, so reputation may play a stronger role with a heterogeneous good than with a homogeneous good; seller reputation may also give some indication of the reliability of the seller in providing the correct description of those item-specific characteristics. As noted by Bajari and Hortacsu (2004), "[w]hen the item is ... used, and has uncertain quality, such as a hard-to-appraise antique, reputation might play a more important role." However, this notion is largely untested. (10)

   In this paper we examine buyers' willingness to pay for a heterogeneous product (U.S. silver Morgan dollar coins in "Almost Uncirculated" condition), using data collected from eBay.com. We estimate the impact of the seller's reputation on buyers' willingness to pay for these coins by including the Web site's own measures of the seller's reputation. We also estimate the impact of a variety of other informational variables and auction characteristics that allow us to vary the degree of uncertainty about item-specific characteristics, including separate variables for the presence or absence of visual scans of the coin and for certification of the coin's quality by a credible third party. We find that a seller's overall reputation typically has a positive and statistically significant effect on the willingness of buyers to pay for the good, a result that is robust across a wide range of alternative specifications and alternative subsets of our data. A negative rating for a seller is also often shown to have an important--and negative--impact on willingness to pay. Importantly, however, these reputational effects tend to vary with the degree of uncertainty about the quality of the good. "Certified" coins are likely to have little uncertainty about item-specific characteristics because the quality of the coin is examined by a reliable third...